Urbanization and upgrading needs will create an estimated demand for 6 billion square meters of housing from 2017 to 2021. This will keep the investment in housing growing at around 5 percent in real terms over the next five years. Investment demand, however, may lead to overbuilding and derail China's rebalancing and industrial upgrading agenda. The Chinese leadership therefore needs to promote reforms by introducing a property tax, which will be an integral part of any long-term solution, preferably implemented in a revenue-neutral manner.

Housing investment has grown rapidly over the past two decades, leading to a significant improvement in living conditions in China. Housing reform introduced in the 1990s allowed the development and sale of homes based on commercial principles. In the past two decades, the investment in residential housing development has grown by an average of 19.2 percent per year. As a result, the urban living area per capita more than doubled to 36.6 sq meters of gross floor area in 2016 from 17 sq m in 1996. With per-capita living area increasing by about 0.8 sq m each year, China can close the gap with the average in the European Union in five years.

The housing sector has become too big to fail. Real-estate investment accounted for over 10 percent of the economy last year. The International Monetary Fund has estimated that the real-estate and construction sectors together contributed 33 percent of China's GDP growth in 2013 if upstream and downstream sectors are included. Bank lending to the real-estate sector totalled 26.7 trillion yuan ($4 trillion) last year, or one-quarter of banks' total credit outstanding. In addition, real estate is used extensively as collateral for corporate borrowing, and a major housing-market correction could undercut the value of the collateral.