Smaller cities key to nationwide real estate policy

China's housing market is active again. After a slump in 2014 and most of 2015, housing starts are rising, responding to an earlier recovery in housing sales that is also showing in housing price increases. The renewed enthusiasm in real estate has been key in supporting GDP growth and heavy industry sectors, such as steel.

But the recovery is uneven, with signs of a price bubble emerging in some, mostly large, cities, while inventories remain high in others. Property prices in Tier-1 cities and some Tier-2 ones have risen sharply since early 2015. In Shenzhen and Shanghai, they were around 38 percent higher on average in August than a year ago. The rally has also spilled over to the land market, with prices at auctions breaking new records. Meanwhile, mortgage lending is surging and a record share of housing sales is financed by lending. That said, household balance sheets remain reasonably healthy overall and loan-to-value ratios are still moderate.

At the same time, many Tier-3 and Tier-4 cities are still struggling to digest sizeable inventories of unsold housing. Although housing sales also recovered in smaller cities, bringing down stocks, they still remain elevated in comparison to historical high levels. Indeed, the demand supply situation in most of the smaller cities remains very different from that of the large ones, with many developers having over-built without realistic assessments of demand prospects.