China’s Property Market: Policy Is the Real Risk by Hayden Briscoe, AllianceBernstein
Concerns about a possible collapse in China’s property market continue to grow. However, our research suggests that fundamentals are more robust than many think. The biggest danger lies in the potential for policy mistakes.
Investors are understandably worried about the headlines coming out of China’s property sector. Sales fell in July after having seemed to stabilize in June. For the first half of this year, sales nationally fell by 6.7% year over year, to RMB3 trillion (US$488.4 billion). That’s the first time such a steep fall has occurred since 2011.
We see three reasons for the sector’s slowdown. The main cause is China’s credit tightening, but there’s also the base effect created by extremely high sales in 2013 (a result of strong pent-up demand in 2012) and the country’s overall economic slowdown. Each of these stems from government policy. Credit expansion fueled demand for property in 2012—now, the government is rebalancing the economy so consumption will play a much bigger role alongside investment as a driver of growth.
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To appreciate the impact of these policies on the property sector, it helps to consider its key fundamentals. Despite the decline in sales volumes, there has been no meaningful drop-off in property prices nationally. During the first six months of the year, the implied average selling price nationally fell by just 0.8%. But sales prices and volumes vary from project to project and city to city. On residential projects in Tier One cities such as Beijing, Shanghai, Guangzhou and Shenzhen, for example, price cuts of 5% to 10% can boost sales volumes literally overnight. Price cuts—even with steeper discounts—tend not to work in lower-tier cities.
This relationship explains why sales prices haven’t really moved. In Tier One cities, the number of properties being sold as a result of price discounting is too small to have much impact on national average sale prices. Developers in other cities aren’t lowering their prices because they know it won’t improve sales. Based on this evidence, if credit isn’t relaxed on mortgages, or if national prices don’t correct to stimulate demand for upgrades and investment, the physical market will likely consolidate further.
Oversupply is the main cause of concern for many people, but it’s not a nationwide issue, in our view. It’s particularly severe only in a few lower-tier cities (Display 1) and in the commercial property sector. On the national level, the supply-demand imbalance is manageable, and our research suggests that it can be resolved over the next two to three years, with demand underpinned by urbanization and, to an even greater extent, by people wishing to upgrade.
In the commercial property sector, oversupply is high—much higher than in the residential sector—and it has created images of ghost towns. While this could evolve into a bigger problem, commercial real estate accounts for a very small proportion of the overall property market (Display 2). This suggests that a crisis in commercial property is highly unlikely to destabilize the whole sector.
So, while there’s a supply-demand imbalance in the Chinese property market, it should be capable of resolving itself in the medium term, assuming a stable policy and credit environment. The key risk isn’t supply or demand, but the availability of short-term liquidity: Over the past few years, developers have been taking leverage from local governments’ balance sheets and adding it to their own. A severe shrinkage of bank and non-bank liquidity for the sector (most likely policy driven) would probably be the catalyst for a much larger correction. This, however, is not our base case scenario.
The views expressed herein do not constitute research, investment advice or trade recommendations and do not necessarily represent the views of all AllianceBernstein portfolio-management teams.
Hayden Briscoe is Director of Asia-Pacific Fixed Income and Jenny Zeng is a Research Analyst for Corporate Credit, both at AllianceBernstein.
This article previously appeared in the Financial Times.