Editor's note: China's Bubble is a four-part multimedia series on an emerging threat to China's booming economy — a residential real estate bubble, particularly in the business and finance hub of Shanghai. The series also explores one of Shanghai's hottest residential developments, and examines how one unique social custom is driving prices even higher.

SHANGHAI, China — “Do foreigners think there’s a great real estate bubble in China?” Mr. Cai, a Shanghainese millionaire, wants to know.

Cai, 46, owns three homes in Shanghai. He and his family live in an apartment that he bought in the late 1990s for RMB6,000 ($882) per square meter. Ten years later, and for the same price, he purchased a second home — a 1950s brick and wood house built by a nearby university to house visiting Soviet professors — and moved his aging parents into it.

Last year, Cai invested in a third home for RMB20,000 ($2,941) per square meter in the city’s central Xuhui district, or more than triple what he paid a decade ago.

“Every year there are more and more wealthy Chinese. What are they going to do with all their cash?” said Cai. “You can only buy property or start a company. Property is the safest way to go.”

Thanks to China’s rapid economic growth, Shanghai has an abundance of people like Mr. Cais — wealthy entrepreneurs and white collar workers who have amassed more cash than they can invest. Apart from placing savings in a bank account with a very low interest rate or buying securities on a volatile market, there are few options that seem as lucrative to them as real estate.

In an echo of a pre-bust U.S., Shanghai’s housing market has yet to experience a major downturn. Over the last five years, the city’s average property prices have doubled to a record RMB14,986 ($2,204) per square meter, according to Shanghai’s Uwin Real Estate Information Services, vastly outpacing the rise in middle class income.

Some analysts view the surging real estate sector as an unsustainable bubble that poses grave risk to China’s economic growth and stability.

Worse, when people buy homes as a form of investment, it diverts investment into less productive areas, while driving up costs for the vast majority of Chinese who are buying homes in which to live.

(Watch how one Chinese social custom is driving prices even higher.)

Premier Wen Jiabao spoke out last November, saying property speculation must be suppressed. In December, regulatory measures struck like rumbling thunder bolts as the Chinese government attempted to cool the market. China canceled favorable tax incentives on the purchase of second homes and raised minimum down payments to as high as 50 percent on land and property purchases.

It worked, to a point. Transaction volume plummeted immediately, but prices didn’t budge.

Andy Xie, former chief Asian economist at the investment bank Morgan Stanley, predicts that this “politically driven” bubble — caused by pressure on local governments that embrace property development in order to sustain economic growth — could pop in 2012.

“The biggest risk to China's economy is the desire to maintain past economic growth rates by maximizing investments in property — an unproductive asset,” Xie wrote in China International Business Magazine earlier this month.

As wealthier Chinese stash money in luxury homes, there is less capital available for more productive ventures, agrees Patrick Chovanec, an associate professor at Tsinghua University’s School of Economics and Management in Beijing.

“It’s a classic landing problem for the government,” said Chovanec. “When there is so much exuberance, all the government can really do is try to deflate the bubble slowly enough that you don't create a panic and that people don’t lose value unnecessarily.”

In December, the Shanghai government unveiled plans to provide more low-income housing for its poorest residents through a lottery system.

To qualify, a family must currently live in a home smaller than 15 square meters (160 square feet) and earn less than RMB2,300 ($340) a month. If chosen, the buyer will be allowed to purchase homes at 40 percent below the current market price, contingent on the agreement that he or she would have to pay a substantial fee if the home is resold within five years.

“From this year on, the government will play a more active role in building low-price homes. The central government is sending a very clear signal to local government that they cannot walk away from this responsibility,” said Remy Chan, managing partner at CBD Commercial Investment Management in Shanghai.

But as the welfare housing market grows, Chan warns, fewer resources will remain for the commodity housing market. “So assuming that demand doesn’t change, there will be a shortage of supply in the private sector, resulting in an even sharper rise in home prices,” said Chan.

Meanwhile, Mr. Cai is thinking about moving into his new house and renting out his condo, which is now worth four times what he paid for it 10 years ago. But according to his calculations, the return on his investment would be appallingly low. He would have to collect rent for a half century to match what he could sell the apartment for today.

Concerns about a property bubble, however, won’t push him to sell.

“I don’t know what it’s going to be like in three to five years, but in 10, 20 years, I don’t think I’m going to lose,” said Cai. “No way.”

Paul Schittek contributed to this article.

Read the complete "China's Bubble" series:

China's Bubble: Must have house to marry

China's Bubble Video: StreetLife Shanghai

China's Bubble: "Shanghai Dream"

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