Conventional supply and demand dynamics suggest that when demand for housing declines, so should prices. But in China, where local government balance sheets are uniquely intertwined with the property market, stable land prices may be important for local governments to roll over existing debt and secure new debt financing. During the pandemic, China saw a massive drop in housing demand, yet prices did not fall in parallel. What happened?  

The data. The researchers analyzed trends in land and housing sales volume and prices across 173 Chinese cities from 2017 to 2022, comparing cities with different levels of fiscal dependence on land sales and land-backed debt financing over time. The dataset includes 104,070 land transactions from the China Land Market website and city-level new housing unit transactions from the China Real Estate Index System (CREIS). Economic indicators, including GDP growth, inflation, and fiscal deficits, come from the Qiyeyujingtong and China Stock Market & Accounting Research (CSMAR) databases, which track financial and debt metrics across Chinese cities. To analyze the link between real estate prices and financial markets, the researchers gathered information on bond market characteristics from the Wind Economic Database. Annual housing sales and developer balance sheets come from CREIS.

Land sales and local government finance. In China, land is state-owned, but “land usage rights” are transacted much like land sales. Local governments face the challenge of funding infrastructure and other expenditures without collecting property or other local taxes common in advanced economies. Instead, they rely on land sales and land-based financing for revenue. Since budget laws restrict direct local government borrowing from banks, localities have created “local government financing vehicles” (LGFVs). LGFVs are state-owned entities that use land as collateral to borrow from banks and issue bonds. This “off-balance-sheet debt” surged in the 2010s as Beijing tacitly approved its use for stimulus-driven development after the global financial crisis. Local governments, however, faced increased financial pressure during the pandemic due to slowing economic growth and the high costs of enforcing strict health protocols. The researchers evaluated whether local governments intervened in land markets to stabilize land prices given their critical role in rolling over debt and securing new financing. Remarkably, land prices kept rising during this period. Even in 2022 when zero-COVID policies were most stringent, prices rose 1.2%, reaching 16.4% higher than in 2019. A similar divergence in the sales volume and prices for housing also occurred in this period: in 2022, housing sales were down 30.4% relative to 2019, but prices were 7.1% higher. 

Land price and sales growth (2017–2022) 

Higher fiscal dependence on land sales means disproportionally higher land prices. In 2019, 38.1% of local government revenue came from land sales. The analysis shows that cities with greater fiscal dependence on land sales prior to the pandemic saw a larger increase in land prices during 2021 and 2022, with a one standard deviation increase in land dependence leading to a 5.3% rise in land prices in 2022. Cities with higher LGFV debt burdens also saw higher land prices than comparable but less leveraged cities.   

Housing price and sales growth (2017–2022)

LGFVs serve as agents for propping up prices. Before the pandemic, LGFVs acquired land at a steady rate each year. However, their land purchases increased by 3.6% in 2020, 6.1% in 2021, and a striking 22.4% in 2022 relative to 2019, despite weakening private demand for housing. This evidence suggests that LGFVs stepped in to buy more land to keep land prices stable during the pandemic era downturn.

At the same time, LGFV debt levels (leverage) also increased. Compared to 2019, LGFV leverage grew by 1.2% in 2020, 3.1% in 2021, and 4.1% in 2022, reflecting their aggressive land acquisitions during the pandemic. LGFVs also purchased more land at higher prices than non-LGVFs, suggesting that governments actively managed land prices to protect their debt financing strategies. 

Manipulated property prices help some local firms, hurt developers. Local government efforts to prop up land prices had mixed impacts on local business. On one hand, firms using land with artificially high prices as collateral for bank loans saw lower interest rates on their loans. On the other hand, the higher prices meant fewer buyers for real estate, which hurt developers that needed to sell housing to repay their debt. Specifically, in cities with local governments that were more fiscally dependent on land sales prior to the pandemic, a one standard deviation increase in land dependence was correlated with a 15.5% decrease in housing sales value for developers in 2022. In this way, price management by local governments appears to have prevented developers from lowering housing prices to sustain demand, furthering the financial distress of developers, as evidenced by high-profile debt defaults by real estate firms, including Evergrande, Country Garden, and Sino-Ocean.   

Local government fiscal fix highlights deeper problem. Driven by their dependence on land sales and land-backed debt for fiscal financing, local governments appear to have played a crucial role in shaping China’s real estate market. While past research has pointed to overbuilding by developers and speculative homebuying, this study emphasizes the role of local governments in driving excessive construction. As financial institutions extend debt secured by land values, local governments are further compelled to manipulate land and housing prices, exacerbating China’s real estate challenges. The authors conclude that bailing out distressed developers may provide temporary relief, but a long-term solution requires restructuring local government finances to reduce reliance on land sales and land-collateralized debt as primary funding sources.