What causes astronomical apartment prices in Shanghai and other large cities?

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My friend and I have been engaged in a heated debate over the astronomical purchasing prices of apartments in New York (and even Shanghai, as we live in China) and what causes them to be so high. He believes they are solely based on supply and demand, while I believe there are other factors independent of supply and demand that determine why the prices are so astronomically high. Could you please inform us as to which is the case?


As for the high price of apartments in China's big cities, I believe the supply and demand play the main role.

1. The supply in big cities is depressed by the heavy land regulation. There are two types of regulation. First, according to the Constitution, the urban land is owned by the state and the rural land is owned by the rural collective economic organization (CEO). Moreover Land Administration Law stipulates that CEO cannot sell the rural lands to the market directly, but the city government can confiscate the rural land with some compensation and resell it to the market. As the consequence, if a city expands and need more undeveloped land, the city government becomes the only supplier and thus a monopolist in the land market. Second, the land use is also regulated by the city government. To achieve high GDP growth, most city governments would allocate more undeveloped land for industry use. For the whole country, the ratio of land allocated to the use of manufacturing industry is around 40~45% every year, while the ratio for housing land is 18.5% in 2006, 25% in 2011.

2. The demand side also has important factors. First, the saving rate in China is pretty high. The total savings in China is around 4 trillion U.S. dollars per year. All of these savings need to be invested, and due to underdevelopment of the financial market, for the middle class, purchasing housing is the best way to invest their money. Second, the income growth is also high. The average urban income growth rate is 12% during 2003-2012. Third, China also experienced rapidest urbanization in the last decade, ex., around half million people migrated to Beijing every year in recent years. For the whole country, the urbanization rate rises from 36% in 2000 to 53% in 2013.

3. Due to the high growth rate of housing prices, the central government frequently implemented policies to depress the apartment purchase. The down payment for purchasing a house is 30% in China, which should be one of the highest around the world. In 2010, 42 big cities implemented more restrictive polies. Ex.., The down payment for purchasing second apartment is 60%, and for third apartment is 100%. And this policy is implemented based the record of the mortgage instead of the number of apartment you own. For example, if I now does not own any apartment but once purchased one and sold it and thus had a mortgage record, to buy an apartment in these cities, I had to pay 60% down payment with an interest rate 7.2% per year. Moreover in these cities, a family can only purchase up to 3 apartments. The last and also most restrictive policy in these cities is that only people having Hukou of this city or have a 5-year working timing in this city are eligible to purchase apartments. All of these policies, though very distortive, very much limit the housing speculation. Fortunately, due to the economic slowdown, except biggest cities, most cities have abolished the last (eligibility) policy recently.

The housing price in China declines this year due to the economic slowdown, but I do not think there will be a big drop. It would be a normal price adjustment.

The last and also very important factor, money policy. Money was tremendously expanded in the last decade: M2 increased from 20 trillion Chinese yuan in 2003 to 120 trillion Chinese Yuan July 2014. The money expansion definitely stimulated the housing price a lot. For example, in 2009, under the stimulation policy, the growth rate of money supply hit 30% once in that year, and the housing price in most cities was almost doubled in that year.