Here's the smoking gun that China has a huge housing bubble

Speculative buyers have eschewed Chinese stocks in favour of property, prompting even the chief economist at the central bank of the world's second largest economy to declare that housing was in a "bubble."

But when strategists at UBS recently compiled a list of bubblicious housing markets, it included cities like Sydney and Vancouver but there weren't any selections from mainland China due to the lack of reliable data on the subject. Their absence from the list underscored the continued difficulty in declaring Chinese real estate to be in overheated territory.

But now, Deutsche Bank Chief China Economist Zhiwei Zhang thinks he's pinpointed "a clear sign of a bubble" in the market - one that will end in a major correction in two years' time.

After analysing how much developers were willing to spend to win land auctions in 10 major Chinese cities in which values are already up 23 per cent year-over-year, the economist found that the business case for these bids evaporates unless property prices continue to increase.

One traditional sign of a bubble, across different asset classes, has been the willingness of people to buy something because they assume they'll soon be able to sell it at a higher price to some 'greater fool.' In fact, University of Chicago Professor Greg Kaplan argues that the chief cause of the US housing boom, which ultimately ushered in the financial crisis, was that people bought homes "simply because people thought they would increase" in value.

If property prices simply tread water from here, the Deutsche Bank economist reckons that buyers accounting for more than half of land sales values in these auctions would lose money.

'Flour more expensive than bread'

The "soaring land auction premium revealed very high expectation of further property price inflation," Zhang said.

The economist used the results of land auctions in Suzhou, a major city west of Shanghai, as a case study in irrational buying behaviour.

"Indeed unit land prices in many auctions are even higher than the finished apartments nearby, a phenomenon referred to as 'flour more expensive than bread,'" he writes.

The property bubble has been fuelled by the rise in broad credit growth, according to the economist, which has recently moderated and may continue to decelerate. In addition, Zhang expects Beijing try to slow house price growth by introducing targeted measures to cool select markets.

But a moderation of the real estate market as 2017 kicks off will likely prompt a rate cut from the People's Bank of China in the second quarter of the year in order to avoid a hard landing, he believes.

But that will only delay the property sector's day of reckoning, Zhang predicts. He reckons that a "severe correction in 2018" looms.

Bloomberg