Are fears about Chinese real estate justified?
One of the reasons frequently cited as a cause of China's slowing economic growth is the property market correction. There has clearly been a downturn so far this year, with national sales of new properties down 6.7%. Meanwhile urbanisation continues to be a strong trend, securing a high demand for real estate. In the last two years there have been big changes on the real estate market and its speculative share has heavily decreased.
One of the reasons frequently cited as a cause of China's slowing economic growth is the property market correction. There has clearly been a downturn so far this year, with national sales of new properties down 6.7%. That compares to an increase of 26% in 2013. According to the 70-city property price survey by the NBS the number of cities in which property prices fell month-on-month rose to 55 in June, up from from 35 in May and eight in April.
Some people have warned of a major crisis looming, fueled by unsustainable prices, oversupply, ghost towns, a property bubble and a host of other reasons. However, we disagree and do not see credible evidence of a major crisis in the short to medium term because the sector is too big to fail and the government has many tools in its “toolkit” to stimulate demand and avoid a major slowdown in the real estate market. Especially in a year when Beijing has decided to tackle other, more crucial, priorities such as corruption, pollution and SOE reforms. The anti-corruption work has, in itself, affected the real estate market.
Indeed, the Chinese real estate sector is crucial to the Chinese economy and society as a whole. The sector stands for 15% of Chinese GDP and 25% of Chinese fixed-asset investments, absorbing huge quantities of commodities. When trying to balance their budgets, local governments are very dependent on land sales, which are obviously strongly related to the property market.
In Chinese culture, home ownership is very important (it is notoriously difficult for young men to get married if they do not own a flat), hence the high home ownership rate of around 90%. Besides, since the savings rate is very high but interest rates are low and equity investments have been deceptive, property has also become a fashionable asset class, with average yearly property prices increasing 10%. That in turn has made people feel wealthier and consumers feel more confident as prices have been constantly rising for several years. Many are also upgrading their living standards on the back of the increasing income levels. The real estates’ impact on the national consumption is an additional reason for the Chinese government to avoid a crisis. In the last two years we have seen big changes on the real estate market and its speculative share has heavily decreased. When apartments are purchased to live in, rather than as investments, it affects the consumptions patterns. Some of our portfolio holdings, such as domestically listed household electronics producers confirm that people are still buying apartments and equipping them, with yearly sales of white goods up by 10-15%.
It is true that there have been over investments in some places which have led to oversupply, but China is the size of a continent and a number of cities are growing at rapid pace. The situation is more worrying in inland third or fourth tier cities that do not succeed in attracting home buyers and, in some cases, the population has even been decreasing. Together with my colleagues, I’ve been travelling to many such cities, and it has been clear to us why people are not keen on either staying or moving in.
However, urbanisation remains a very important trend in China, as well as one of the government’s main priorities. One example of this was the recently released details of the long-awaiting Hukou Reform.
Figures of around 10 million people leaving rural areas on an annual basis mean that the demand remains strong. Lately, measures in selected cities have been taken to support the sector, such as relaxing and lifting home purchase restrictions and mortgage restrictions that were in place for the last couple of years. Despite a more favourable policy direction - which has triggered a rebound in property stocks - we still think that this it is not a reversal to the overall correction trend. At the beginning of the year we became less bullish and reduced our overweight to the sector. Within the sector we chose to have large positions in high quality developers that will sustain good growth amid market consolidation. That is reflected by the fact that the market share of the top 10 developers in China has gone up to 19% from 14% compared to a year ago.
