China's residential property glut is going nowhere fast

Long road ahead

China's residential property glut is going nowhere fast

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If you only looked at the price tags of property in Beijing, Shanghai, Shenzhen and Guangzhou, you might think China’s real estate industry was staging a comeback.

From June to September this year, China saw average new home prices per square meter grow more rapidly to end September up 0.2% from August—and down only 2.94% from the same period in 2014, a marked improvement over June’s year-on-year fall of 5.87%. And while prices in China’s top megacities did much to counter slower growth among their lower-tier peers, the number of cities reporting month-on-month price growth rose from 20 out of 70 in May to double that number in September, according to figures from the National Bureau of Statistics.

Yet September also marked a six-year low for investment growth in real estate projects, and the Tsinghua UnionPay Advisors Real Estate Index, a proxy for sales, showed year-on-year growth in property market transactions had fallen from a June peak of 51% to only 25% in September.

These figures suggest not a sustained recovery, but rather that housing demand in China may have already peaked in absolute terms, in which case any recovery would first require burning off the current surplus of residential real estate so that developers' inventories can return to less bloated levels. The speed and severity of that adjustment is up to policymakersand once it is complete, strong underlying demand can step in to ensure healthier and more sustainable turnover.

But it also means that while certain segments and sectors will see continued growth despite widespread industry pain, observers and analysts aren’t expecting the latest gains in Beijing and Shanghai to lead a nation-wide rebound any time soon. Instead, it appears that the prospects of top-tier cities have detached from the rest of the national real estate market, where the outlook is far more varied, and often far grimmer.

“For non-first-tier cities I personally still have concerns that overstock remains a major issue,” said Carlby Xie, head of China research for global real estate consultancy Colliers International. “Especially in residential property markets.”

Speculative gains

That prices have recovered as much as they have since April can be attributed in part to a reversal of home-purchasing requirements, said Michael Cole, proprietor of China real estate news site Mingtiandi. The restrictions, introduced in 2011 and 2012, were meant to cool down what regulators saw as a rapidly overheating market.

“Generally speaking, changes in interest rates and changes in the money supply through [banks’] reserve requirement ratio do not have that much effect on the housing market,” Cole said. “What has really had an impact has been home purchase restrictions that involve down payments.”

Such restrictions didn’t forbid speculative buying, but they did make it a whole lot costlier for those who already owned a home to buy another. Authorities have backtracked on those restrictions twice this yearfirst in March, when they lowered down payments for buyers of second homes in lower-tier cities from 60% to 40%.

Yet while gains in sales value have outpaced those for the year to date in floor space volume sold, growth in both has been slowing of late, according to the National Bureau of Statistics. Official figures for the first nine months of the year show growth in sales value for new homes holding at 15.3% year-on-year from the previous reading; gains in floor space sold eked up only 0.3 percentage points to reach 7.5%.

Worse, investment in real estate projects grew only 2.6%, likely reflecting continued wariness of developers to take on more projects. Those tapering trajectories, taken together, might explain why regulators lowered the down payment requirement yet again in September from 30% to 20% for buyers without loans on their existing properties. Cole said such changes to national property policy gave speculators the green light they were waiting for.

But the monthly figures on 70 mainland cities published by the statistics bureau seem to suggest that individual investors are funneling their money to top-tier cities - which have retained purchasing restrictions - in order to get more bang for their buck. Xie said Colliers had identified a significant trend among cash-rich Chinese investors of refocusing on high-end real estate in the wake of this summer's stock market rout, with some having sold off their surplus property in order to more profitably re-invest the proceeds.

In top tier cities, Xie said, "individual investors are gradually taking more initiative, [and showing] stronger interest in investing in the upscale or high-end luxury property sector instead of the mass market in order for them to gain stronger capital appreciation in the next round of the market cycle."

Price gains in Shanghai have become so swift that on October 26, the city’s party boss announced plans to rein them in, though state media reported that new home sales in the municipality surged 20% the following week. And little wonder: Xie said Colliers had observed that in both Shanghai and Beijing, “some buyers have purchased property in the high-end [segment] for less than two months—and they gained a 10% increase in capital value.”

Secondary concerns

The secondary market likewise seems to indicate divergence in valuation between top-tier cities and those of lower rank. Although the National Bureau of Statistics doesn't publish figures on sales volume for the second-hand home market, in mid-October a subsidiary of Beijing-based property services firm Guoxinda launched its own "China City Housing Index" as an alternative measure.

The index purports to track both the pricing and volume of secondhand housing on offer in 337 mainland cities by using publicly available data scraped from the websites of more than 500 real estate agencies. Of the cities tracked, four are Tier 1, 25 are Tier 2, 83 are Tier 3, and 264 are Tier 4.

Shoving so many cities into a single low-end category runs the risk of glossing over the variation inherent to local real estate markets, and using online listings means relying on pricing data that agencies have good reason to exaggerate in either direction depending on the situation.

But the housing indices from National Bureau of Statistics pay far more attention to higher tiers, allotting 50 of 70 slots to Tier 2 cities and leaving just 16 spots for Tier 3. Seen in this light, Guoxinda's new index is a potentially valuable indicator of whether sales of existing homes in the majority of Chinese cities are keeping pace with listings of the same.

Records for second-hand home prices going back to August of last year appear to echo the primary market: Tier-1 housing broke away from the pack late in 2014 and at last count had seen cumulative gains of over 10%. Tier-2 valuations have steadily climbed their way back into positive territory after hitting bottom in early in 2015. But used home prices in the third and fourth tiers have failed to do the same, with the latter down close to 4% at the start of October.

That dip may stem from the volume of second-hand housing listed for sale in fourth-tier cities, which appears to have risen dramatically in recent months. While used floor space on offer from all tiers saw gradual, similar gains after bottoming out in February, volumes listed in first and second-tier cities have risen only moderately compared to the sudden surge in third- and especially fourth-tier cities, which began about halfway through 2015. 

 

If the trends in listed valuation and volume shown by Guoxinda’s data are to be believed, the lowest tier of Chinese cities has been hit by a sudden inundation of listings for second-hand homes, possibly held in reserve until the peak fall sales season was imminent. That flood of supply may be outstripping demand and driving down prices. Still, it isn't entirely clear whether actual sales volumes in those cities have fallen as well, which Cole said would be a red flag.  

“A slow-down in transaction volumes for second-hand homes will show you that, even though prices might appear stable, that buyers are not motivated," he said.

The long hangover

Even the total unsold inventory of new housing in China is hard to pin down because the official figure only counts finished housing that is ready to be sold. In an April study (pdf) the International Monetary Fund estimated year-end inventory for 2013 stood at about triple the official figure, and noted that in mid-2014 local data showed two years of inventory, in contrast to national figures indicating just four months’ worth.

In order to get a better handle on exactly how over-supplied China had become, Rosealea Yao, a real estate analyst with research firm Gavekal Dragonomics, constructed an alternative measurement of implied inventories based on the difference between cumulative housing starts and cumulative sales by developers. The resulting gap showed 34 months of sales (3 billion square meters) in 2014, set to decline to about 30 months’ worth this year.

By Yao's reckoning, that leaves eight months of excess inventory above a historical average of 22 months that is only slightly higher than the 20 months construction projects typically take from start to finish. But the current surplus will take far longer than eight months to unload thanks to new project starts and completions coming down the pipeline.

Yao said she expected a continued decline in construction through the first quarter of 2016, and that a rebound was unlikely next year thanks to the aggregate glut weighing on smaller cities that still needs to be burnt off. However, a faster adjustment scenario - in which authorities let construction starts decline without too much interference - could result in a cyclical rebound for construction in 2017 or 2018.

Although more intensive intervention could further delay a recovery, Yao said, “I would continue to think that the faster adjustment should be the base case.”

State of expansion

State-run developers would likely be less than pleased were that the case, as the downturn has afforded them an opportunity to grow market share at the private sector's expense. 

While state-owned enterprises have always been a presence in China’s real estate markets, it was only last year that one toppled privately-owned China Vanke to become the largest developer by sales. According to a recent Deutsche Bank report on 36 major mainland property developers listed in Hong Kong and Shanghai, state-backed expansion hasn’t let up in the face of market turmoil.

In their report, Deutsche Bank analysts Tony Tsang and Jason Ching wrote that 10 key state-owned firms have attained faster market share growth than their private counterparts, with total market share rising to 10.1% in the first nine months of this year from 8.8% in 2014.

"In the past, industry consolidation in the China property market was mainly characterized by the listed developers taking market share from the unlisted developers," Tsang and Ching wrote in their report, cited by the South China Morning Post. But starting in 2014, “even among the listed developers, the state-owned developers are gaining market share, while most private developers (especially the small- to mid-caps) are no longer gaining market share, or are even losing share.”

Indeed, private developers including Dalian Wanda, Country Garden and Shimao Property recorded declines in market share during the period. Meanwhile, state players like China Overseas Land & Investment, Poly Real Estate Group and China Resources Land all gained ground. The analysts expected the central government would debut more support policies to boost property sales in the year’s final quarter, with state-owned developers like those mentioned above tipped to benefit more than most.

Consumption-driven change

The same drive to abandon heavy industry for consumption and services-based growth in China has also redrawn the map for the property sector, outlining a new landscape where gains still exist, but are unlikely to be as widely shared.

The most marked beneficiary is logistics real estate, where investment is ample and willing, but opportunities are less obvious or subject to more geographical caveats. Interest began building in 2013 based on the recognition that if Chinese consumers were going to power the country’s economy, they’d need better logistical networks to deliver goods to them. 

"Demand for modern logistics facilities in China is driven by long-term, structural trends in domestic consumption and the country’s need to replace obsolete logistics facilities," said Kent Yang, president of Global Logistic Properties China.

In July the Singapore-based developer of distribution centers announced it had closed funding for its second mainland-focused investment fund with US$3.7 billion of equity commitments from itself and investors, enabling investment capacity of about US$7 billion, or roughly twice its previous China fund. Since then it has leased a total of 283,000 square meters of warehouse space on the mainland.

Yang claimed about 80% of existing logistics facilities in China were "obsolete and not in strategically significant locations," and added that land supply had become more scarce thanks to land reforms reducing the supply available for industrial facilities in large urban areas—exactly the kind of proximity logistics hubs need. But he added that the firm’s new fund would begin purchasing land later this year and begin construction on new developments in April.

Collier’s Xie expected logistics property expansion would be more limited in southern China, where large-scale properties were in short supply, and in northern China, where land available for sale was also limited. But he favored Eastern China and the central cities of Wuhan and Chongqing for more distribution center developments going forward.

Upside's downside

The same forces driving expansion for logistics are also threatening brick-and-mortar retail: In July, the state-run paper China Daily reported that mainland real estate conglomerate Dalian Wanda would shutter 40 of its 99 department stores (along with 80 karaoke dens) in the face of growing competition from online retail platforms.

It's also unlikely that demand in logistics or other sectors, such as office buildings, will be able to pick up the slack left by the residential market. Gavekal's Yao did, however, point to one bright spot in social housing: With investment from a national drive to redevelop slums in major cities under-performing this year, an uptick in government funds to the initiative could provide some relief in the near-term for the construction industry. “As long as this kind of construction will not increase the inventory, that should be fine,” Yao said.

The need for such redevelopment highlights the mismatch of developer desires and more modest local market demands that helped bring about the current glut. But while excess inventory may well take ages to work through, home ownership remains a must for marriage in China, and Cole said underlying demand for (suitably located, reasonably priced) housing remains strong.  

"I don't have a nice line graph of demand for housing, but if I did, that's been steadily going up in the last five years," Cole said. "The line graph that’s been going up and down over the last five years is 'am I interested in buying a house at the current prices in my city'."

That prerequisite of a stabilized, sustainable market means the future well-being of China’s real estate industry depends more heavily than ever on policymakers' resolve not to panic if housing prices drop and sales growth slows in lower-tier cities—as they almost certainly will heading into 2016. 


Author: Hudson Lockett (@KangHexin)