Concrete Analysis

China's 'golden era' of real estate may be gone, but good times ahead for developers with longer-term outlook

Althoughgolden era for the industry may be gone, developers which are prepared and have a long-term view will still find opportunities

PUBLISHED : Wednesday, 09 September, 2015, 12:31am
UPDATED : Wednesday, 09 September, 2015, 5:42pm

China's real estate market has been on an upward trend since its privatisation about 25 years ago and has become known as the "golden era" over the past two decades because most developers have delivered high returns to shareholders through aggressive land-bank building, leveraging to the limit, and by taking advantage of cheaper financing sources.

Coupled with a strong sales momentum and various support measures introduced by the central and especially the local governments, real estate has contributed attractive returns to developers in a "quick and effortless" way. It is a demand-and-supply play with almost unlimited demand in the past for housing and commercial properties.

As a result, it became one of the most sought-after business sectors by capital markets. As long as you owned some land, you could raise capital through various means and there would always be homebuyers waiting outside your door. Forget about the market cycle because each "recession" lasted for no more than 18 months. Share prices went up so you could raise even more capital to buy more land. So it went on and on.

In contrast, the market is now experiencing decreasing sales volumes and contract sales. Housing prices in the country started to cool in late 2013, with annual growth in average new home prices falling to an 11-month low in April that year. Saleable inventories brought forward from the previous year grew 35 per cent in 2014, compared with a 22 per cent year-on-year drop in 2013 and higher than the 16 per cent sales growth for the year.

The number of months to digest these inventories, using last year's average monthly sales, increased to 9.4 months from eight months by the end of 2013. Developers' core return on equity declined to below 10 per cent from 14 per cent.

The slowdown in construction value becomes one of the key measures for most developers to control inventory and achieve more efficient capital utilisation to improve (or rescue, to be more precise) core return on equity.

Do not underestimate the impact of slower sales as it creates multiple problems for the industry, no matter where we are in the market.


What is the future direction of the mainland's real estate market?

A hard landing is unlikely even if sales or market growth slows, largely for two reasons.

First, the central government cannot afford any further tightening of the property market, given its indispensable contribution to gross domestic product (currently about 23 per cent). Even if we ignore the handsome tax contributions by real estate, the declining GDP numbers in the past few years have forced policymakers to turn a blind eye to rising housing prices.

Second, massive local market liquidity without many investable products will always support property prices. I am not sure anybody dares to put their money into the mainland stock market, given what has happened in the past few months!

While I remain positive - even more so today - about the genuine affordable demand for the property sector (excluding commercial properties) in major mainland cities over the medium term, I believe the market will go through a three-year cycle of increased volatility, restructuring (or repair) of developers' balance sheets and market consolidation. To put all three under one term - the "institutionalisation" of the real estate sector. Yes, it is happening now and quite fast.

The "golden" era may be gone, but better prospects await those who are prepared and have longer-term views. When developers' shareholders are struggling to achieve single-digit return on equity on the A-share market, debt products, especially trust loans, are enjoying virtually risk-free 10 per cent all-in funding costs, if not more.

Industry consolidation will occur. Yes, liquidity is abundant on the mainland, but only those big developers, mostly owned by the government, can get access to capital, regardless of whether it is cheap or not.

Smaller players with limited access to capital markets have to resort to more expensive funding, such as domestic trust companies (non-bank lenders) or the so-called peer-to-peer market (private unregulated lending). These sources generally provide short-term high-yield loans packaged into debt products and sold to retail investors.

Developers realise the impact of these short-term expensive loans, especially when sales slow, and are trying hard to deleverage. The 50 to 60 per cent discount in listed developers' net asset value is a warning sign to repair their balance sheets quickly.

The market has undoubtedly entered into a new phase of deleveraging and we expect some industry consolidation as well through mergers and acquisitions.

The impact will be significant: the 65,000 registered developers on the mainland could be downsized by two-thirds through friendly mergers and acquisitions, and less aggressive future sales tell developers to do so. That is why we have recently seen life insurers aggressively buying stakes in property companies, which are not expensive at all.

Other than typical bank loans, developers are actively seeking alternative capital sources for growth and refinancing. Some leading players have either partnered with financial institutions, such as life insurers, or established in-house financing platforms to access alternative sources, such as securitising commercial assets.

I believe new opportunities come from new challenges. The sector is far from finished - it is only 25 years old and considered very young compared with the much more mature Western markets. The golden era may be gone, but a more institutionalised market will emerge. It is hard to predict its exact shape, but it will offer better opportunities to investors who are prepared and willing to take a longer-term view.

Ren Rong is a veteran China property investor and the founder and former chief executive of Harvest Capital Partners