China’s property downturn may have found a floor
The government’s will to reform a wayward real estate industry is balanced against the more urgent task of reviving a slowing economy, but Fidelity International thinks upstream ancillary sectors – and underlying demand fundamentals – could still offer growth opportunities for the near and long term.
Published 12 July 2022
Written by Tae Ho Ryu, Portfolio Manager, Fixed Income, Alex Dong, Research Associate, Ming Gong, and Terrence Pang
China’s love-hate relationship with property investment appears to have reached a new level. Hot on the heels of a nationwide clampdown on speculative housing purchases, a rash of stimulus measures for homebuyers is being rolled out.
Local governments have for weeks been vying to offer incentives, from lower transaction levies to smaller down payments, financial support for shantytown renewal and even cash rebates for home purchases. More and more cities are joining a chorus of mortgage rate cuts after the Chinese central bank made a large reduction in its five-year benchmark lending rate in May. These measures are telegraphing the shift to global markets: China’s leadership is getting serious about putting the real estate ship back on an even keel.
Given the policy softening and what Fidelity International views as the long-term resilience of some fundamental drivers, Fidelity International thinks the current slump in home sales could finally be finding its floor. While demand may not recover to the red-hot levels of prior years, a lot of existing homes in China were built decades ago and Fidelity International sees demand for upgrading these in the pipeline. The need to refurbish older buildings, including non-residential structures, should provide support over the next decade and beyond for upstream businesses that rely on the sector tangentially, such as manufacturers of paint, waterproofing and pipes.
Respite for the weary
For months, markets have absorbed the blows from China’s campaign to cull leverage-spurred excesses in the property sector, which included allowing some huge developers to default and buyers’ demand to shrivel. The fallout has slowed China’s economy and cast a shadow on global growth, as property and related sectors remain disproportionately large contributors to the nation’s GDP. The focus on curbing leverage isn’t going away, and nor are several limits on speculative activity, but the new signals of policy stimulus measures suggest the housing sector, with 18 trillion renminbi ($2.7 trillion) in 2021 sales according to the National Bureau of Statistics (NBS), appears to have been given a chance to catch its breath.
More resilience upstream
While residential developers are still struggling with headwinds, Fidelity International sees some resilience in related sectors that capture demand for building maintenance and upgrades. The total floor area of housing in China has grown to 60 billion square metres, according to Fidelity International’s estimate based on NBS data, even as new home sales decline year-on-year. A conservative projection of renovation frequency, once every 20 years, would mean there are 3 billion square metres of residential property undergoing upgrades or renovations every year. In addition, Chinese markets for architectural paint, waterproofing and pipes have been highly fragmented compared to those in developed countries, implying significant room for consolidation and market share growth for larger players. The latter in many of these sectors are relatively well-capitalized, which should enable them to weather downturns in the wider property market - like the current one.
Urbanization, meanwhile, remains a long-term demand catalyst. Low value-added housing blocks may be a thing of the past, but developments tailored for modern consumer demand, like housing designed for its ageing population or rentals for younger Chinese – think of it as Urbanization 2.0 – appear set to continue. Around two-thirds of China’s population live in urban areas, according to NBS data, far below the 83 percent in America, based on US Census Bureau estimates, but the Chinese ratio continues to rise steadily.
Selective, targeted relief
Recent city-level policies indicate how deep-seated demand for real estate in China is still trying to find its way to the market, despite the economic challenges. Multiple cities have issued measures allowing households with second or third children to buy additional properties. Changsha in Hunan province is allowing homeowners leeway to buy more homes, as long as they are rented out and don’t sit empty.
Macro policy too suggests the government’s views on the compounding issues in the sector are evolving. In addition to the latest rate cuts, policy makers have been asking banks to lend more to developers. The government has also issued policy measures supporting onshore bond issuance for selected developers, a move aimed at providing credit risk mitigation and protections to investors. None of this amounts to a bailout, rescue package or other dramatic intervention. But directionally it marks a clear shift, and one that’s likely to help the consolidation of quality in the industry.
We are not out of the woods yet. Delivering some clear successes on the restructuring of developers would do much to promote investor confidence. China’s zero-COVID policies have been adding another layer of uncertainty. And without further cuts in long-term lending rates, many of the efforts at keeping the sector afloat so far appear to have had limited impact.
Lastly, to the extent that the ongoing restructuring forces greater financial discipline and consolidation, leading developers could emerge with stronger balance sheets. Far from losing relevance, Fidelity International thinks China’s property sector may remain a significant cornerstone for the economy for years to come, albeit with up and downs.
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