Starting in 2008, a significant but largely unnoticed trend took hold in the California real estate market – massive and increasing investment by Chinese buyers.
In the coming years, Chinese buyers were responsible for an ever-larger number of real estate transactions as the total transaction value and count of their housing purchases soared. By 2013, Chinese buyers accounted for 3.5% of total housing transaction value in California, a 30-fold increase from 2008.
The impact on the local economy was substantial. Employment and property values both went up, but lower-income residents were also displaced from their homes.
The causes and effects of this surge in Chinese housing purchases are documented in a paper co-authored by Federal Reserve Bank of Boston economist Leslie Shen called “Local Effects of Global Capital Flows: A China Shock in the U.S. Housing Market.”
The paper focuses on California, but Shen said its broad aim is to show that foreign investment in domestic housing markets has major impacts.
Shen noted foreign real estate investment is very tough to track, so it’s sometimes unnoticed or overlooked. She added this investment is often sparked by the domestic policies of foreign governments, not the natural ebb and flow of business cycles, and it has consequences that policymakers need to understand.
“The mechanism we document here shows that foreign real estate capital can really influence local employment and potentially affect welfare,” Shen said. “I think it's important to highlight this kind of under-documented, underappreciated component of international capital flows that can really have domestic impacts.”
Shen is an economist in the Boston Fed’s Supervision, Regulation & Credit department. Calvin Zhang, another paper co-author, is an economist at the Philadelphia Fed. A third co-author, Zhimin Li, is an economist at Peking University.
Shen said while the paper focused on the housing shock in California, “this (phenomenon) is definitely not something that's restricted to one specific area.”
According to the paper, the sudden and large Chinese investment in California real estate in 2008 was tied to: a) the loosening of Chinese “capital controls” that restrict how much money citizens can move out of the country, and b) the introduction of a series of domestic housing purchase restrictions, which were aimed at taming housing price inflation.
These policies fueled “smurfing,” a popular technique for moving capital abroad for real estate-buying purposes. Smurfing occurs when a group of people (could be family, friends, or neighbors) lend their government-imposed foreign currency quotas to a single individual by wiring money to one overseas bank account. The accumulated funds increase the individual’s purchasing power and enable investment in foreign real estate. The Chinese government has tried to curb smurfing, but the loosening of capital controls aided the practice.
The subsequent investment in California real estate had a few distinct features, including:
- Clear “home bias:” The California real estate purchases were concentrated in ZIP codes historically populated by ethnic Chinese.
- Flat Chinese immigration. More Chinese homeowners in California didn’t lead to more Chinese immigrants. Studies and anecdotal evidence show that the Chinese often leave their houses abroad vacant – in some cases, they just use the address to obtain the “green cards” that give their children U.S. residency.
According to the paper, the increase in local housing demand due to the surge of Chinese investment raised local housing values. The homeowners’ greater wealth gave them more buying power, and they bought more local goods and services. That created and sustained more local jobs, Shen said. The researchers calculated, for instance, that a 1% increase in the number of housing transactions by foreign Chinese increased local employment by 0.247%.
But the paper documents a flip side: The higher housing prices forced out lower-income residents. As property values increase in a neighborhood, so does the cost to live there, so some can no longer afford it.
The researchers found a 1% increase in the number of housing transactions by foreign Chinese also decreases the low-income household count in an area by 0.112%
That displacement makes the topic of foreign investment in local housing markets contentious, not just in the U.S., but abroad, Shen said. It also makes it essential to better understand it, she said.
“We need to see the full picture, all the effects and consequences,” Shen said. “It’s the only way to construct good policy that really addresses this issue.”
Read the paper.
