The mainland property sector is waging a battle on several fronts. Rising costs and oversupply are hitting developers' margins.
The smaller, more peripheral developers are also getting cut off from capital markets, particularly the trust sector. The more indebted ones face refinancing risk and potential bankruptcy, as seen with the recent collapse of Zhejiang Xingrun Real Estate.
All events are pushing investors to rank developers in the markets they cover, with those focused on first and second-tier cities favoured over the rest.
Beijing, Shanghai, Guangzhou and Shenzhen belong to the first tier and provincial capitals stake out the second tier. Smaller and more economically peripheral cities fill out the rest.
According to Xinhua, Zhejiang Xingrun is "struggling" to repay 3.5 billion yuan (HK$4.4 billion) of debt, of which 2.4 billion yuan is owed to banks. The firm was hit by falling land prices that hurt the value of its land bank, said the news agency.
The company also borrowed from the underground lending market - essentially, pooled loans from individuals - an expensive form of credit that was the firm's undoing, according to analysts.
Zhejiang Xingrun focused on Fenghua, a small city in Zhejiang province that is decidedly fourth-tier. Its implosion reinforced the view that developers focused on such markets are vulnerable.
The third and fourth-tier markets are oversupplied. A Nomura report issued on March 14 says a depleting labour pool from rural areas and ageing demographics mean urban population growth is at its lowest since 1996, and set to drop further.
The bank says this slowdown is most pronounced in third and fourth-tier cities, which is showing up clearly in developers' inventory levels, or the amount of unsold flats they have in each market.
"If you look at sales to inventory levels, you can see very high inventory [among the developers devoted to third and fourth-tier markets], which is in stark contrast to the developers in the first-tier cities," said Stephen Chang, the head of Asia fixed income at JP Morgan Asset Management.
The government in 2010 applied cooling measures that initially favoured development in the third and fourth-tier cities. This included restrictions on second home purchases that only applied to first-tier cities, and mortgage restrictions that cut the level of loans banks could extend to buyers of second homes. This measure applied to all cities, but as most of the buyers in lower-tier cities were buying for the first time, it had less impact in those markets.
Many property firms responded by focusing their development in the lower-tier cities. In the beginning, this was a good move as the cities were undeveloped and margins were high, but it quickly led to oversupply, hurting prices.
A JP Morgan economic report released last week projects home prices to rise 5 to 10 per cent in higher-tier cities but stay flat in third-tier cities this year.
The bond market reacted badly to the Zhejiang Xingrun news. Property dollar bonds dropped in price last week by about 3 per cent, and debt issuance from the developers - which in normal times make up about half the Asian high yield market - ground to a standstill.
But investors do not see this as a monolithic market. They are differentiating credits according to their refinancing risk, largely by looking at their access to capital markets, which is highly correlated to the tier of market in which they do business.
"It's not the best of times [to bring a real estate bond]. If it were a blue chip, it might price a little wider, but for weaker names, investors have a lot more concern," said Deepak Dangayach, the head of Asian high yield at Deutsche Bank.
The larger, listed developers have financing options. They can sell shares, convertible bonds, and they continue to have good access to the offshore syndicated loan market. They also raised a lot of money in the bond market in recent years, giving them a buffer.
Moody's says rated developers have raised US$9.1 billion in offshore bonds since the beginning of the year, and have only US$1.9 billion of offshore bonds maturing during the remainder of this year - their refinancing risk in this market is low.
Large developers have also worked hard to cut their exposure to the trust loan market over the past year, making this beleaguered market less critical to their refinancing needs.
This is not the case for smaller developers exposed to lower-tier markets. As exemplified by the Zhejiang Xingrun implosion, they are more dependent on the shadow finance sector, and have limited access to capital.
"For unrated players, we think the refinancing risk is high. From a bank perspective, we saw a liquidity crunch happen a couple of times last year," said Bei Fu, a director of corporate ratings at Standard & Poor's.