Fixing Chinese real estate

Liquid Real Estate, Euromoney magazine, December 2008

Chinese real estate: the worst-performing sector in the worst-performing stock market in the worst-performing continent in the world this year. It was little surprise that a large part of the stimulus package China launched in October was designed to remedy the problems and put local property back on an even keel.

Doing so is highly important to China. Granted, its government doesn’t need to get re-elected, but it is still aware of the devastating impact a protracted real estate downturn would have on its population: hundreds of millions of people have become property owners for the first time in the last 10 years, and many of them are now experiencing declining prices for the first time. The knock-on effects are potentially huge, from consumer goods and construction stocks to investment behaviour, the broader Chinese economy and even global commodity prices. Any worse, and it’s going to hit the banks too.

And it’s not just individuals. Local governments and regions rely on land sales, which can account for as much as 40% of their revenues. These local governments are supposed to be helping China out of this slump (insofar as one can call 8% GDP growth a slump) by spending, and they can’t if they don’t have any money.

Hence, on October 22, the following measures: land sales were exempted from value-added tax; payments for first-time home owners were cut from 30 to 20%; and the property transfer tax for new buyers as been cut from 3% to 1% in some circumstances. Alongside this, the People’s Bank of China (the central bank) has been cutting interest rates heavily – the November 26 cut meant the benchmark lending rate is down 1.89% since September – and has eased reserve requirements on banks, in an attempt to encourage new lending.

Is it working? Not yet, or at least not obviously. “Almost all the developers we cover have indicated to us that they have noted very little positive volume boost from the stimulative measures announced so far,” says Eva Lee, an analyst at Macquarie Research in Hong Kong. On first glance that seems to fly in the face of some recent announcements by Chinese developers: Agile Property lifted its contracted sales to RMb1 billion in the first two weeks of November, compared to RMB800 million for the whole of October. And Sino Ocean, which launched a new property on the outskirts of Beijing in October, sold all 780 units. But Lee points out that Agile had lowered prices by as much as 30%, and that Sino Ocean’s face prices were 27% lower than the norm in the primary market.

That said, Lee says most of the developers she covers have been able to defer scheduled land capex payments and rolled over their short-term debt, improving their cashflow positions. That means that companies that used to have negative cashflow positions, such as Guangzhou R&F and Country Garden, are now positive. One can argue about the exact causes of this – banks were relaxing on lending even before the stimulus package – but it does improve the solvency of developers.

According to China’s Bureau of Statistics, the floor space of residential dwellings sold between January and October this year was down 17% on the same period last year, with the sales of marketable dwelling houses down 49.6% in Beijing and 40.4% in Shanghai.

Despite recent wobbles, the long term fundamentals of Chinese residential property are arguably very good: millions of people, probably tens of millions, move from rural areas to cities every year. They all need houses, and that’s quite a driver.