In Shanghai, Zhou Lin almost has it all. The 27-year-old has a steady job with an auditing firm and a new husband. Now she and her spouse are looking for the next piece of the newlywed puzzle. Her husband already owns an apartment in Beijing, but Zhou’s family wants them to buy something close to home in Shanghai and she’s been scouring the city’s Putuo district for deals.
"We want to buy a house as soon as possible, but I don’t think now is a good time. We may have to wait until next year when the price is more acceptable," she told CHINA ECONOMIC REVIEW.
While Zhou is waiting for prices to bottom out, others have already seized upon bargains. Stella Ye, a Beijing-based public relations consultant, purchased an apartment in her native Chengdu in December. Ye said the timing of her purchase was driven in large part by price cuts.
"I planned to buy an apartment in 2007, but now the price has dropped sharply, although it is still not very cheap," she said.
The waiting game
Zhou and Ye provide a glimpse into the stalemate being played out in China’s property markets. Overextended developers are struggling to entice buyers at a price that will help salvage what many believe will be another challenging year. Buyers are waiting to see the market’s floor before they purchase.
While a rebound in China’s property markets won’t singlehandedly counter the country’s slowing economic growth, it would provide a welcome boost to a flagging economy. A study by brokerage Nomura International in Hong Kong found that China’s property sectors account for 8% of nominal GDP and 10% of the country’s total employment.
Yin Zhongli, vice director of the institute for finance and banking at the Chinese Academy of Social Sciences in Beijing, is pessimistic about the difference property might make this year, however. "Reviving the real estate market in 2009 is impossible, because there is an imbalance in supply and demand," he said.
Residential real estate prices had been on a steady climb for years, to the glee of many. Local governments, which derive much of their revenue from land sales, courted developers while raising land prices. Developers financed their projects with debt from willing state-run banks.
One expert referred to the cycle as "the greater fool theory," in which developers, investors and individual homebuyers could flip their property at a higher price to the next buyer. All the while, the inventory of unoccupied homes grew.
But years of aggressive expansion collided with economic uncertainty in the second half of 2008, dragging the property market into a slump. "China has run out of fools," the expert said.
Residential vacancy rates ballooned by 47% over the course of 2008, reaching 90.7 million square meters. China’s housing price index stood at 99.6 at the end of December, down from 111.3 in January, and analysts say official figures paint a rosy picture of the current situation.
While there is some evidence of a slight turnaround, most predict that 2009 will be tumultuous year for China’s property markets as well as developers.
Although keen to promote the long-term view of urbanization-fueled demand, Xiao Li, vice president of China Vanke, the country’s largest real estate developer, admitted that "short-term market fluctuations in supply and demand may exist."
Xiao said that Vanke last year slowed its development activity to 5.7 million square meters of ground floor area (GFA) compared to a planned 8.48 million in response to market conditions.
Vanke isn’t alone in curbing development. According to official statistics, GFA under construction in China grew by 16% from January to December of last year, to 2.74 billion square meters. This is down sharply on the 23% rise for the first 11 months of 2007 (full-year figures for 2007 were not available).
Such cutbacks, though needed, do little to address the current situation.
"There is oversupply across the board," said Jing Ulrich, chairman of China Equities at J.P. Morgan, speaking to reporters in February. Based on 2008 sales levels, she estimates it will take one-and-a-half years to clear unsold inventory in Beijing, Shanghai, Shenzhen and Guangzhou. In this environment, developers are struggling to make ends meet.
"Funding is a common trouble for Chinese real estate enterprises in 2009, no matter if they are state-owned or non-state-owned, listed or non-listed," said Pan Shiyi, CEO of developer Soho China, responding to questions submitted by CHINA ECONOMIC REVIEW via his blog.
For the past three years, restrictions on bank lending to developers have been at the heart of government efforts to cool the property sector. These restrictions were reversed late last year alongside the introduction of a raft of policies to entice homebuyers back into the market (See: "Stimulus: Market boosting measures"). Chinese banks went on a lending spree in January, extending US$237 million in loans, more than doubling lending from the year before.
Policymakers hope the surge in lending bolsters developers, but this is unlikely, according to David Ng, head of regional property research for Royal Bank of Scotland (RBS) in Hong Kong.
"Developers are very cautious, which makes me believe that loan growth and credit easing won’t be that attractive for developers. When nobody’s buying the existing inventory, why would they want to borrow money to build more?"
Some believe that statistics on overcapacity might be overstating the problem, however. Nomura International in Hong Kong has found that November’s vacancy rate of 70.8 million square meters, while representing an increase of around 15% since March, is one of the lowest rates seen in the past 10 years.
Kenneth Gaw, president and co-founder of Gaw Capital Partners, a private equity firm with around US$1 billion under management in the Asia-Pacific region, said he expects a sharp drop off in supply over the next two years due to lack of funding, while core demand remains unchanged. This will lead to opportunities for those investors who have the stomach to ride out the current downturn.
This is the case that believers in China’s residential market make time and again. Despite short-term fluctuations in supply, a low base of modern housing, as well as a vast population and continued urbanization will fuel robust residential demand for years to come (See "The long view: China’s urban future").
There may already have been signs of a shift in market sentiment. Residential transaction volumes received a small bump in November 2008, rising to 40.3 million square meters, from 39.64 million in October. The significance of this figure is widely disputed. Some believe it marks the beginning of a recovery, while others see it as a monthly anomaly.
Soho China’s Pan is in the latter camp and notes that more than 50% of November’s transaction volumes in Beijing was driven by low-income housing.
"The sharp downturn in transaction volumes did not change," he said.
The year ahead
The conventional wisdom among many analysts who spoke to CHINA ECONOMIC REVIEW is that housing prices will fall in 2009 while transaction volumes increase – meaning that larger developers who can survive on volume sales while forsaking margins will be best suited to weather the storm.
But RBS’s Ng is cautious about volume growth this year. While price cuts may have been effective in boosting transaction volumes in 2008, he expects the strategy to yield diminishing returns.
"The effect of price cuts may not be replicable in 2009. People have seen the price cuts last year and now everyone is cutting prices. It’s become more competitive," Ng said.
Analysts believe that purchases by "end users" – those who intend to use the house as their primary residence – will drive volume growth this year. But market watchers are anxiously awaiting the return of people to buy additional residences for investment purposes, to know that the market is back on track.
Stella Ye may be ahead of the curve in this respect. Her apartment in Chengdu was her third home purchase, the other two being in Beijing. Ye bought the apartment primarily as a residence for her parents and for her frequent visits home.
These buying patterns were once common in Chengdu, according to Eddie Ng, the managing director of property consultancy Jones Lang LaSalle’s office there. Buyers would purchase multiple homes with the expectation that the price would increase between pre-sale and occupancy. The downturn in the market, combined with a weak leasing market, has scared many of those buyers away.
"At the start of 2006, every week there was some investor coming to my office. But in the last four to five months I’ve only had visitors once a month or once every two months," he said.
Flight to quality
According to Greg Penn, senior managing director of investment properties for CB Richard Ellis in Hong Kong, it is not unusual for investors to leave second- and third-tier cities in a downturn and return to the first tier for deals. Rising prices and unfavorable government policies pushed many investors into the lower-tier cities for deals in 2006 and 2007. But this has changed as prices have dropped to affordable levels. Cash-strapped local developers, often with attractive assets but limited funding options, also are beginning to look more seriously at selling off their portfolios to raise money.
"A couple of years ago we were looking at secondary and tertiary cities, [but] today we’re mostly focused on major cities," said Robert Zulkoski, managing director of US private equity firm Oaktree Capital Management’s office in Singapore.
He describes the allure of the first-tier cities in one word: comfort. Although opportunities exist throughout China, the first tier has the veneer of reliability. Zulkoski said Oaktree was likely to close a deal in China in the second quarter.
Analysts say that this return to comfort should also guide individual investors looking to invest in China’s listed real estate developers. They suggest taking shelter in big brand names with national exposure and strong ties to the state – the likes of China Resources Land and China Overseas Land Investment (See "Built to last: Shelter for the individual investor").
These developers have geographically diversified assets as well as war chests that put them in a position to weather the expected industry consolidation.
That consolidation is coming is beyond dispute. But the shape it will take and its long-term implications remain a matter of debate. Between 2,000-3,000 property developers are active in each city, many with only one or two properties. Manfred Ho, an analyst with Bank of China International in Hong Kong expects this inefficiency to be rectified, but not as drastically as some might believe.
"I actually won’t expect to see 30-40% of developers [disappearing] in a year or something like this. I think it will be a longer-term procedure," he said.
Nonetheless, M&A activity is expected to pick up in the second half of the year, encouraged by M&A laws released in December that allow banks to extend loans for acquisitions. Such lending will almost certainly favor larger developers and they will have plenty of targets to choose from, many of whom had no business getting into real estate in the first place.
"Ten years ago, everybody wanted to be a real estate developer … Everyone from autos to steel to cement companies have been active in real estate," said Michael Harris, chief operating and investment officer at Beijing-based Gao Fei Consulting, which works with private equity firms investing in real estate assets.
Hand of the state
These "part-time developers" would be the likely first victims in any wave of industry consolidation, although takeover candidates with strong ties to local governments may have a staying power beyond their commercial viability.
Market watchers also expect the central government to step in before any major developer goes bust, as such an incident would further deteriorate shaky market sentiment. As such, some believe much of the consolidation will occur under the radar, rather than via mass selloffs of portfolios by collapsing developers.
"Consolidation doesn’t mean firesale," said Rong Ren, chief executive of private equity firm Harvest Capital in Hong Kong, which has about US$1 billion under management in two Greater China-focused real estate funds. "I think the consolidation will be gradual, face driven, more partnership-driven. That’s part of the Chinese philosophy."