Chinese Residential Real Estate 中国住宅市场特别报告.ppt

Ying Wang,Corporates,Property/RealEstateChinaSpecialReportAnalysts+86 10 8567 9898 ext.Kalai Pillay+65 6796 RelatedResearchApplicable Criteria Rating Chinese Property DevelopmentCompanies:Sector Credit Factors(February 2011),Chinese Residential Real Estate:Q&AOverviewThis report addresses some key market questions and concerns over Chinasresidential property sector,as a followup to Fitch Ratings report“Rating ChineseProperty Developers:Sector Credit Factors”published on 16 February 2011.This report highlights factors which differentiate the Chinese housing market fromdeveloped housing markets in the Western world.The report does not attempt topredict the direction of Chinas property prices such speculation has already beenwidely circulated by different research houses in many different ways.Instead,Fitch explores what any“downturn”would look like,and the implications of adownturn for the agencys rated Chinese property developers.The report addresses the key risk factors facing property developers,and,moreimportantly,the actions which property developers have taken or are expectedto take as they attempt to navigate through a downturn.How istheChineseHousingMarketDifferent?It is relatively easy to become concerned over the threat of overinflation in Chinashousing market,judging from the combination of residential property valuationscomparable with or,in some regions,above Western developed levels,andaverage income levels significantly below those of developed countries.Fitch agrees that Chinas residential property prices are at a stretched level byWestern standards,and that the inherent sector risks are more consistent with thecurrent speculativegrade ratings of Chinese homebuilders in the BB and B ratingcategories.Figure 1Fitchs Published Ratings on Chinese Property Issuers,Franshion,Shimao,Evergrande,Road King,Properties(China)Ltd,PropertyHoldings Ltd,Real EstateGroup Ltd,Sunac ChinaHoldings Ltd,InfrastructureLtd,Shanghai ZendaiProperty Ltd,IDROutlook,BBBStable,BB+Stable,BBStable,BBStable,BBStable,B+Stable,Source:FitchHowever,the agency believes that the fuller picture is more complex,and thefollowing are the key factors differentiating the Chinese housing market fromWestern developed markets.Rapid Urbanisation:Continues to Drive Housing DemandUrbanisation in China is taking place at an unprecedented pace,and will continueto drive demand for infrastructure construction and real estate over the next fewdecades.China expects its urbanisation rate to rise from 47.5%in 2010 to 51.5%bythe end of 2015,with an average annual increase of 4%,according to thegovernments 12th fiveyear plan.Furthermore,Fitch notes from a poll of estimatesby sellside research analysts that the countrys urbanisation rate is likely to growat an average annual increase of 1%beyond 2015 and to approach 70%by 2030.Many of the people moving from rural areas will become firsttime home buyers,while the rest(including the existing urban population)will have a greater desireand more disposable income to upgrade their housing.,3 May2011,2,Corporates,Affordability:Income Multiples May be Inflated,Chinas average income levels which are commonly used to estimate thecountrys housing affordability relate generally to the entire spectrum of thelocal population.,It must be noted,however,that the vast majority of the Chinese urban populationlives in homes built by the government,ownership of which was transferred to theirtenants in the 1990s.This accounts for the high levels of homeownership in China,where rentals generally only apply to temporary residents.Many owners ofgovernmentbuilt homes do not have the income capacity to afford even thecheapest of the homes being sold by private property developers.These individualsand households are not their target buyers;simply put,these homes are not beingsold to the“average”Chinese.,In addition,income data collected by Chinese government agencies are notinclusive of grey income,or nontaxable income such as allowances and stipendsrewarded by Chinese companies as supplemental employee benefits.There are alsoa variety of ways adopted by private enterprise owners to understate their taxableincome.Therefore,the official income statistics are not reflective of actual incomelevels in China.,LowLeveraged Buyers,A further support to the argument that affordability,while appearing stretched,isnot at explosive levels,comes from the leverage being employed in home purchasesin China.In stark contrast to the recent subprime debacle in the US,a substantialproportion of new home purchases in China are made in cash(i.e.no mortgage istaken out).Fitch estimates from discussions with major property developers,bankers and investors that this proportion of cash payment is in the region of30%50%of newbuild purchasers.,This figure is supported by the lack of a vibrant private rental market there is avery limited supply from real estate investors willing to accept yields of 2%3%onleasing otherwisevacant properties.While this may seem odd for many investorsglobally,it is consistent with practices elsewhere in Asia,notably Singapore,wherehigh rates of unoccupied investment properties coexist with low rental supply.Italso supports the conclusion that few,if any,of the home purchases are funded byleverage through a different channel(i.e.other than bank mortgages)not visible toproperty developers.,Lack of Alternative Investments,China is grappling with rising inflation.Despite the central banks multiple interestrate hikes over late2010 and early2011,real interest rates remained negative inChina at endQ111.A lack of sound alternative investment opportunities make realestate the most attractive asset class in China from the perspective of both capitalappreciation and inflation hedging.,The Chinese peoples preference with regard to real estate investments is alsosupported by the countrys lack of a wellestablished social security and medicalsystem.China faces the challenges of a CNY10trn social security fund deficit whichwill continue to widen over the next few decades.The Chinese people regardproperty ownership as a sense of security,in addition to a storage of value.,Chinese Residential Real Estate:Q&AMay 2011,1,3,Corporates,ADifferentStageinTime,The reader must keep in mind,though,that some of the factors“differentiating”the Chinese market also existed in other developed markets in their earlierstages of development.Urbanisation,inflation and income growth contributed tothe fairly steady and rapid rise of median home prices in the US from USD11,900in 1960 to USD17,000 in 1970.The period of high inflation in the 1970s resultedin their median prices hitting USD47,200 in 1980 and rising further to USD79,100,in 1990,despite the onset of the Savings&Loans crisis1.,WhataretheLikelyScenariosforaDownturn?,Fitch believes that property sales volumes are more meaningful than pure valuationdeclines in assessing the magnitude of a housing downturn.,Lower Price,Lower Volume,In one scenario,both property prices and sales volumes may fall from their peaks,and be sustained at low levels for at least two years.Fitch believes this is the mostnegative scenario for property developers.A sustained period of low transactionvolumes coupled with declining prices would indicate severe damage to buyerssentiment,which could arise from a significant and unexpected slump in Chinaseconomy and requiring years to recover.,A shrinkage in contracted sales will retard the cash inflows of property developers,and liquidity crunches could be exacerbated further if the economic slowdown ispreceded by or coincides with a major failure in Chinas banking system,making government macroloosening ineffective.,In addition,any prolonged period of high real interest rates may also result in lowproperty sales.While mortgage rates may not directly influence demand,due tolow household leverage,as acknowledged above,high real interest rates coulddampen demand by raising the opportunity costs of locking up cash in lowyieldingproperty investments.,Lower Price,Higher Volume,A more plausible scenario is for property prices to decline with a simultaneous dropin sales volumes.However,sales volumes would start to rise again to approach oreven exceed predownturn levels within 12 to 24 months.This scenario assumesthat the macroeconomy and the banking system remain fundamentally intact suchthat the Chinese government maintains the flexibility to implement macro policiesto stimulate housing demand.,As was observed in some other Asian markets like Hong Kong and Singaporebetween end2008 and end2009,once prices fall sufficiently,demand returns driven by low real interest rates,low household leverage,and the existence of alarge number of potential buyers who felt that they had“missed the boat”in theprevious rapid price rise.Indeed,this phenomenon was observed on a somewhatlower scale during the same period in China.,An additional factor that may boost demand in China would be the potential for thegovernment to encourage banks to grow by focusing on mortgage and consumerlending to improve profitability and capital ratios after large losses in the wholesaleloan book.A rapid shift to consumer lending and personal financial services wasobserved in South Korea following the corporate loandriven banking crisis in thelate1990s.,Source:US Census Bureau,Chinese Residential Real Estate:Q&AMay 2011,a,4,CorporatesUnder this scenario,property developers will face shortterm liquidity pressures.Those developers who have accumulated cash prior to the downturn from presaledeposits and fundraising exercises to refinance some debt maturities,whilemaintaining discipline over land replenishment needs,will be more financiallyresilient than those challenged with imminent bond maturities and,to a lesserextent,unpaid land premiums.Although unloading inventories at low prices will result in reduced or even negativeprofit margins,Fitch would expect property developers to prioritise liquidity,ratherthan profit,during the initial 12 to 18 months(“Phase I”)following the onset of ahousing downturn.Rising sales volumes,despite price drops,can still allowdevelopers to conserve cash by unloading inventories at a faster rate.In addition,land costs generally contribute no more than 20%of turnover for mostrated developers,unlike more developed markets where this figure may be 30%orhigher.There is potential for other costs including construction and buildingmaterials to fall in a period of downturn.Fitch notes that metal spreads in theChinese steel industry and gross margins in the cement industry remain healthydespite chronic overcapacity in these industries,indicating potential for lowerprices if demand tapers off.As a result,the“lower price,higher volume”scenario contains a manageabledownside for developers.Industry consolidation activities are likely to beconcentrated during Phase II of the housing downturn,after a number of small andweak developers have failed within the first 12 to 18 months and the stronger oneshave survived the worst period.In Phase II,large,geographically diversified,midend and mid to highendfocused developers such as Evergrande Real Estate GroupLimited(Evergrande,BB/Stable)may take the opportunity to acquire good qualityland banks and/or projects at a low cost from weaker competitors in distress.Another Fitchrated issuer,Road King Infrastructure Limited(Road King,BB/Stable),which is known for its toll road operations in China,established itspresence in the mainland property market in 2007 by acquiring the assets of a thenhighprofile property company(i.e.Sunco)which was in distress at a significantdiscount to its precrisis market value.Fitch believes the ability of those developers to survive a downturn and leadindustry consolidation is not only driven by their geographic and project profilesand existing liquidity positions,but also by the equity cushion in their financialleverage.Figure 2 shows that Fitchs publicly rated Chinese property developersmaintained moderate financial leverage(measured by net debttoinventory ratios)in the range of 20%to 50%at end2010,providing modest headroom for additionaldebtfunded acquisitions.Figure 2Financial Leveragea,Franshion,Shimao,Evergrande,Road King,Shanghai,Properties(China)Ltd,Sunac ChinaHoldings Ltd,PropertyHoldings Ltd,Real EstateGroup Ltd,InfrastructureLtd,ZendaiProperty Ltd,IDR/outlookNet debt/,BBB/stable20,BB/stable18,BB+/stable46,BB/stable38,BB/stable20,B+/stable53,inventory(%)As of 31 December 2010 for Franshion,Sunac,Road King,Shimao,and Zendai;as of 30 June 2010 for EvergrandeSource:FitchHowEffective are GovernmentPolicies?In Figure 3,Fitch outlines a number of policy measures the Chinese government hasimplemented since April 2010 to tighten the property market.Although many of themeasures have taken a toll on transaction volumes over the past six months,Chinese Residential Real Estate:Q&AMay 2011,5,Corporatesnationwide property prices have remained relatively resilient.The agency notes anumber of“loopholes”which have made these measures“less effective”from apriceadjustment perspective.Figure 3Chinas Property Tightening Measures,Government measuresBank mortgage lending limits are beingcentrally reduced.Consumers are being prohibited fromtaking out a mortgage for second orthird properties.,Effect upon marketMany buyers are cash,or largely cash.Families may arrange their purchases to evade this restriction,through extended family members or artificial divorce.Corporates will continue to invest(though most are just buying,raw land).Residency limits are being enforced(eg Extremely effective in the nearterm driving sales volumes,in Beijing it is necessary to show fiveyears of tax returns)A 5%tax is levied on any house salewithin five years.Banks are prevented from lending todevelopers to buy land,only toconstruct.Policy is encouraging people towardsthe interior.,down significantly.Questionable as to how sustainable Chinastraditional focus on residency in regulating its citizens willremain at a time when labour mobility is still encouraged.Tax rates in this bracket are not a major deterrent for thoselooking to longterm appreciation,or if shorttermappreciation expectations are above 15%.Developers can still raise equity,domestic bonds or offshorefunds.Discipline on the lender side may be more patchy forsmaller,rural banks where local governments may be moreinfluential.High demand may just be exported,as inflation pressures arerising in the interior as well.,Source:FitchIn addition,while the scope and range of Chinas policy response is formidablerelative to the types of policy tools available to the authorities in developedmarkets,Chinas central authorities face similar,significant challenges to all othermarket factors from the low level of data transparency and verification within theproperty system(see the Limitations section below).This will inevitably act todilute the efficacy of policy measures in practice.WhichTypeofDevelopersareMostVulnerable?The factors which would lead to i