Safe as houses?

More bad news from the property sector as developer defaults


Fears growing of a property crash

China’s first ‘upside down’ house is scheduled to open this April at a village near Shanghai specialising in folk painting. Apparently, visitors will enter through an upstairs window into a home where all the furniture is attached to the ceilings. It doesn’t sound very practical – and visitors will be well advised not to try flushing the toilet.

Economists trying to make sense of recent property market data are also becoming concerned that something unpleasant might be about to rain down on their heads, after fears that China’s debt-fuelled growth model is starting to unravel.

The latest HSBC purchasing managers’ index (PMI) flash report, released at the beginning of the week, came in at an eight-month low of 48.1, well below consensus estimates of 48.7. There were no signs of a post-Chinese New Year rebound, with HSBC reporting broad-based weakness, and the most bearish economists now believe GDP growth could drop far below the government’s 7.5% target to as low as 5% over the next couple of years. Some have even suggested that 4% growth is possible if the property market implodes and a disorderly unwinding of credit excesses ensues.

Then again, over the last two years, there was PMI softening in the first quarter, which was then offset with new stimulus measures. Will stability continue to trump reform this time around?

The signs have been contradictory. On the one hand, premier Li Keqiang has insisted that the government isn’t “pre-occupied” with GDP growth and that debt defaults are “hardly avoidable”.

But as economists predicted, investment projects are already being fast-tracked to keep the economy moving – the largest being five new projects accounting for 20% of all rail investment in 2013.

Property companies are also being given more leeway to strengthen their balance sheets in an acknowledgement of the sector’s wider importance to the economy. After a four-year hiatus, the CSRC recently allowed a number of companies to access the equity markets again. The candidates included state-owned Greenland Holding, which is pursuing a backdoor listing in Shanghai via a Rmb65.5 billion ($10.55 billion) asset injection into Shanghai Jinfeng Investments. Shanghai-listed Join.In and Shenzhen-listed Tianjin Tianbao have also been given permission to launch placements amounting to Rmb3.27 billion, the first in a potential pipeline of new property-related equity funding estimated at Rmb178 billion by Ping An Securities.

For many economists the more important question is not whether the government will implement new stimulus measures, but how much longer they will prove effective. Is China reaching its Minsky moment when borrowers that took advantage of 2008’s record breaking $586 billion stimulus find they can no longer service their debts?

As such, the collapse last week of a small property developer in eastern Zhejiang has had wider ramifications.

On March 18 it was reported that Xingrun Real Estate in Fenghua City had gone bust with Rmb2.4 billion of debt. For some analysts, Xingrun represents the first in what could be a very long line of bankruptcies. But for others the news is a welcome sign that the government is doing what critics have long demanded – letting weak companies fail so that others learn to operate more prudently.

The lesson from Xingrun isn’t absolute. The 21CN Business Herald says that the government will assume 70% of Xingrun’s debt, with banks forced to write-off the remaining 30%. The partial bailout suggests that the authorities believe they can punish poor risk management, without sacrificing investors entirely.

Does the episode need to be repeated in other places? One of the main challenges for the government and for developers is a lack of reliable data from the third and fourth tier cities (where Xingrun’s sales were based) and where problems are thought to be most acute.

Such cities are believed to account for about two-thirds of building activity and WiC has referred in earlier articles to falling home prices in places like Hangzhou and Changzhou (see WiC227). Changzhou looks like a particularly bleak spot: the South China Morning Post has reported on a “nightmare” situation for the city’s real estate this week, with empty units estimated to be the equivalent to 10 years of oversupply.

Tier one cities aren’t immune. While prices are still rising, sales are flagging. According to property broker Centaline, unit sales this February were down 13.8% year-on-year across the 54 cities it tracks.

Anecdotal evidence comes from other sources too.

New Century magazine quotes Hong Kong tycoon Li Ka-shing who said he is offloading two developments in Shanghai and Guangzhou because “the flour had become more expensive than the bread”.

There were also jitters last week at the developer Country Garden, with the sudden exit of its chief financial officer. Its shares promptly fell 12% and they are now well down on their 2007 peak of HK$13.68, trading this week at HK$2.85.

Concerns about cash flow and debt levels have had a big impact on equity prices at other developers too, many of which are trading at distressed level.

Take Hong Kong-listed Agile Properties, which has net gearing of about 98%, and is currently valued at only 0.5 times estimated 2014 price-to-book – as is KWG Properties with net gearing of roughly 84%.

Those worried by China’s economy say there are no examples in which countries with rapid, debt-fuelled growth have avoided a credit bust. But supporters of Chinese exceptionalism wave the country’s urbanisation drive as their trump card. Despite millions of Chinese moving to cities over the last generation, China is still less urbanised than Japan and South Korea at similar points in their economic development.

Property bosses will be hoping that further flows from rural areas to urban ones is going to protect real estate prices over the longer term too.

The central government says that it plans to boost the urbanisation ratio from 53.67% to 60% by 2020, with some of the likely benefits laid out in a landmark report released this week by the World Bank and the State Council’s Development Research Centre.

In particular it advocates overhauling China’s land policy to address the perverse situation in which a majority of the population can’t afford to buy a house no matter how great the oversupply of housing stock.

This is partly due to the richest 10% driving up prices by speculating in real estate in the absence of more attractive investment opportunities. But it is also the result of local government fiscal policies. The report says that local authorities tend to zone excessive amounts of land for industrial usage (hoping to raise taxes from factories), but allocate much less for residential use in order to sell what is available at the highest possible price.

The report reiterates calls for a national property tax to replace land sales as the main source of local government revenue. For the past three years a pilot scheme has been running in Chongqing and Shanghai, but there are concerns that the market could go into a downward spiral if it were to be rolled out nationally. For instance, what would happen if investors decided it was more cost-efficient to start selling the estimated 15% of homes sitting empty rather than pay the new tax?

The second negative consequence of zoning so much land for industrial use is urban sprawl. This is another area where the report believes the government can make a major difference. Some 260 million people may have migrated to the cities over the past 30 years, but China’s urban density has actually fallen 25% during the past decade. The situation is particularly bad in smaller cities like Anhui’s Anqing, which has expanded in land area by 12% despite a decline in population.

Another of the report’s suggestions is that adding a further 5.3 million residents to Shenzhen would give it the same urban density as Seoul.

The argument is that many cities have a terrible track record in spending efficiently on infrastructure and urban planning, and that building denser, rather than larger, cities, will help China cut down on traffic congestion, air and water pollution and the maintenance costs for infrastructure services.

So more concentrated urban development should enable capital to be deployed more effectively, nurturing better quality growth.

The report says that $5.3 trillion needs to be spent on infrastructure over the next 15 years but that China can save $1.4 trillion, or 15% of last year’s reported GDP, by making cities denser.

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