aranca views - china property market: prepare for the end game?

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China Property Market: Prepare for the End Game?

September 16, 2014

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Will deceleration in Chinese property market lead to a fully fledged crash?

China’s economic slowdown: Hoax or reality?

China experienced a robust average annual growth rate of 8% even during the global economic crisis. Moreover, the country continues

to defy expectations of a hard landing and grow at a significant pace even as the rest of the developed and developing world is still

recovering from the recession and slower growth. China’s policymakers have rightly shifted the focus from an export-oriented growth

model to a more inward consumption driven model. The government utilized massive stimulus and domestic credit creation for

infrastructure to offset slower export growth in the past few years. However, similar to the ‘law of unintended consequences’, the

excesses are starting to affect the country’s economic growth. The substantial infusion of liquidity in the financial system ended up

overheating the real estate market in the absence of alternate financial investment avenues. To control runaway price gains, the

government imposed curbs to avoid overheating and prevented the property bubble from bursting. However, in the context of current

slowdown in growth (an annual growth target of 7.5% for 2014, the lowest in a decade), China’s property market appears vulnerable to

effects of overall slower economic growth. We explore the possibility of current slowdown in the real estate sector having far-reaching

outcome on the country’s economy.

Slowdown in real estate market in China gains pace, causing more urgent action from government

The real estate sector in China has been slowing for the past few quarters; however, the pace of deceleration has been increasing.

Annual growth in real estate investments roughly halved to 12% YoY in July 2014 compared with just six months ago. Sales of

commercial buildings have decreased by an average of 9% in the past six month vis-à-vis growth of 35% in 2013. Prices of residential

property (two-third of real estate investments) fell on a MoM basis in 64 of the top 70 cities in July 2014 compared with an average of

just four cities in full year 2013. Although the price decline on a YoY basis is limited to few cities, our analysis of historical price data

indicates the fall in prices will spread to more cities in the next few months. The Chinese government, which is cognizant of deceleration

in the real estate sector and its widespread implications on the economy, has eased previously established restraints on purchasing

property. The Central Bank has encouraged banks to increase mortgages. Property developers are also offering easier purchase terms.

However, considering the oversupply in the market, concerns over whether consumers will return persist, especially in light of the

overall deceleration in growth

China real estate monthly investment (CNY Billion) Residential price index growth (% YoY) in top 10 cities

Source: National Bureau of Statistics of China

10.0

13.0

16.0

19.0

22.0

25.0

0

200

400

600

800

1000

1200

Jan'13

Mar'13

May'13

Jul'13

Sep'13

Nov'13

Jan'14

Mar'14

May'14

Jul'14

Real Estate Investment (CNY billion ) - LHS

YoY growth (%)- RHS

(10.0)

(5.0)

-

5.0

10.0

15.0

20.0

Jan

2011

Ap

r 201

1

Jul 2011

Oct 201

1

Jan

2012

Ap

r 201

2

Jul 2012

Oct 201

2

Jan

2013

Ap

r 201

3

Jul 2013

Oct 201

3

Jan

2014

Ap

r 201

4

Jul 2014

Beijing Shenzhen ChengduGuangzhou Hangzhou NanjingShanghai Shenyang TianjinWuhan

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Unstable demand factors, whereas supply abounds

Real estate demand in China is dominated by the residential segment (two-third of real estate investments). Demand for residential real

estate is driven by socioeconomic factors, such as demographics, increased urbanization, and subsequent migration to urban centers;

social norms (self-owned property prior to marriage); and demand due to the absence of viable alternate investment opportunities for

the increasingly affluent Chinese population. Due to structural financial suppression (cap on deposit rates) and low real returns (post

inflation), Chinese consumers opt for short-term investment avenues, including shadow banking products, such as wealth management

and trust products. Investment in real estate represents an alternate to shadow banking. Speculative short-term demand accounts for

up to 20% of demand in tier-1 cities, according to research by JP Morgan. Owing to the current overall slowdown in economic growth

rate (7.5%) and the crackdown on corruption, real demand for property has been decreasing, as reflected in the residential price indices

of 70 cities. In addition, Chinese property developers face concerns over unsold inventory, leading to financial stress.

Residential prices decline in 64 of top 70 cities in July on MoM basis; YoY fall to follow over next six months?

The monthly price index of 70 cities published by the National Bureau of Statistics of China indicates a rapid decline in the real estate

sector, especially the residential segment. Compared with price increases (on a MoM basis) in 65 of the 70 cities in December 2013,

prices declined in 64 cities in July 2014. In the previous instance of a similar deterioration in MoM price changes (starting June 2011),

the sector required an entire year to recover (by July 2012). Furthermore, our analysis indicates that on a YoY basis, the fall in prices

takes place with a lag of ~6 months, which implies we expect the YoY fall in prices to extend to more cities during the next six months.

MoM vis-à-vis YoY price changes in 70 cities (lag factor of ~6 months)


0

10

20

30

40

50

60

70

Jan-11 Jun-11 Nov-11 Apr-12 Sep-12 Feb-13 Jul-13 Dec-13 May-14 Oct-14

Number of cities with price changes on MoM

basis

0

10

20

30

40

50

60

70

Jan-11 Jun-11 Nov-11 Apr-12 Sep-12 Feb-13 Jul-13 Dec-13 May-14 Oct-14

Number of cities with price changes on a YoY

basis

Increase in prices Decrease in prices Constant

6 months

Past bottom of property price decline on a MoM basis

Past bottom of property price decline on a YoY basis

Recent bottom of property price decline on a MoM basis

6 months

months New bottom of property

price decline on a YoY basis?

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The changes in severity in price declines on a YoY basis are also of interest. On plotting the maximum increase and decrease in price

in any of the 70 cities surveyed, we find price declines of up to 16% YoY occurred during the last real estate slump in China (April–

October 2012). Furthermore, the maximum price increases and declines appear to follow a definite trend, with the current trend

continuing until it reaches a bottom or a peak. The current trend is that of a decline in prices, with new lows of maximum price increases

and maximum price decreases witnessed over the past few months. We believe the trend will continue over the next few months as

well, leading to a more widespread slowdown in the real estate sector.

Maximum price increases and declines (%YoY) in 70 cities


Chinese government and Central Bank keen on arresting slowdown in property market

The real estate sector contributed 16% or one-sixth to growth in China’s economy last year, according to the World Bank. Hence, the

Chinese government and the Central Bank (People’s Bank of China) are making significant efforts to stem the slump in the real estate

market. They have removed several restrictions on property purchases (related to second home purchases, cash requirement for

payment, and restrictions on mortgage loans, among others) and continue to encourage purchases of homes.

Time/period Action taken by government/regulators/banks

August 2014 China to consider allowing listed developers to sell interbank bonds

August 2014 Major banks start offering discounts on home loans

June 2014 onward Local governments easing restrictions on home purchases, especially second home

purchases

April 2014 China Securities Regulatory Commission allows four real estate companies to sell

mortgage-backed-bonds for the first time since 2009

Source: Media reports

(16)

(11)

(6)

(1)

4

9

14

19

24

Jan

-11

Ap

r-11

Jul-

11

Oct-

11

Jan

-12

Ap

r-12

Jul-

12

Oct-

12

Jan

-13

Ap

r-13

Jul-

13

Oct-

13

Jan

-14

Ap

r-14

Jul-

14

Maximum Decrease Maximum Increase

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Property developers offer easier purchase terms, following collapse of Zheijian Xingrun Real Estate

In March 2014, the privately owned Zhejiang Xingrun Real Estate Co. reportedly collapsed and its majority shareholder and his son

were arrested. The company had assets worth 3 billion yuan; however, the company owed debt of 3.5 billion yuan to more than 15

banks, of which more than 1 billion yuan was owed to China Construction Bank alone. Zhejiang, a relatively small developer,

symbolizes the survival challenges faced by hundreds of smaller real estate developers. Soon after the collapse of Zheijian, China’s

largest property developers, including the largest China Vanke Co., Greentown China Holdings Ltd., and many more, reportedly

reduced prices to enable sales.

Considerable impact of ‘shadow banking’ on real estate sector

Chinese real estate developers have been one of the major beneficiaries of the shadow banking industry in terms of borrowings;

however, they may find it difficult, if not impossible, to repay their debt due to slower sales. Chinese developers need to repay at least

$10.4 billion worth of bonds and loans maturing before the end of 2014, and another $23.9 billion by the end of 2015, according to a

Bloomberg news report. Despite this debt burden, Chinese developers continue to borrow, even more so now, from the offshore loan

market. Property developers have borrowed $5.9 billion (+39% YoY) from foreign banks this year so far, according to a Bloomberg

news report. About CNY1.1 trillion or nearly one-tenth of trust investments (a shadow banking product) have already been allocated to

real estate. In contrast, banks such as Industrial Bank Co. have suspended mezzanine financing for developers. Chinese developers

have responded to the increasing difficulty in raising debt by issuing ‘perpetual notes’ (issuance of securities without set maturity dates)

with high base rates of ~8% per annum, which would put further strain on their financials.

Chinese real estate to deteriorate further before improving

In Q12014, new property construction fell 25% YoY to 291 million square meters, the worst Q1 performance since 2009. Urban real

estate investment contributes almost 10% to the Chinese economy. Despite low household leverage toward real estate, owing to the

association between Chinese property developers and the banking sector via the shadow banking industry, the decelerating real estate

market will put banks’ balance sheets at risk. In addition, the secondary effects of a real estate sector slump on industries such as

construction machinery, construction materials, and metals, among others, would further impact the overall industrial growth rate. As

the current overall economic growth target is just 7.5%, any deceleration in the industrial sector would imperil the government’s growth

target. Although the government has already taken several steps to halt the decline and encourage growth, considering the excess

supply scenario and constraints faced by developers in raising capital, we expect the slowdown to persist for some time to come.

Chinese property developers’ financials continue to deteriorate; equity markets already factoring in impending crash in property market?

The financials of listed Chinese property developers has reflected the continued weakness for the past four quarters. For the 54 listed

Chinese real estate companies, revenue growth has slumped to 14% YoY in last quarter from 68% a year ago. Similarly, operating

profit growth has crashed to just 4% YoY in latest quarter from 44% a year ago. Operating margins continue to fall yoy, while net

income growth too is on a declining trend.

The deteriorating financials are also reflected in stock prices with each of 54 listed company shares trading below their 52 week high,

with the worst decline at 34% below peak. This contrasts with the Shanghai Composite index trading near its 52 week high. With a

multitude of factors converging (overall growth slowdown, credit expansion slowing down, property price declines spreading to more

number of cities) we believe it will be an uphill task for the Chinese government to spur growth in the real estate sector at present.

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China listed developers revenue growth (% yoy) China listed developers net income growth (% yoy)

and operating profit growth (%yoy)

China real estate developers’ current stock price (% below 52 week high, from -34% to -10%)

68.3

46.8

33.7

14.3

44.1

33.0

20.5

4.3 0

10

20

30

40

50

60

70

80

Q3CY13 Q4CY13 Q1CY14 Q2CY14

Revenue (% YoY) Operating profit (% YoY)

(44.9)

52.5

42.4 34.1

-50

-30

-10

10

30

50

Q3CY13 Q4CY13 Q1CY14 Q2CY14

-40 -35 -30 -25 -20 -15 -10 -5 0

China Merchants Property Development Co., Ltd.

ShangHai Tianchen Co.,Ltd.

Guangzhou R&F Properties Co., Ltd.

Shenzhen International Enterprise Co., Ltd.

Jiangsu Future Land Co., Ltd.

Poly Real Estate Group Co Ltd.

Xiamen Insight Investment Co.,Ltd

China Enterprise Company Limited

Join-In Holding Co.,Ltd

Shanghai Industrial Development Co., Ltd.

Tianjin Songjiang Co., Ltd.

Tianjin Jinbin Development Co., Ltd.

Beijing Centergate Technologies

Shanghai Shimao Co.,Ltd.

YunNan Metropolitan Real Estate Development Co., Ltd

Lushang Property Co., Ltd.

Beijing Dalong Weiye Real Estate Development Co.,Ltd

Shenzhen Properties & Resources Development Group Ltd.

DongGuan Winnerway Industrial Zone Ltd.

BEIH-Property Co., Ltd

Beijing Capital Development Co. Ltd.

Gemdale Corp.

Beijing Capital Land Ltd.

Winsan (Shanghai) Industrial Corporation Ltd

Huafa Industrial Co., Ltd. Zhuhai

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China real estate developers’ current stock price (% below 52 week high, from -9% to -0.1%)

Source: CapIQ, Stock Prices as on 15th

September 2014

Research Note by:

Nikhil Salvi

Senior Research Analyst, Aranca

-10 -9 -8 -7 -6 -5 -4 -3 -2 -1 0

China Vanke Co. Ltd.

Cred-Chongshi Real Estate Corporation Limited

Guoxing Rongda Real Estate Co., Ltd.

Shanghai Chenghai Enterprise Development Co., Ltd.

Tianjin Guangyu Development Co., Ltd.

Tianjin Reality Development

Shanghai Fenghwa Group Co., Ltd

Zhongtian Urban Development Group Company Limited

COFCO Property

Beijing Urban Construction Investment & Development Co., Ltd.

Cinda Real Estate Co., Ltd.

Lvjing Holding Co., Ltd.

Myhome Real Estate Development Group Co., Ltd.

Nanjing Chixia Development Co., Ltd.

Beijing Urban Construction Design & Development Group Co., Limited

Yango Group Co., Ltd

Financial Street Holding Co., Ltd.

Beijing HOMEYEAR Real Estate Company Limited

Wolong Real Estate Group Co.,Ltd.

Jiangxi Zhongjiang Real Estate Co., Ltd

Guangzhou Pearl River Industrial Development Co., Ltd.

Beijing North Star Company Limited

Shenzhen SEZ Real Estate & Properties Group Co. Ltd.

Shandong Tyan Home Co., Ltd

Jilin Guanghua Holding Group Company Limited

Hainan Haide Industry Co.,Ltd.

Hefei Urban Construction Development Co., Ltd

Cosmos Group Co., Ltd.

Greattown Holdings Ltd.

Wedge Industrial Co., Ltd.

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