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 