The property market only started its existence in the late 90s when property ownership was liberalized and commercial development of residential housing started. Private property in urban areas came as a consequence of State-owned enterprises’ (SOE) restructuring. In order to make money, SOEs started to sell off their property to employees. That was the start of the real estate market in China. After a number of years of very high growth the market is now slowing down. Right now the general mood is extremely bearish, with many doomsayers predicting the collapse of the property market in the coming months.
The property market means a lot to the Chinese economy, because it means a lot to the Chinese people. Many people see property as their preferred asset class, and Chinese saving rates are very high, due to the absence of safety net. Since there is a lack of investment alternatives (bank deposit rates are low and the stock market has been disappointing), the Chinese tend to see property ownership as a safe bet, especially considering the fact that the property prices have kept going up for many years.
Home ownership is very high at 80%, also in part due to what is called “mother-in-law economics”, i.e. a young man must own an apartment to get a wife, and the competition for ladies is high in a country where gender balance has been distorted due to the one child policy. Which means that parents will find it very natural to buy an apartment for their son at an early stage - provided they can afford it which becomes less likely when prices surge.
When talking about preferred asset class, I don’t suggest that the property market is dominated by investors or by speculating patterns. Actually, research shows that only 15% of all property transactions are done for investment purpose, when people buy, betting on making a gain by selling the property (usually left empty or even core shell) after some time. In a country as big as China, it is difficult to know how accurate statistics are but this figure is more or less in line with what we can see and what we hear when visiting property development projects in different cities.
A group of investors looking at a new residential property project.
On top of this, the property market development has big implications for a number of other sectors, not only inside China. What comes first to mind is obviously commodities: the construction pace of residential housing has been gigantic. China is the place where the equivalent of one Rome is built in two weeks; wherever you travel in China you won’t be able to ignore the construction cranes and concrete- and steel-hungry building sites.
But other sectors such as consumer goods are affected by the temperature of the property market, not only the ones related to home equipment such as furniture and white goods but also for instance cars. The correlation between new auto sales and property sales is very strong, this correlation should however be analyzed in view of policy incentives or policy restrictions that have been affecting both sectors at the same time. Then you can also draw the line one step further and remember that the local governments are very much dependent on land sales to finance their expenditures and the slowdown of property market can jeopardize their budget. Banks are also exposed to the property market, but the degree of vulnerability varies from one institution to another.
It is clear that the property market in general is softening. However there are many data points and sometimes it is very confusing. Many commentators ring alarm bells very loud, looking at weekly data and forgetting that the demand-size of the market is actually not leveraged that much. But they also seem to omit that prices are down or have stopped increasing mostly for new projects, while prices for existing properties or more centrally located new projects are still holding up quite well.
The most dramatic decreases in transaction volumes have been seen in the larger cities - for example, transaction volumes in Tier 1 cities went down 19.5% in 2011- that only account for a small part of total transactions nationwide- where several measures, the toughest in the history of the Chinese property market, have been strictly implemented to cool down the market: different home-purchase restrictions (enforcing high down-payment requirements, limiting the number of properties per head, excluding non-locally registered buyers) and other measures through the banks (reduction in mortgage loans and reduction in credit to real estate developers).
The problem is that many so-called nationwide statistics exclude the smaller cities even though that’s where the bulk of transactions take place – for example the closely watched housing data from the National Bureau of Statistics cover only 70 cities. Prices and number of transactions in the so-called Tier 3 cities where 55% of the urban population live do not show signs of collapse.
The authorities have made it clear that they intend to keep curbing on the property markets that have overheated. They have partly succeeded. Our recent visits to projects in Shanghai and on the southern island of Hainan clearly indicate a drop in the number of transactions as people expect new residential property’s prices to go down. But when travelling to cities like Wuhan or Chengdu, one gets other impressions. In such cities there seems to be such a booming local economy and increasing disposable income, implying continuous strong demand for residential housing in the long term.
The question now is how far the tightening will go and what implications there will be for the property market itself and for the whole Chinese economy. China has embarked on a rebalancing act to promote domestic demand in order to diminish its unsustainable dependency on external trade and fixed asset investments. At a time of weak global demand, internal weakness can make this rebalancing act more challenging.
Our investment team follows very closely our carefully-selected holdings in the property sector. They are solid companies, with good geographic distribution of their portfolio, better access to financing than many other developers and that might even benefit in terms of increased market share and participation in the consolidation process in the sector. Valuations are historically low and there have been a lot of share purchases by insiders over the past several months. The investor sentiment is however very dependent on policy headwinds, so the coming months will prove to be extremely interesting for the real estate sector, and all the sectors affected by its temperature.
