China's real-estate slump is about to get worse

• Capital Economics says an "unavoidable structural decline" in China's property sector has just begun.
• Property sales and starts have collapsed, and construction could fall by half in the years ahead.
• Beijing has taken some steps to boost construction, but that may not last.

Several years in, China's prolonged real-estate slump has been well documented, but the landscape may be about to deteriorate further as construction enters a deeper correction, Capital Economics said in a note Wednesday.

Property sales and starts have tumbled, but Beijing has been able to support construction activity by ramping up investment in the sector and pressuring developers to complete their work.

"A variety of approaches suggest that a sustainable level of residential construction activity is about half of what's underway today, given China's demographics and its need to replace aging housing stock," strategists wrote, adding that "property construction still has a long way to fall."

Since peaking in 2022, floor area under construction has slipped by a mere 3%, as shown in the chart below.

Sizable infrastructure support has prevented construction from falling as much as anticipated. Investment in infrastructure has expanded at a "reasonably rapid rate," the Capital Economics team said. It's plausible, in their view, that construction output would have softened further without it.

"The drag from the unavoidable structural decline in China's property sector has only just begun," the strategists said.

Meanwhile, Beijing's pressure on builders seems to have worked so far. Last year marked the first year since 1997 that reported residential property completions outpaced project starts.

As Capital Economics highlighted, real-estate construction remains an opaque measurement in China. Much of the country's property data omits details that could help paint a clearer picture or explain the apparent lack of weakness in new building.

Construction's impact on economic growth

Real estate contributed roughly 1.5 percentage points to China's annual economic growth before the contraction began, the research firm said. But that weakness has so far come without a meaningful drop in construction.

When similar steep drop-offs have occurred in other countries, they've usually taken place over three or four years. In Capital Economics' view, Beijing will drag it out so that it doesn't fully materialize until 2030.

That ultimately could crimp China's GDP by about 1% across the rest of the decade compared with an outlook without as dramatic a construction slump.

The strategists said that despite China's efforts in sector investment and developer pressure, it's unlikely that Beijing could offset the underlying weakness in property demand for much longer. Ultimately, China is attempting to use cyclical tools to solve structural issues.

Much of the infrastructure investments are financed by local governments that face diminishing returns and other financial headwinds. Capital Economics said demographic challenges including a falling population and stalling urbanization suggest weaker property demand in the years ahead.

"In sum, while property sales and project starts have collapsed, and many developers have been driven into bankruptcy, the full impact of China's property crisis on real economic activity has not yet been felt," Capital Economics strategists said.