Meeting China's Affordable Housing Challenge

Like everything else in China, the affordable housing problem is bigger than in most other places. In our recent research, A blueprint for addressing the global affordable housing challenge, we looked at the affordable housing gap (the number of households that live in substandard dwellings and/or pay a disproportionate share of income for housing) in cities around the world. We estimate that 200 million urban households in Asia, Africa, and Latin America live in substandard housing; 62 million of those are in China.

China has unique challenges

China has unique challenges and opportunities in housing. Because of rapid urbanization, demand for housing has outstripped supply, despite a building boom that created a massive construction sector that now accounts for about 15 percent of GDP. China’s cities may not have the sprawling squatter communities that are seen in the large cities of other developing economies, but it has tens of millions of housing units that either do not meet basic standards for essential amenities (plumbing, electricity), cost or space (even using a localized standard of 50 square meters for a four-member household compared with 90 square meters in the United States).

Across China, 60 percent of households in cities of more than 7 million cannot afford basic housing at market rates. In total, China’s affordable housing gap (the difference between market-rate housing costs and 30 percent of income for households in lower-income groups) equates to about $180 billion per year, or about 2 percent of GDP. That’s about 28 percent of the global gap of $650 billion, based on data for 2400 cities.

Not surprisingly, the housing affordability gap is concentrated in China’s largest cities, where residential property prices rose by as much as 86 percent from 2008 to 2014 (Exhibit). Today, about 14 million low-income households in China are financially overstretched by rent or mortgage payments exceeding 30 percent of income. And, based on current trends in urbanization and income growth, the number of low-income households in Chinese cities could rise by 56 million by 2025. Shanghai could add 2.3 million low-income households and Beijing could add 2.5 million. Four of the five cities in the world with the fastest-growing population of low-income residents are likely to be in China.

Four opportunities to close the gap

How can China halt the expansion of the affordable housing gap and begin to move millions of urban households into decent housing that they can afford? In our research, we find that there are four opportunities globally to improve the supply of affordable housing: securing land for development at the right price and in the right place for low-income households to integrate into the economy; improving productivity of construction firms; raising the efficiency of building operations; and expanding access to housing finance.

China is making progress in most of these areas, but there are still gaps in both policy and implementation. For example, to reduce land hoarding and speculation in cities, China imposes penalties on owners who leave tracts undeveloped. The government also releases public land for development every year, granting 70-year land leases. And local governments are starting to pursue innovative approaches to incentivize private developers to include affordable housing in their projects. In Nanjing a pilot land auction was held last December in which developers competed to maximize affordable housing once a target price was reached.

However, there are still shortcomings in China’s land policies. For example, industry continues to squeeze out other uses for land. Limits on building heights reduce the opportunity for densification. And while government’s own programs for building affordable housing are significant—from 2012 through 2014, government built an estimated 13.4 million units—local implementation of the new policy varies. In some places, for example, the migrant workers who are most in need are still excluded from publicly-financed housing.

Around the world, we find that advanced design and construction methods, including use of industrial approaches (such as greater use of pre-fabricated components), can cut construction costs by as much as 30 percent, helping make new construction more affordable. Chinese companies, such as the Broad Group, are pioneering new low-cost construction processes, but overall China’s construction industry faces the same productivity challenges that are seen around the world, including rising wage rates: average monthly wages in Chinese construction rose by 76 percent from 2008 to 2012.

While China spends about half as much as EU-27 nations on operation and maintenance as a share of housing costs, it has taken steps to improve efficiency. From 2006 to 2011, China funded energy-efficient retrofits (new heating systems, insulated windows, etc.) for 182 million square meters of housing in northern provinces. And in 2004, China regulated the property management industry and introduced a certification scheme for provider firms to encourage professionalism and cost-effective service.

Affordable housing can be an economic opportunity for China. We estimate that $94 billion to $104 billion per year would need to be spent on construction to close China’s affordable housing gap by 2025. Even a small share of that could help to engineer a soft landing for the construction industry as the building boom slows. The real estate market has softened considerably, with the value of transactions dropping by 14 percent from April 2013 to August 2014—and by 31 percent in Shenzhen. Inventories of unsold housing have risen to as much as 77 weeks’ worth in Tier 3 cities. Financing affordable housing would also be an opportunity for China’s banking industry. We estimate that it would take $300 billion to $400 billion a year in mortgage underwriting to close the affordable housing gap and perhaps a fourth of that would be needed in China.

Equally important as adopting new methods and pursuing the affordable-housing opportunity is ensuring the money that is spent is used effectively and efficiently. This requires comprehensive planning and targeted policies to encourage construction and rehabilitation of affordable housing. It also requires a clear understanding of how housing fits into an overall plan to integrate low-income Chinese into the modern economy and begin to raise their incomes. Hong Kong provides a model for successful transit-oriented development that includes affordable housing. Likewise Singapore excels in construction management with its CONQUAS construction quality assessment system. By adopting market mechanisms and best global practices, China can make affordable housing a reality for all.

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I'm a Director in McKinsey's Shanghai office and Director of the McKinsey Global Institute (MGI) in Asia. I also co-lead the Urban China Initiative (UCI), a thinktank devoted to transforming China's urban future. Visit the UCI website here.

Read my latest book, The One Hour China Book: Two Peking University Professors Explain All of China Business in Six Short Stories