Rental market boom is a silver lining for China’s property sector

A liquidity crisis has called into question the way Chinese developers financed and built homes, and shattered confidence among homebuyers and investors
With Xi Jinping prioritising affordable rental housing amid a ‘common prosperity’ push, however, investors could do worse than align themselves accordingly

Nicholas Spiro

Published: 9:15am, 5 Apr 2022

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Warren Buffett, the legendary investor, famously quipped that “you only find out who is swimming naked when the tide goes out”. In China, the housing market is having its Buffett moment. Since last July, sales have fallen sharply, plummeting 22 per cent year on year in the first two months of 2022. New home prices in 70 cities have contracted in month-on-month terms almost every month since last September.

Beijing’s deleveraging campaign and much tougher regulation have caused an acute liquidity crisis that has called into question the way developers financed, built and marketed homes. Severe distress and financial contagion across the industry has shattered confidence among homebuyers, investors and creditors.

The rapidly retreating liquidity tide has revealed that the swimwear of even some of the higher-quality builders was not sturdy enough to cope with the sudden closure of global capital markets to Chinese developers. Despite a pledge by the government last month to ease pressure on the sector, persistent doubts about the scope and efficacy of a reversal of policy are prolonging the crisis.

Yet, it is not all doom and gloom in China’s housing market. The slump in residential sales has accentuated the resilience and appeal of rental housing. With more than 200 million people renting homes in the world’s second-largest economy, the sector is estimated to be worth 1 trillion yuan (US$157 billion), according to data from JLL, and is starting to become more institutionalised.

While policy-induced stress in the sales market has increased dramatically, government support for the rental sector has intensified over the past several years. This is because housing has become a much more politically sensitive issue since President Xi Jinping launched his “common prosperity” campaign aimed at spreading the nation’s wealth and reining in financial excesses.

In a sign of the extent to which policy towards the rental and sales markets has diverged, Beijing has introduced a range of measures to promote the development of rental housing by boosting the supply of land, providing tax incentives and strengthening regulation.

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10-storey residential building in China constructed in a day

Indeed, Xi himself made clear that affordable rental housing was a priority in his essay on common prosperity, published last October. The government has also encouraged more market participation in state-backed programmes to provide affordable rented homes, and has made it easier for existing commercial buildings to be converted into rental accommodation.

Charles Ma, managing director of Greystar China in Shanghai, said that, at a time when confidence in the residential sales market has eroded, the government is “more willing to consider rental housing”.

It is not just supportive policies that are driving the rented sector. Demand is being underpinned by favourable demographic trends, notably large migrant populations in Tier 1 cities and growing demand from young professionals and fresh graduates for professionally managed and amenity-rich rental housing.

Moreover, while home values have fallen, price-to-income ratios in Beijing, Shanghai and Shenzhen remain much higher than in other major cities around the world, increasing the appeal of renting.

From an investment perspective, government support for rental housing adds to the attraction of an asset class which, while still in its infancy in China, is benefiting from a global reallocation of capital towards real estate assets with defensive attributes in a post-pandemic world.

In the United States, the most mature and liquid rental housing market, multifamily properties – apartments that are institutionally owned and rented out to a variety of tenants – accounted for 42 per cent of commercial real estate deals in the first three quarters of last year, compared with 19 per cent for offices, data from RCA shows.

Even in Shanghai, mid-to-high-end rental housing units, which only accounted for 8 per cent of the city’s rental stock in the first half of last year, enjoyed an average occupancy rate of 91 per cent, data from JLL shows. Leasing activity in Shanghai’s office market, by contrast, was much weaker during the pandemic, with the overall vacancy rate still in double digits.

To be sure, institutional investors in China’s rental housing sector have their work cut out. With the government focused on supporting affordable rental accommodation, the market-based leasing market faces bigger challenges.

One is the difficulty in acquiring land zoned for rental housing since sites are granted almost exclusively to state-owned enterprises and local developers. Investors must rely on conversion opportunities, making it hard to build scale quickly.

Another key constraint is the lack of liquidity, which has a deleterious effect on pricing and transparency in the sector, and reduces the range of exit routes for investments.

Yet, the establishment of a market for real estate investment trusts (Reits) in China could be a game changer for the rental housing investment market. The successful listing of nine Reits on the Shanghai and Shenzen bourses last June encouraged Beijing to include affordable rental housing in the Reit pilot programme.

Although, for the time being, China’s Reits exclude traditional types of commercial real estate, Ma said that the government treats rental housing as part of the infrastructure assets it allows Reits to finance, making it more likely that market-based rental housing will eventually be included in the Reit programme.

China’s residential sales market is experiencing a severe crisis, mainly as a result of the government’s austere policies. The prospects for the rented sector, on the other hand, remain bright. Being aligned with Beijing’s policy priorities has never mattered more.

Nicholas Spiro is a partner at Lauressa Advisory

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