Wednesday, June 11, 2014

Will China avoid a severe housing market correction?

Staying with the topic of residential property markets, let us now take a look at China. Investors continue to be concerned about the nation's builders who have been under pressure lately. As housing price appreciation slows, some media outlets are calling the situation an outright "panic" (see video). Others are pointing to tight credit conditions hitting property developers:
Want China Times: - There is ample liquidity in the inter-banking market since overnight rates and seven-day repurchase agreement rates are both at low points, but borrowing rates continue to climb, signaling higher costs for businesses, the newspaper stated.
The banks' more cautious attitude has resulted in liquidity not being channeled into the real economy, the newspaper said.
The property sector is expected to bear the brunt under the government's financial reform plans, according to UBS chief China economist Wang Tao, since the current market downturn, unlike those in the past, is caused by oversupply, the government's anti-corruption campaign, and the growing number of investment options.
Some are also concerns about the "wall" of maturing debt in China's property sector.
Bloomberg: - The amount of dollar-denominated bonds that must be repaid in 2015 will jump to $2.83 billion, the most in data compiled by Bloomberg going back to 1993. Most Chinese builders listed on the mainland or in Hong Kong are behind fiscal-year sales targets and achieved less than 33 percent of their target in the first four months, analysis based on Bloomberg data show.
There is little doubt that we are going to see some failures among developers. The question is what will this do to the housing market in China. Is a severe correction on the horizon? According to Deutsche Bank, this is simply a part of another housing cycle - a third one in 6 years.

Source: Deutsche Bank
DB feels that buyers are simply waiting for discounts and will begin to move back into the market once prices are cut.  DB's economists make the following points:

1. Chinese property buyers/investors have seen this downturn a couple of times before in the last few years. This is not a panic. In the past, discounts of 20% on new properties brought buyers back and cleared excess inventory in a few months. We could definitely see a correction as we did in the past two cycles, but nothing too severe.

2. Current inventory levels and price increases are fairly close to their historical averages.

3. Some correction will likely occur in the "tier 2" cities, where inventory levels are elevated. That's also where we may see some developers fail. Unsold inventory in Beijing, Shenzhen, Guangzhou, and Shanghai on the other hand is at moderate levels.

4. Wages in China have been growing faster than housing prices, making properties more "affordable" (though a great deal of the new housing is not accessible for the bulk of urban residents).

5. Nearly half of China's urban population lives in "pre-housing-reform" dwellings. Given the horrible quality/conditions of many of these structures, they will need to be replaced soon. Such buildings get demolished, taking housing stock out of the market.

6. There are estimates that some 150 million more people will be migrating into the cities in years to come, increasing the demand.

As China's population ages, construction is expected to slow in the long run. But for now DB does not see anything other than a cyclical adjustment.
DB: - We think this replacement or upgrading demand coupled with the migration of at least another 150mn people to the cities could support urban residential construction at about last year’s level for many more years.
... our perspective on the property market sees the current difficulties as primarily cyclical – tightening credit, slowing growth and over-exuberance on the part of some developers – rather than structural. 
... In the near term, the cyclical downturn that began late last year is likely to continue at least a few more months. But we are confident that once developers start cutting prices meaningfully – 20% seems a reasonable guess – demand will revive.
Consolidation among property developers is inevitable. A severe housing correction however seems unlikely.
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