Talking Point

A developing problem

The world’s two biggest risks? Try the eurozone and a China real estate bust

The signs are not looking so good for China’s property barons

Chinese developers have a penchant for giving their projects exotic names, often with a French twist.

Maybe they are of the impression that it adds a touch of class. Take, for example, the Palais de Fortune or the Chateau Zhang Lafite, two apartment blocks located in Beijing.

Last week, during a trip to Xi’an in Shaanxi province, WiC stumbled across another project cloaking itself in the French luxury image. This time the property bosses had opted for something simpler in naming terms – just ‘Cartier’.

We checked, and there is no connection to the luxury jewellery brand. But the project, on the road out to the airport, still likes to think of itself as “minimalist but dignified”. Residents will be able to wander through a “European-style botanical garden” or lounge next to an “elegant, man-made lake”. At least, that’s what is promised for the months ahead. When WiC passed Cartier by, it looked more like a semi-abandoned construction site. Another sign, perhaps, that the long-running boom in China’s property market has finally run out of steam?

Property prices are finally dropping…

In Beijing, Guangzhou, Shanghai and other first-tier cities, home transaction numbers are now at a three-year low. Sales of new projects are being hit hardest, with prices of newly-built homes in 17 of 70 large and middle-sized cities falling in September compared with August. Prices have stopped rising in most other locations too. The number of unsold homes is also reaching new highs. In Beijing, for instance, 9,152 new homes released for sale in October have joined the capital’s total unsold housing stock of 118,000 units, taking the total to its highest level since June 2009, says Centaline, a property agency. It would take 22 months to sell off the inventory on current demand.

As cash dwindles and liabilities fall due, some developers have started to slash prices. First to move were larger firms like China Overseas, Longfor, Greenland and Vanke, which have been selling some of their newest projects at discounts of as much as 30% to previous launches in adjacent areas.

More may follow suit. The South China Morning Post has reported that Future, another large property developer, was so desperate for cash that it priced flats at one of its new projects below development cost.

Another developer in Wenzhou is throwing in a free BMW for the first 150 buyers of its new luxury apartments, says Shanghai’s Dragon TV.

Are developers in panic mode?

Certainly, some seem surprised that the central government is persisting with its efforts to take the steam out of the market.

Others are trying to extricate themselves from decisions made at the market peak. The Wall Street Journal reported on Tuesday that Zendai, which set records in February 2010 for agreeing to pay Rmb9.2 billion for a plot of empty riverfront land in Shanghai’s historic Bund district (see WiC75), is now selling the project to Fosun Group, a conglomerate run by billionaire Guo Guangchang.

“Lots of companies are in far worse shape than people think,” Ronnie Chan, the outspoken chairman of Hong Kong’s Hang Lung Properties, told Bloomberg recently. “Even the big guys may not have enough money because they have borrowed a lot. The situation is such that the smaller players will go out of business.”

Indeed, Greentown, one of the largest developers in Zhejiang province, saw its shares tumble when news surfaced that the banking regulator was expressing concern about trust company exposure to the heavily-indebted developer (see WiC124).

Analysts say other developers with a glut of supply may soon have little choice but to dump some of their inventory.

“In Beijing alone, there are over 20% of property developers that will be forced to sell at whatever price they can get,” Yang Shaofeng, managing director of Beijing Lianda Sifang Realty, told the China Securities Journal.

Property brokers too are bracing for tough times. Beijing News has reported that brokerage giant Centaline is closing 60 outlets and laying off 1,000 workers around the country, and industry insiders told the China Daily that 3,000 outlets could close nationally this year, affecting over 50,000 employees.

What are the broader implications?

For a start, a collapse in home prices means a wider slowdown in investment. Property investment in the year so far has been tearing along at 35% growth year-on-year. But that pace is not likely to sustain if sales continue to decline.

That is also bad news for commodities. China consumes up to 50% of the global market in key commodities and materials like cement, iron ore and steel, and the property sector is a leading driver of that demand.

Add to that investments in property-related infrastructure, and as much as two-thirds of total steel consumption in China is broadly driven by property spending, reckons the Wall Street Journal.

A property slowdown also puts local governments in a more precarious position. They continue to rely heavily on land sales to property developers for a major portion of their revenue.

Falling prices for new apartments means lower auction revenues: last week the Guangzhou authorities cancelled a major auction for 12 plots due to poor demand, says Xinhua.

Without the income from similar sales, local governments could face cashflow problems, especially with larger refinancings and repayments coming due in the next two years (see page 9 for more on their financing challenge).

CBN, a Chinese newspaper, believes that a prolonged fall in home prices could trigger a wave of municipal debt defaults, and a new crop of bad loans in the banking system.

Any signs of that happening?

Not yet, although some cities are starting to show symptoms of financial stress.

Hangzhou, the capital of Zhejiang province, has 87% of its total debt tied directly to revenue from land sales, says Caixin. But budgeted income from land sales has dropped to Rmb37 billion from last year’s Rmb55 billion, a 40% year-on-year decrease.

In Liaoning province, finances already look tightly stretched, with nearly 85% of local government-related financing vehicles missing debt service payments last year, according to an audit report published on the local government’s website.

So perhaps it shouldn’t come as a surprise that some cities are trying to outflank the very government austerity measures that are designed to slow the real estate market.

In early October, Foshan, a city of about seven million people in the southern province of Guangdong, tried to cancel restrictions on the purchase of multiple apartments – a rule that the central government had come up with to dampen property speculation. Within a day, the local authorities were forced to backtrack when the move was shot down by Beijing.

A real estate slowdown could also leave the Chinese banks out-of-pocket. Around 20% of bank loans are directly tied to the property sector, on top of the 16% of loans outstanding to the local governments themselves, many of which are collateralised against revenues from land development.

Will Beijing relent on the tightening measures?

The central government looks determined to persist with its current approach. During a trip to Russia this week, Premier Wen Jiabao pledged that there would not be the “slightest wavering in China’s property-tightening measures”.

He added: “Our target is for prices to return to reasonable levels,” Wen confirmed.

Learning from 2008 – when housing prices roared back in the weeks after the government eased its policy clampdown – Beijing seems resolved to force a correction this time around. One official told the Financial Times that the government would be “happy to see” consolidation in the industry (i.e. some developers go to the wall).

Investors are worried, dumping the bonds and shares of Chinese developers. Hedge fund manager Jim Chanos, who made headlines in February last year by predicting that China was heading for a property bust “a thousand times worse” than Dubai’s, has also been back in the press, championing his gloomy outlook once more. “The Chinese are beginning to realise that property prices can go down as well as up and this is going to be a very, very troubling development for the market,” Chanos warned Bloomberg late last month.

Will the worst-case scenario play out? Many commentators see a much softer landing ahead for the Chinese economy and say that fears of a worsening credit crunch across the country are overblown. This week the government also gave the green light to the local government in Shanghai to raise money in the bond market. Other cities that get similar approvals are expected to follow suit, which could buy breathing space for municipal finances.

Policymakers also hope that the launch of a construction campaign to build tens of millions of subsidised apartments for those on low-incomes will help to offset the impact on the broader economy of a slowdown in private sector building (see WiC118).

And others predict that a sharper decline just won’t be allowed to happen, as the priority will be a smooth transition to the new leadership team in 2012.


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