Levy expected to dampen speculation, excessive investment

A top-level decision to authorize the State Council, China's Cabinet, to pilot property tax reforms in several regions will finally end long-standing speculation about the levy, according to experts.

They also said the pilot plan would further pave the way for the nation's real estate market to progress toward stable and healthy development.

On Monday, the Political Bureau of the Communist Party of China Central Committee sought to stress the importance of making a "virtuous cycle" for the real estate market to expand.

The decision to authorize the State Council to pilot property tax reforms in selected regions in the coming five years was taken in October by the Standing Committee of the National People's Congress.

Sheng Xiuxiu, research director of JLL China's residential sector, said, "Key factors for the real estate sector are now the nation's pursuit of common prosperity, the guideline that 'houses are for living in, not for speculation', and giving people decent homes to live in."

A trial property tax launched against this backdrop is clearly a long-term answer for the property market, Sheng said.

En-route to realizing common prosperity, a property tax, along with other measures, will help ease unequal distribution of income, balance the social structure, and narrow the wealth gap, Sheng added.

Xie Chen, head of research at CBRE China, said a property levy is aimed at rebalancing the real estate tax structure and further curbing speculation in the housing market.

It is widely believed that under the pilot tax plan, the cost of owning a property will rise, particularly for investors with a number of houses or high-end apartments. As a result, this will dampen speculation and excessive investment in the housing market.

A Xinhua News Agency report said the pilot plan would actively and steadily promote legislation and reform on property tax, guide reasonable residential consumption and economical use of land resources, and propel stable and healthy development of the real estate market.

The report added that the tax would apply to properties for residential and non-residential use, but not to legally-owned rural land and residential properties built on it.

James Macdonald, head and senior director of Savills China research, said: "The property tax trial will create an alternative revenue stream for local governments to help reduce reliance on other such streams like land sales, and offset the subsequent loss in revenue. These revenues are essential to pay for local services such as healthcare, education, police, infrastructure, city beautification and more."

According to Macdonald, with the real estate tax announced as the property market is experiencing a transition period, policies and the tax regime will have to be adjusted to adapt to these changes.

"Many sectors, not only real estate, are seeing new regulations introduced to encourage healthier business practices and development trajectories," he added.

Choice of cities

The Xinhua report said the State Council would determine the regions, or areas, where the property tax is trialed. It will also draw up details of the pilot plan, leaving local governments in the areas that are selected to work out specific implementation measures.

Experts said it is not yet known which cities will pilot the tax. However, those more likely to be chosen are locations where the central government has greater regulatory oversight, such as Beijing, Shanghai, Chongqing and Tianjin. Cities with high-priced housing markets and weak affordability, including Shenzhen, Guangdong province, and Hangzhou, capital of Zhejiang province, are also likely to be selected, along with locations focusing on pilot plans, including Hainan province.

Markets where revenue from land sales has started to fall may also be considered, the experts said.

Jia Kang, chief economist of the China Academy of New Supply-side Economics, said a few cities are in urgent need of a real estate tax.

"For example, Shenzhen is in the process of building a demonstration pilot zone for socialism with Chinese characteristics. The city should seize the opportunity to pilot the property tax to replace its existing administrative measures with economic instruments," Jia said.

"Similarly, Hainan free trade port in South China, destined to be the world's largest duty-free market, is in need of an adequate market-driven property sector to match its future international status. So is the eastern province of Zhejiang, where the Communist Party of China Central Committee and the State Council are setting up a demonstration zone for achieving common prosperity."

Some experts suggested that cities piloting property tax reform may relax real estate purchasing restrictions.

Jia said, "Once there is an economic solution, extreme restrictions imposed on property purchasing may gradually be phased out."

But Macdonald said it was more likely that a property tax would be introduced, but no other measures taken. If the tax had a significant negative impact on the market, then other, more short-term policy measures, such as house purchasing restrictions, may be removed. If the impact was minimal, other policy measures might remain in place for a while longer, he said.

Xie, from CBRE, said, "From what we can see from previous pilot plans in Shanghai and Chongqing, and the latest statement by the NPC Standing Committee on promoting more provinces or cities to introduce such plans, we believe implementation of a property tax in China will allow local flexibility based on housing market conditions."

Learning experience

Although details of the pilot plan have not been released, experts said it would take tax regimes in mature markets into account and adapt them to the situation in China.

In 2011, Shanghai and Chongqing became the only two cities in China to introduce a property tax.

In Shanghai, the levy applies only to families with a total housing space of more than 60 square meters per person, and the taxation rate is either 0.4 percent or 0.6 percent of the property's annual valuation, based on the price per sq m.

In Chongqing, the rate is set between 0.5 percent and 1.2 percent of the annual valuation－an indication that the trial tax is focused mainly on taming speculative investment in high-end properties.

The two cities mainly levy the tax on homeowners with a large number of properties, with various deductions and exemptions being made.

Jia, who agreed that there could be changes to the tax trials in Shanghai and Chongqing, said: "Some observers commented that the trials in these two cities were too soft to impact home prices, but I think that is out of cautious consideration. Nobody wants to see a brand-new experiment mess up the local property market, and through previous experience, we may easily reach a consensus on more trials."

Macdonald said, "Part of the initial trial was about the mechanism for enforcing and collecting property taxes, so there may now be adjustments to the rates charged, the properties that are subject to the tax, or the exemptions allowed."

He said property tax is widely collected in the United States, mainland Europe and the United Kingdom. Although there is no perfect system, there is a comprehensive ownership database, accurate and consistent valuation methodology, a clear rate structure and exemption policy that ensures fairness, ongoing monitoring and review of the property tax system, and coordination between government agencies.

Ren Zeping, chief economist at Soochow Securities, said, "Regardless of their various policies, property tax raised in the US, UK and Japan is either based on rents or the valuation of the property, and it can be deducted, postponed or cut for people meeting special requirements."

In the US, seniors, the handicapped and the low-income population are among those entitled to property tax cuts, Ren said. In the UK, by limiting spending, local governments effectively strike a balance between their budgets and the amount collected in tax. The tax generated in the UK is mostly spent on public services offered by local administrations, he added.

Li Chao, chief economist at Zheshang Securities, said, "Property tax in the US and Japan mostly focuses on providing funds to local governments, but it plays a limited role in regulating the real estate market and the economy, facilitating urban development and public spending."

By trialing a real estate tax, China could learn from the experience in the US and Japan to increase local government revenue, boost local initiatives, and promote development of national common prosperity, Li added.

Better future

In addition to piloting property tax, central regulators and local governments have signaled that they want to work together for the nation's property market to progress toward stable and healthy development.

Emphasizing the guideline that "houses are for living in, not for speculation", China's financial regulators recently made clear their desire to safeguard healthy development of the real estate market and protect homebuyers' lawful rights, suggesting more fine-tuning will be made to stabilize the property sector.

In October, such fine-tuning regarding financial credit saw reasonable home purchasing demand restored. The improved financing environment for real estate companies is also effectively boosting market expectations.

Yan Yuejin, director of the E-house China Research and Development Institution in Shanghai, said that last month there was speculation in cities, including Shenyang, capital of Liaoning province, that regulators would loosen local home purchasing restrictions.

"Although such measures have not been announced for the time being, this shows the market expectations for loosened home purchasing policies, and that some local governments are trying to activate demand with measures other than credit and financing," Yan said.

He added that to ensure stable and healthy development of the real estate market, local administrations should be alert to any loopholes for speculation or illegal activities in property transactions.

Sheng, from JLL, said that in the short term, the property tax trial may curb new home purchasing demand in the pilot cities by raising the cost of owning real estate, but people with a number of properties would likely sell or lease additional apartments to lower such costs. As a result, with the increased amount of homes on the market, housing prices and rentals would stabilize.

From a long-term perspective, a real estate tax would not be a major cause of property prices fluctuating in a particular city, and the market would return to its correct development track, Sheng said.

The Xinhua report said that with a pilot period of five years for property tax, the NPC Standing Committee would decide whether to extend the authorization for six months before it expires. Legislation would be introduced promptly at the right time.

Sheng said she expects the five-year trial period to be implemented in accordance with local conditions, "so that the property tax can achieve its goal of wealth redistribution without causing home price fluctuations."

An S&P Global (China) Ratings report by analysts Zhang Renyuan and Liu Xiaoliang states: "A property tax combined with efforts to stabilize house prices would, in our view, weigh on second-home investment in the sector. We would expect a greater proportion of property demand in future to be for residential, rather than investment, purposes."

Under this assumption, local populations and regional economic development would be important drivers of real estate sales.

The report adds that pilot plans and the gradual introduction of property tax would help boost local governments' finances and wean them off a dependence on land sales.

As a sustained and long-term source of income, property tax may supplement fiscal revenue to a certain extent and promote a more conservative approach to use of land resources. However, it would take some time for the levy to come into effect, and initially, revenue may pale in comparison to that received from land sales, the report said.

Macdonald said: "Property taxes are long-term mechanisms for developing healthier markets. If the tax base can be equitable with a progressive tax rate system, and the proceeds can be used for providing local services, this will prove positive for the market and society in the long run."

Given that this is a new tax, there may be some initial resistance and market disruption, but if the levy is introduced gradually, and clearly communicated, the impact should be manageable, he added.