Second course

In the property market, tightening measures are kicking in

Second course



For all the central government’s attempts to cool the property sector, monetary tightening and loan restrictions couldn’t keep the big boys down. China Vanke, the country’s largest property developer by market value, announced in August that profits for the first half of 2011 were up 5.9%. But compared with competitors, Vanke’s earnings were relatively unimpressive. Country Garden’s profits surged 63% in the same period. Evergrande beat expectations with a whopping 147.9% year-on-year rise in core business profits. Among the 65 Chinese listed property developers who had reported first-half results by the end of August, average revenues surged 11.75% and profits increased 19.92%. Beijing’s crackdown on real estate speculation does not appear to have hurt developers’ bottom lines so far.

Down-market strategy

Part of the explanation for continued growth is that Beijing did not extend targeted property investment barriers to lower-tier cities; nimble developers with nationwide networks therefore followed equally buyers into those areas. Sam Crispin, director at PwC, said diversification has spared margins for many developers. “It’s not developers finding loopholes; they’re developing nationwide markets. Those developers posting higher results are those that have successfully diversified geographically and moved into commercial developments.”

Yet even as realtors prepare for “golden” September and “silver” October, the traditional high season in Chinese residential markets, the smell of dead leaves is in the air. The first harbingers of winter are the restless markets. The TAO, AlphaShares’ China Real Estate ETF that tracks 47 Chinese real estate firms on the New York Stock Exchange, is down nearly 17% year-to date, compared to a 5% decline in the Dow Jones Industrial Average.

Bond markets are also starting to look queasy. Evergrande’s dollar-denominated bonds, for example, have lost ¬popularity even on the back of its rising profits. According to data from the US Financial Industry Regulatory Authority, yields on the company’s 13% notes due January 2015 climbed 3.17 percentage points to 14.92%, indicating increased skepticism.

The skepticism is based on a collection of headlines. Beijing’s efforts to slow lending and property price growth this year (including three consecutive reserve-requirement ratio hikes and two deposit and loan interest rate hikes) are already having some effect on residential ¬property prices in first-tier markets, and will continue to apply downward pressure to lending for the rest of 2011. That’s bad news for smaller developers that have failed to diversify. Of the 26 out of 65 listed Chinese developers that reported a decline in profits in H1, ironically most were smaller players in lower-tier ¬cities, who appeared unable to compete with nationwide developers.

The central government is now ¬saying it plans to extend existing loan restrictions into lower-tier cities; at the same time, it plans to create a nationwide home ownership database to prevent speculators from evading mortgage restrictions by buying second and third (and eighth and twelfth) homes in disconnected ¬markets. Financial regulators are also ¬increasing their supervision of banks to crack down on new innovative ¬financing channels – such as Banker’s Acceptance notes – that have been used to skirt reserve ¬requirements. Some of these loans have presumably found their way into property markets.

There are other worrying signs: Among listed developers, inventory increased nearly 40% in the first half of the year. According to data from Knight Frank, the residential land bank among developers is expected to grow by 51% to 140,000 hectares by the end of 2011. Such an overhang will take between five and 10 years to profitably digest.

“The golden month will not be that booming,” said Regina Yang, director of research at property consultancy Knight Frank. She predicted that while transaction volumes may increase month-on-month due to the seasonal effect, they will likely decrease year-on-year.

Not an emergency

But developers’ prospects – big developers, that is – may be better than they appear. The last time the central government slammed the brakes on the property markets in 2007, it overcorrected, with a negative effect on wider economic performance. As frothy as the China market may be, Beijing knows that pushing prices too far down would be a mistake. “A 15% correction is desirable, 30-50% is not,” said Crispin of PwC.

This time policy-makers appear to be proceeding more carefully, and the recent slowdown in inflation and softening in export markets will only make them more cautious. In fact, despite all the noise, Beijing may not get around to enforcing new restrictions in lower-tier cities if the wider macroeconomic picture remains volatile.

Meanwhile, consumer demand is still strong. A report from CLSA claims that 90% of Chinese homebuyers are not, in fact, speculators, but are buying a place they plan to live in – many are likely upgrading from smaller, cheaper apartments, a far more sustainable source of demand. And part of the price increases is no doubt due to improvements in the quality of housing being sold today – better bathrooms, higher water pressure and parking spaces. CLSA reports that one-third of buyers pay with cash.

Buy to sell

Most of the large developers are also sitting on plenty of cash, and the smart ones are moving it into commercial real estate. Michael Klibaner of real estate consultancy Jones Lang Lasalle noted that demand for top-shelf office space in China is particularly strong these days – but he also said that credit shortages are slowing new investment.

Other parts of the commercial property sector are even more attractive, in particular those that offer exposure to the China consumption story.

“If you can get a good tenant mix, I believe retail is the best asset you can have,” said Yang of Knight Frank. “Even in the second- and third-tier cities, where office rents may be only RMB4-5 per square meter per day, retail rent rates may be as high as RMB20-30 per sqm per day.” She said companies like Dalian Wanda are building mixed-use residential/commercial complexes, selling off the condos and keeping the stores.

Despite a lingering chill in the air from government restrictions, property developers appear equipped to outlast the winter. Profits from residential may slow for the rest of the year, but the well-hedged will endure it. The secret to their success is the Chinese fondness (madness?) for property; until there’s something better to do with their money, Chinese will endure big penalties to keep buying in. “Real estate, love it or hate it, is a very effective way to generate wealth,” said Crispin of PwC.