Chinese Housing Market Risks Subsiding…

Whenever I walk around a Chinese city, I’m struck by how poor the finish can be on ‘luxury lifestyle’ new developments of bare shell flats which rarely match up to the billboard images of foreign sophistication. A key issue is that with no national building code, the quality of construction is generally very poor and sometimes downright dangerous compared to HK or Singapore (thin floor plates with exposed rebar, disconnected sprinkler systems etc.) and the depreciation rate will be far more rapid. There have been numerous cases of new towers subsiding into the ground soon after construction, and the same is now happening to prices in several markets. Average new home prices in China’s 70 major cities rose 7.7% y/y in March, slowing from 8.7% in February but activity and prices are slumping in some second and third tier regional cities.

For instance, although national home sales declined 7.7% in Q1, in the weaker provincial markets they collapsed e.g. -38% in Hangzhou, -25% in Wuxi, reflected in developers slashing prices to sustain cash flows, a trend I highlighted in a note last month. Indeed local media have reported that the cities of Changsha, Hangzhou and Ningbo have been openly discouraging property developers from cutting prices further. The coastal city of Wenzhou, which saw an SME liquidity crisis, and Ordos in Inner Mongolia where coal mining profits spawned a well-publicised boom of empty towers have seen their property markets hardest hit by the shift in sentiment. In Hangzhou (home city of Alibaba), the average selling price for residential units in the downtown area is down by over 11% y/y while as of March, 76,004 residential housing units were available for sale, an annual increase of 36%.
<New property construction starts fell 25.2% y/y to 291m square meters (the lowest quarterly amount of new floor space started since Q1 2009).

Urban real estate investment accounts for more than 10% of GDP, so ongoing weakness in the property sector would be a drag on H2 GDP growth. Some degree of policy loosening has already begun, with a few of the worst hit cities discussing removing curbs on property purchases but the key remains to boost supply of low-income rental housing (with a 7m unit public housing target this year, and 4.8m completions – the latter is actually over 600,000 fewer than last year) and accelerate the property introduction (being piloted in Shanghai and Chongqing) to curb speculative hoarding and expand the local tax base. Low income housing only accounted for 13% of total real estate investment last year (or 2% of GDP), so it can’t offset weaker trends in the wider market – the focus in any case seems to be on renovating existing 1950s/60s shantytown flats rather than Greenfield new build.

Beijing and other Tier 1 cities remain resilient although momentum is slowing; developers remain aggressive buyers with the total value of YTD land sales in Beijing reaching 102bn RMB as of last week, a level not seen until late September last year and even allowing for a moderation, the total is likely to exceed 200bn RMB this year for the first time. Meantime, commercial property investment also seems to be stalling after a huge rise in values (e.g. prime office space up 65% in Shanghai in the past 4 years, with gross yields sub 6% and flat to falling). I think indoor shopping malls (of which the country has 2,500 and still rising) remain the most egregious example of real estate over-investment and looming write-offs now that the online share of retail sales has reached 10%. At the moment the risks of a property crash look more regional than systemic, but contagion risks to Tier 1 cities bear close watching in coming months. In the meantime, with China’s total foreign debt at only about 9% of GDP and export demand still sluggish, the RMB will continue to take the growth strain.