China’s skyrocketing real estate market has been a topic of both fascination and concern. Beginning in 2011, the government has attempted to curb real estate speculation and slow down the rapid pace of the property market’s expansion. However, during the second half of 2012, China’s property market rallied on the back of strong demand from first time home buyers along with the availability of cheap mortgages. Prices in some top tier cities rose sharply, especially in January 2013, with Beijing recording a month-on-month increase of 2.1%, Shanghai at 1.3%, Guangzhou at 2.0% and Shenzhen at 2.2%, compared to an average of just 0.7% for 70 other major cities. This trend has attracted the attention of the government, which introduced policies designed to stabilize the market including higher down payments, residency requirements, tougher mortgage qualifications, and limits of investment purchases.
Although speculation about China’s “hard landing” scenario has received much attention in the not so distant past, it seems China’s economy is heating up again. With China’s construction sector making up approximately 15% of GDP, it is a bellwether of economic trends. In addition, because Chinese households tend to invest much more of their household wealth into real estate, a sudden collapse of the real estate market would be disastrous. This would also affect finances at local government levels given their large property-related income and taxes. Thus, as part of our fundamental analysis for our Emerging Market Debt strategies, we closely monitor the corporate health for Chinese real estate and construction companies. With a large percentage of the health of the country’s economy weighing on real estate, should the Chinese government take a harder line in attempting to suppress demand? Is it time to worry about the bubble bursting? All valid concerns, but we don’t believe it is time to hit the panic button just yet.
Despite the backdrop of rising policy risk, we maintain a constructive outlook for the near-term property market in China. After a recent property tour that took us from Shanghai to Changsha to Wuhan, we identified three factors that should cause the improvements in real estate fundamentals to continue through 2013 – a bad sign for pundits heralding the end of the Chinese property “bubble.”
1) Policy risk is still there, but manageable given the pre-emptive and effective government interventions over price and volume in last 12-18 months. With Chinese leaders’ reiteration of their agenda to control property prices in order to ensure the stability of the market, we do not expect any relaxation in policy. However, we consider this manageable as the recent measures point to stricter enforcement of some existing measures or reiteration of the government’s stance to increase land supply. These policies only target some selected top tier cities where property prices had risen sharply, rather than a nationwide implementation. We believe the overall price increases expected this year will be within the government’s tolerance level, so we do not anticipate stringent tightening measures that would hamper the healthy development of the sector.
2) Fundamental drivers are supportive following the normalization of nationwide inventory levels after slowed construction starts and encouraging presales in 2012. Bond valuations are attractive as trends for home prices in the major second-tier and third-tier cities are still healthy and mortgage rates and availability remain supportive for first-time home buyers. My discussions with local sales people still consistently point to a strong and sustained demand from first time home buyers. Urbanization will be a key growth engine for housing demand.
3) Favorable rating actions are expected given the stable industry outlook from Moody’s, and the recent action from S&P to change its outlook for China’s property sector back to stable.
While there are downside risks such as a sharp and sustaining price hike in first-tier cities, the three factors discussed, combined with our local insight and on-the-ground research confirm our rationale for a constructive outlook for Chinese property bonds for 2013.