The photos of so-called ghost cities do not show a true image of the real estate market outside the first-tier cities

Ordos in Inner Mongolia autonomous region and Changzhou in Jiangsu province have become synonymous with China's supposed housing market excesses. Pictures of parts of these towns show desolate apartment blocks and deserted streets, with accompanying stories of real estate market collapses. However, these pictures do not tell the whole story. Our research shows that Ordos and Changzhou are exceptions rather than rule for China's 200 or so small lower-tier cities.

Understanding what is going on in the smaller cities is becoming increasingly critical in assessing the impact of the real estate sector on China's overall economic growth this year. We examined the limited public data available for the real estate market and found that the situation in smaller cities is not nearly as bad as the situation in Ordos would suggest.

Our first indicator is the inventory level of available houses in the 30 largest cities. This is calculated by deducting apartment sales from land sales in prior years. This arguably simple model has worked well in predicting future apartment prices in first, second and third-tier cities since we developed it a couple of years ago.

For instance, in 2012, the model clearly signaled that apartment prices in first tier-cities were likely to rise in 2013, given very limited projected supply. As we stand today, the inventories in first-tier cities have to fall further in the second half of the year. Bolstering the reliability of the model, cities with higher past inventory levels - according to our estimates - such as Tianjin, Wuhan, Qingdao, experienced limited price gains or even price declines in the subsequent quarters while those with lower inventories such as Shenzhen, Fuzhou and Nanchang saw higher prices.

In the same vein, the model suggested that supply in second-tier cities was sufficient to prevent prices from rising as aggressively, and that price inflation in some second-tier cities, such as Nanjing and Xiamen, does not appear to be a problem. Inventories in second-tier cities, usually the municipalities in well-developed provinces, remain elevated, equivalent to about 15 to 17 months of sales. This suggests that price pressures in these cities will be limited for another year or so.

In the third-tier cities, such as Changsha, Fuzhou, Shenyang, Nanchang, Hefei, Zhengzhou, Changchun, Haikou, Guiyang, and Baotou, inventories do not appear to be a problem. After peaking between the second half of 2011 and early 2012, inventories in the third-tier cities gradually fell to about five to six months worth of sales by the second quarter this year.

Thus, our inventory model suggests that China's housing supply problem may be concentrated in the second-tier cities. The rule of "the smaller the city, the worse the inventory problem" certainly does not appear to hold, at least according to data for the 30 largest cities.

Our second set of data, provided by consultancy company Soufun, covers 40 cities. These cities include four first-tier cities, six second-tier cities, and five third-tier cities, plus 25 "new" lower-tier cities. The figures include apartments that have been authorized for sale or pre-sale - those which have received the "for sale" license - and includes both those under construction and those completed.

The average monthly number of homes for sale in third-tier cities has been falling this year, to 3.4 million as of June, while the monthly floor space available for sale in lower-tier cities below tier three has stayed almost flat for the past 18 months. In other words, the small cities appear to be stuck with inventory, though we do not see evidence of rising inventories here.

However, one cannot rule out the possibility that apartments are being kept off the market to avoid unnervingly high inventory numbers. Developers may postpone applying for the final sales approval if they sense the market cannot absorb their stock.

Finally, we have land purchase figures, the only available data that cover more than 300 cities. The land markets in the small cities appear to be recovering well, annual sales growth accelerated to 50 percent in May and June, after bottoming out in early 2012. The land market suggests that developers are seeking to add to their land banks in smaller cities, implying that oversupply is not a widespread problem there.

China has some 650 cities of which probably around 300 drive the national residential real-estate market. In such a large market, all kinds of events and activity will occur, including situations like Ordos. However, despite the ghost town stories, the picture in smaller cities looks resilient.

It is true inventories are high in some cities - and this will concern developers there - but, a closer study of the land market activity suggests that developers have enough cash and confidence to buy more land and the floor space available for sale in lower-tier cities suggests stable market dynamics. This portrays a healthier picture of China's property market than the poster towns of Inner Mongolia.

Lan Shen is an economist and Stephen Green is head of Greater China Research at Standard Chartered Bank.

(China Daily USA 08/06/2013 page11)