Believe many readers have noticed that my previous 2 blog posts aren’t posted by me. My best friend I mentioned whom I started my investing journey with, is currently an author of this blog too.
Anyway, been researching into the China property market, with a main focus in the residential market. Sorry for the lengthy post (heh!) I tried my best to be concise.
Recently, Yu Liang, CEO of China Vanke – the largest residential real estate developer in the People’s Republic of China predicts that majority of the China’s property developers will cease to exist within the next 15 years. Yu’s remark is not the first time developers have sounded a bearish note on the industry. Pan Shiyi, Chairman of Soho China and Ronnie Chan, Chairman of Hang Lung Properties are some of the others having a pessimistic view on the China Residential Property industry. In this research, I would be delving on why developers have taken such a negative stance despite China’s GDP growth still in the 7% region.
Looking at the current residential property industry in China, it would reflect a property bubble, one similar to that in the USA before the lead up to the Global Financial Crisis in 2007. With the cheap money supply in China, developers borrowed heavily from shadow channels, using property as collateral for large proportion of their loans. Given the soaring housing prices within China, one would expect it to be attributable to demand outstripping supply. On the contrary, it is the exact opposite. We see many ‘Ghost Developments’ in big cities like Shanghai and Beijing. In recent studies, Beijing alone has 3.8million vacant homes as compared to the 1million vacant homes in the USA during the same period. Furthermore, in a mid-sized Hebei province city, home ownership rates are at 200%.
Despite all this vacant homes, property prices are still trending upwards due to government policies. The Chinese government restricts her citizens in investing in anything outside China, and given how Chinese stocks are notoriously volatile; the most popular store of value is residential property.
First tier city housing prices at sky-high prices by annual measures due to buyers from all over China keeping up demand, assuming that it is the safest bet. However, these markets bear little resemblance to China’s smaller cities, where collapsing prices are rampant. New home prices have fallen in 8 out of the 70 cities (e.g. Wenzhou, Ningbo) in the recent month compared to the previous month where only 4 reported falling prices. Furthermore, cities like Tangshan, Hangzhou, and Haikou that are threatening to tip into negative growth. With home prices to have risen 9.5% in 2013, Bank of America Merrill Lynch expects the pace to moderate to just 5% in 2014.
Such slowdown in prices is due to the Chinese demographics and government policies in curbing a property bubble. With the rapid aging population of the Chinese population, it would mean that future workers will have less to spend due to the decrease in disposable income to spend on housing in the next 2 decades. Furthermore, the government has implemented policies such as a 70% down payment on house purchases and a 20% capital gains tax on sale of second homes to reduce demand in big cities. With such downward trend in prices and decrease in sales where only 28% of China’s domestically listed property companies reporting net cash inflow for 1Q2014 as reported by Goldman Sachs Gao Hua, it would result in a vicious cycle. Even major developers like China Vanke have reported a first quarterly drop in profits since 2002 or Soho China’s profits for 2H203 down 47% vis-à-vis 2H2012.
Given how down payments and mortgages generating about 40% of developer’s investment capital, slowing sales would mean developers needing cash so desperately that they will keep slashing prices. Furthermore, this is exacerbated by the developers having to repay their loans to the banks. This is evident by the fact that major developers have slashed prices by 15% since March, as reported by Bloomberg. On the demand side, with widespread knowledge of property developers’ shaky financials, buyers would be skeptical investing in unfinished developments in fear of developers going bankrupt. With the slash in prices, it would scare off speculative buyers, which makes up 15% of the demand for new homes, causing demand to fall even further.
With residential property being a lynchpin of China’s economic growth, collapse in house prices will drag a huge part of China’s GDP down. Coupled with other factors such as lackluster demand for exports and the government’s push to cut its own investment in bid for reshaping the economy, it has resulted in the China’s GDP growth averaging 9-10% in the past decade to have fallen to 7.5% in 2013. With the property market slide and slowing economy, it has caused difficulty for developers in repaying their debts. Banks would be left with defaulting borrowers and collaterals that are now worth a fraction of what they are owned. In bid to recover some of the loans, banks would resort to a massive selling of its collaterals, causing housing prices to fall even further.
With such a trend, it is inevitable that we expect to see smaller developers either going bust or getting acquired, seeing a separation between the men and the boys. Moreover, we are beginning to see this happening where the Chairman of Greentown China sold off his controlling stake to Sunac Holdings. With this going forward, we would definitely see a consolidation in this industry, where 85,000 of the developers now would decrease to 100 major developers and 15,000 smaller developers. Of course, it would really have to depend on the government’s ability in using a loose monetary policy in resolving this issue.
In my opinion, I would start reducing my investments in any listed companies whose main business in dealing with residential property or rather any form of property in China. To be honest, if the Chinese government is unable to prevent this bubble from bursting, it would be another global recession again. In such times, perhaps it would be best that a larger proportion of our portfolios are in cash.
THE VALUE EDGE 
Hi. Very curious on what the Real Estate Private Equity people are thinking. Being in China, you probably get to see first hand what is going on there, and how the prices are moving. Besides, if you guys are bearish on the residential market, then whats there left to do for a Real Estate PE to do?
[Congratulations on the internship, its really a good one and tough to get.]
What i believe is that the things on the news are rather exaggerated. Indeed sales are slowing but its probably not to the point of crashing. As you mentioned, there are over 85,000 developers in China, and those will be facing problems will be the smaller ones. There will be greater consolidation and that would probably benefit the larger developers. Although the headlines have been screaming falling prices, what you see among the larger and better-known developers (i.e. China Overseas Land, China Resources Land, Vanke, Shimao, Country Garden, Longfor, Sunac) is that ASP only falls by single-digit percentage. S&P forecasts ASP to decline 5% y/y in 2014. Contracted sales is also weaker in 2014 because of 1) sales slowdown; 2) more project launches scheduled in H2 2014; 3) extraordinary strong sales in H1 2013. I’m not denying that there is a problem in the real estate sector, just that the impact on the large developers are not that big as reported.
In any case, i highly doubt that China property equities fully reflect the value in the companies. They seem to be a proxy used by many overseas investors to short the economy and the ‘property bubble’. Greentown’s Chairman sold its stake to Sunac because he was old, and that in fact helped reduce some concerns over his health and succession plans. The fact that they sold at a high price of HKD12 per share (when the stock is trading at HKD7-8) further reflects how disjointed the equity market has become. I thought it also reflects Sunac’s ‘more positive’ view of the property market, and should not be seen as evidence that the market is crashing. Selling at HKD12 doesnt look like a desperate sale. Besides, he continued to maintain a stake in the company, as did Wharf.
Just too bad that my Chinese property stocks are not agreeing with my view…
Thanks!
First off, would like to say that whilst I (I dare not take a stand on behalf of the firm) am bearish on the residential market, there are many areas within real estates that money still can be made. Such as the firm I am working for, in China, we are mainly dealing with office and retail real estates. There is still high demand in the office sector in Shanghai as seen by the current rental per sqm and low vacancy rate. If you are interested, I do not mind posting the research report I did on the Shanghai Office Market. Also, in terms of logistics real estates, I would say there is really huge money to be made here. With the exponential growth in e-commerce, demand for additional warehousing space has outstripped the supply. If you actually look at the trends, many real estate PE firms are actually doing JV with local firms to tap on this area of growth. One of the biggest JV is actually our local GLP.
Would agree that currently it is not to the point of crashing, but I feel if things continue at this rate, a recession is inevitable. Even with the government’s plans on credit easing, I feel this can only delay the inevitable. However, my knowledge on the macroeconomics and policy making is still somewhat limited. Hopefully, after attending the talk on the real estate market in China next week, I would be able to give you a better reply on this 🙂 Indeed, there would be consolidation and benefits for the larger developers but in the process there would be defaults, falling house prices and if it were to be as serious, it would be like in the USA, where we start seeing bank runs and government having to step in. Of course, I believe in China, the government has much more fiscal might given the higher saving rates and all.
Lastly, I did not really look into any of the valuations for the Chinese property counters. The only reason is because it is too difficult to identify accounting fraud amongst these Chinese companies. I mean I talked to my colleagues if they invest in stocks, they told me how they did but ended up losing money due to such frauds. Furthermore, I talked to one of the big 4 accounting firms’ employee in Shanghai, she told me that it is really hard to detect such accounting frauds, and many does go unnoticed. Haha with regards to Greentown’s Chairman, from the news article I read, I felt that concerns for his health was more of a excuse to step down ‘gracefully’ in my opinion. The article is as linked.
http://www.mingtiandi.com/real-estate/finance-real-estate/greentown-chief-blames-govt-on-his-way-out-of-company/
Oh and with regards to the China Real Estate Market, I find other than the top few real estate agents producing top quality research reports, http://www.mingtiandi.com is another great research site.
Hope this helps answer some of your questions 🙂