China's housing market has defied gravity and government restraints for two years, floating on a tide of bank loans and speculation. Until now.

In Beijing and Shanghai -- two of the country's largest markets -- and other megacities, sales have stalled and prices have dropped, falling slightly in some pockets and dramatically in others.

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Demand has dried up in these areas as a result of government measures including higher mortgage rates, higher down-payment requirements and limits on buying a second or third home. Would-be sellers are increasingly putting plans on hold in hope that prices will rebound.

While China has seen brief property downturns before, the high debt levels that fueled the boom makes this slump a particular risk for China's economy and the policy makers trying to manage it.

Home prices fell 0.3% in November from a year earlier In Beijing and Shanghai, the most recent official data show. It was a small drop but a striking reversal from double-digit price surges that lasted more than a year.

Prices of advertised new Shanghai homes decreased 8% from October through mid-December, according to Brandon Emmerich at Granite Peak Advisory, a New York research firm that analyzed over 20,000 daily listings from Anjuke, a Chinese property-listing platform.

Slight home-price drops have been recorded in other megacities including tech hub Shenzhen, and some cities around Shanghai, such as Wuxi and Hangzhou.

Chinese families have taken on bigger and riskier loans to buy apartments as homes or investments. Price drops could leave some owners owing more than they can sell their homes for, just as new restrictions in many cities make it harder to unload a property. To ease the pressure, the government is encouraging the growth of a rental market.

"The more vulnerable side of the household sector is home buyers who are buying just against their own earning power and don't have that family wealth," said Bill Adams, senior international economist at PNC Financial Services Group. "Often it's people who come to major cities from smaller towns and from the countryside."

Because megacities attract migrants, they are likely to sustain price drops at current levels, said Xingdong Chen, chief China economist of BNP Paribas. "If prices decrease 20%, that would be big trouble. Low single digits isn't an issue."

In parts of China with few restrictions, the housing market is still going strong. Growth in total Chinese real-estate investment held steady in November at 7.5% from the year before.

A greater threat to economic growth would be if prices fall in small cities that aren't attracting a population influx, according to Mr. Chen. If prices drop, "who can they sell those homes to?" he said.

Uncertainty about property prices is one of the key downsides to China's economic prospects this year, the World Bank said in its December 2017 economic update on the country.

Though China's Housing Ministry has said that property controls won't be relaxed, the dangers of the downturn are lessened by the government's ability to reboot demand by lifting restrictions -- and Beijing has held off on introducing an anticipated property tax that could curb speculation but damp prices.

China also doesn't have the sort of risky financial products that crashed the American housing market and infected the global economy a decade ago.

But a slowdown can have a wide impact. China's property market accounts for a significant share of economic growth -- as much as a third, according to Moody's Investors Service -- sending ripples outward into the global economy. The property boom stoked imports of housing materials, cars, appliances and other products. UBS called Chinese property one of the major engines of global growth in 2017.

Stricter lending limits cut the level of new mortgage debt each month toward the end of 2017; before that, mortgages made up as much as three-fourths of new loans in some months.

But many households have taken on riskier debt, such as short-term consumer loans, to make down payments -- a practice technically not allowed.

Luo Chuanyun, a 29-year-old liquor distributor, bought his first apartment on Beijing's northern edge for $150,000 in late 2016, when prices were climbing by more than 20% a year.

The purchase put Mr. Luo up to his neck in debt, with mortgage payments of about $15,000 a year on an annual income of a little over $18,000.

Mr. Luo said his real-estate agent told him that to find a buyer for his apartment now he would need to sell for half of what he paid. "I'd be short too much money," Mr. Luo said.

Some developers that a year ago put up special crowd barriers when apartments went on sale are now biding their time. Others face government-set price constraints.

In early December, a group of homeowners stormed the sales office of their Shanghai complex, Central Washington, whose developer, Shanghai Zhaoping Real Estate Development Co., was advertising new apartments at prices about 7% less than ones sold earlier in the year.

One apartment owner said the new prices suggested the value of the apartment she bought from the developer in March had dropped by about 17.5%.

The developer couldn't be reached to comment. It said on the project's social-media account that price fluctuations are normal and that talk of substantial price cuts was "purely a misunderstanding."

In some neighborhoods on Beijing's outskirts, prices have fallen by double-digit percentages. In March, main street in the town of Yanjiao was lined with busy property agencies. Buyers who couldn't pass Beijing residence requirements or afford its prices flocked there, pushing up prices in a sleepy exurb without much of its own economy.

Since then, homebuying limits helped push prices down more than 30%. "For Rent" signs now adorn the windows of abandoned brokerages.

"You came at the wrong time," said Guo Bubin, a property agent at Xing Yue Estate in Yanjiao, sweeping out his arm. "During the busiest time the whole street was filled with property agencies."

Back then, closing 10 sales each day was normal for Mr. Guo's office. Now, he said, he is lucky to handle 10 a month.

"There are people who bought multiple homes who are now trying to sell one to pay off the mortgage on another," said Ran Yunjie, a property agent. One of his clients bought an apartment last year for about $230,000. To find a buyer now, the client would have to drop the price by 60%, according to Mr. Ran.

Mr. Ran said he receives calls all the time from potential buyers who are barred from buying by property controls. "We have to turn them away, " he said.

--Lin Zhu contributed to this article.

Write to Dominique Fong at dominique.fong@wsj.com

(END) Dow Jones Newswires

January 16, 2018 05:44 ET (10:44 GMT)