These questions aren't dumb. In fact, they stem from a sense of how things should work and asking them lead to exploration to why things aren't as we expected. That's how interesting and awesome things are discovered.
I don't have all the answers as this issue is very complex.
I try to answer parts of it based on what I know (from travels in China and reading articles about China).
First, there really aren't that many ways to invest your money in China. The equity market there is quite nascent and rocky. Fraud happens quite a bit more than the US and there simply aren't that many choices. The finance industry in China is underdeveloped and heavily regulated.
The other issue is that a lot of the money was borrowed from state owned banks when lending was cheap and there was a lot less accountability.
Lastly, China runs a pretty big trade surplus.
So basically the conditions lead to a situation where China was or still is awash in capital and very few places to invest. Real estate really isn't that bad of a choice. China moved 500 million people out of poverty and into the middle class in the last couple of decades. Those people will want places to live. In the long term, real estate in China isn't a bad bet but all that wealth China created need to trickle down to people and get spread among the larger population so they can afford to live in these new places.
Just as a general observation, China's development is very uneven. They are good at what they've focused on but lacking systematically (for example, great highways and roads but no one really enforcing traffic laws so people drive the wrong way all the time). They lack larger systems that make everything work together. Those things can't just happen overnight like China's manufacturing industry did. It will take time for them to realize the problems and find solutions to them.
I wonder how difficult it would be (regulation wise) to create hedge-funds in China to help potential investors put their money in more diverse (and relatively safer) investments.
If you can navigate the politics, personalities, culture, and regulations, there is A LOT of money to be made doing that in China. In general, there is a lot of money to be made in China selling the level of sophistication common in the West but doing it in a way that's culturally acceptable to the Chinese. If you're interested, check out James Fallows' "China Airborne". It's about the nascent airline industry in China but it's a bellwether for other nascent sophisticated industries in China. For example, when Boeing needed to get China to follow the same strict practices that the US airlines do, they had to tell the Chinese that they need to meet the "international" standards. While it is true the standards are international, what Boeing didn't mention is that the US pretty much wrote those standards. The Chinese find it a lot easier to accept that it's an international standard everyone has to follow instead of an American standard.
Nobody is banking on that being true later either, though it is the law of the land now. What is the gov going to do at the 90 year mark, confiscate everyone's home whose ancestors bought 90 years ago? Tricky....
No. There is private property in China, even if the laws for it isn't as strongly protected as in other countries.