Tremors under China property

China’s red-hot property market is cooling, threatening the pace at which the government can push through reform of its financial markets and the country’s unwieldy state-owned enterprises.

Property matters because housing sales drive construction, a significant chunk of China’s industrial sector. A real estate slowdown does not augur well for economic growth; GaveKal predicted China’s annual growth could drop below 7% by the end of the year.

The research boutique questioned whether reforms will continue apace as the state needs a backdrop of steady economic growth to push through change, if only to avoid a groundswell of protest.

"The achievements of the past year were substantial – a much tighter monetary policy, reform of the exchange rate and a good start on fiscal system improvements–but much more is needed, especially in streamlining inefficient state enterprises," said Gavekal's Arthur Kroeber. 

China's property market has expanded over the last decade, fueled by rapid urbanisation and an explosion in shadow banking credit. There have been bumps along the way before: demand is highly reactive to macro economic conditions and prices stalled in both 2009 and 2012. 

The sector is once again facing headwinds. Housing transactions have dropped from their recent early 2013 peak.

House sales fell 15.7% year-on-year in April and new construction starts fell by more than 20% year-on-year in the first quarter, following a rise of 30% year-on-year in the fourth quarter. Inventories in first- and second-tier cities hit 14 months at the end of April, weakening developers' pricing power and pressuring working capital as well as profit margins.

Unsold new home inventories

Banks are partly to blame for taking longer to approve and disburse mortgage loans following a spate of defaults. Non-performing loans in China increased to 1% in December from 0.95% in December 2012.

Developers are struggling to fund themselves and increasingly tapping offshore markets. Debt-funded rapid growth has left developers such as Country Garden and Agile Property vulnerable while Shanghai Zendai Property and Zhong An Real Estate are susceptible to refinancing risk, say analysts. The sector’s winners will be those with larger-scale operations, prudent financial management and good liquidity.

Chinese property developers continued to dominate the Asia Pacific high-yield market, with all but seven of the 29 deals that closed originating from the sector.

“There will be a greater differentiation by investors between stronger and weaker credits, but there is clearly strong demand for quality issuers," said Stephen Williams, head of capital financing across the Asia-Pacific region at HSBC.

Economists at ANZ noted that the debt to asset ratio for the listed property developers has declined sharply in the past few years, and fell to about 50% compared with 90% in early 2009.

“Some significant merger and acquisition cases could happen over the foreseeable future as some small developers could fail to get through the tough period,” said Li-Gang Liu, ANZ’s chief economist for Greater China.

The concentration ratio of China’s real estate sector has already increased significantly in the past few years. The top 10 companies took up 13.3% of market share in 2013, compared with 10.7% in 2011 and the market share of the top 50 developers increased by 4.6 percentage points in three years to 25.4% in 2013.

Volatile outlook: Storms likely
Credit rating agency Moody’s revised its outlook for China's property industry to negative from stable in May.

The government is already taking action to forestall a painful property crash. The People's Bank of China recently urged banks to offer more mortgage financing to first time homebuyers and is allowing domestic equity issuance for developers.

Country Garden moved quickly after the PBOC’s call for faster-lending support to execute a $250 million private placement of five-year bullet notes at 7.5%. The deal was challenging given Country Garden's recent changes in management. It was quickly followed by a Rmb2 billion debut dim sum bond from Longfor Properties, which had an easier ride as analysts expect it to prudently manage its land purchases over the next 12 months in view of the slowdown in sales growth, while its land bank could support five to seven years of contracted sales.

“The Chinese government has lifted some restrictions on sales and financing; China tends to quickly counteract pressures building in the sector to avoid serious problems arising,” Weber Lo, Citi’s Hong Kong chief executive told FinanceAsia. “Citi has been very active advising Chinese property companies this year,”
 he added, noting the US bank had handled 15 mandates from Chinese developers for capital raising year-to-date.

China’s property market is unlikely to collapse as long as the central bank has such an arsenal of policy measures and isn’t timid about using them.

While wobbles in the near term are likely, over the long-term urbanisation continues apace and the two-year policy to curb property demand masks real demand. But while the economy may avoid a hard landing, problems in real estate will hamper financial liberalisation and SOE reform. Stormy weather for reformers.