Li Junheng of jlwarrencapital.com provided a summary translation to subscribers of her research and allowed me to post it here on Sinocism:
Mao Daqing, the vice chairman and CEO of one of the largest Chinese developers, Vanke Group, shared his concerns and some red flags he sees in the Chinese property market last night at a private salon.
Someone recorded his speech and posted online-万科毛大庆在建策沙龙上的发言. We at JL Warren Capital have translated and summarized the speech for you, because we think it has good data points and analysis. This was an honest, fact-based, well-thought-out speech. It offers a differentiated view on the Chinese property sector, which is the lynchpin of the Chinese banking and shadow banking system, the domestic economy, commodity prices, and therefore the global economy.
Mao touched upon supply and demand (especially in the Beijing market), the impact of anti-corruption measures on the secondary market, day sale of inventory (DSI)/inventory, trends in house construction per thousand people, and very importantly, the impact of changes in Chinese demographics on the economy in the near- to medium-term.
He singles out three major trends in the Chinese real estate sector in 2014:
(1) T2-3 cities: Supply exceeds demand, by a lot
(2) T1 cities: Continue to see robust demand; however, land prices have gone up more than project ASP.
(3) Credit has tightened.
China’s anti-corruption campaign has had a greater impact on high-end property projects than most have realized. Investigations are ongoing into owners of property priced around 40K-50K RMB/sqm, not to mention more expensive properties. The increased scrutiny surrounding the anti-corruption campaign has caused demand to fall off in the high-end property market.
The second-hand housing market has been even more impacted by the anti-corruption campaign. New listings for sale surged to 10-12 units per day, twice as many as before.
Many owners are trying to get rid of high-priced houses as soon as possible, even at the cost of deep discount, because many corrupted officers have illegally accumulated several or more houses through bribery or embezzlement. As a result, ordinary people who want to sell homes in the secondary market must face deep price cuts.
On the other hand, the supply of affordable homes (for hard demand, i.e. buying to move in) is very constrained. For instance, in Beijing, the number of applications exceeded 250K on the pre-sale day for ~5000 units of such homes.
In Beijing, around 90% of the demand for transactions is driven by consumption demand. Per request by the government, Vanke has launched some property projects in Beijing at lower prices of around ~22K RMB/sqm, regardless of the potential financial losses. All units were sold out in four hours, since the prices were set lower than market price to accommodate consumption-driven homebuyers.
If the price were set at 28K-29K RMB/sqm, the number of buyers for the property would immediately drop, and if it was priced at 30K RMB/sqm, the number of buyers would drop more.
The bottom line is that demand for low-end priced homes is robust, whereas high-end homes are seeing sluggish demand in T1 cities.
In China’s 27 key cities, transaction volume dropped 13%, 21%, 30% year-on-year in January, February, and March respectively.
We expect the trend to continue in April. The drivers behind the fall in price are credit tightening from the banks and customer’s weak sentiment towards the economy.
Most cities have witnessed an increase in inventory-sale ratios for residential buildings. Among the 27 key cities we surveyed, more than 21 cities have day sale of inventory (DSI) exceeding 12 months, among which 9 have DSI greater than 24 months.
The supply of residential buildings is rapidly increasing month-on-month, but transaction volume remains low.
This year is atypical for banks, since there’s no specific loan target set for them. Banks such as BOC, ICBC, Bank of Communications, and CITIC have set up a special group tracking the property projects and identifying the targets to grant loans. The group is made up of professionals who have hand-on experience with real estate, and therefore the criteria for granting loans are in line with market perspectives. Without pressure from to fulfill a loan target, banks have begun to be selective in granting loans.
The average debt-to-capital ratio is 65% for property developers in 2012, and the ratio is 43% for the leading developers. In 2013, the debt ratio has been increasing for developers with projects in large cities with relatively expensive land. Meanwhile, borrowing costs have increased.
Lands acquired in 2013 have been developed, and projects will be launched in early 2015. Beijing is expected to have ~42 projects with floor area priced at 50K-120K RMB/sqm. By the end of 2014, there’ll be another round of surges in the supply of homes priced around 40K-50K RMB/sqm.I’m pessimistic about the housing market in Beijing, given that it’s highly unlikely to have purchase restrictions removed in the next 3-5 years.
In a good market, annual units sold were about ~70-80K, plus ~130K-140K pre-owned/second hand houses listed in the market, so the total amount would be ~200K units. The additional 50K units that would emerge in the market can’t possibly be digested by the consumption-driven demand, especially when those units priced ~50K rmb/sqm.
As far as the future of Chinese real estate industry, we need to keep an eye on the following issues: The first is to determine whether the supply of residential apartments is still lacking. The supply level can be gauged by units per capita based on the area’s permanent population. One relevant measure is house production per 1,000 people. Based on construction completed from 2009-2011, this number is 12.1 in China, a figure that is close to the peak of many other countries but still acceptable. However, this neglects two facts: first, the construction completion rate in China is low; second, many illegal and private constructions are not counted in these totals.
For most developed countries, housing production per 1,000 people is less than 12 even when the housing market is hot; no country has a figure of greater than 14.
Based on construction launch of residential buildings, house production per 1000 people in China reached 35 in 2011. Sorted by tiers, the number for T1 is reasonable at around 10-15. The figures of T3 and T4 cities are consistent with the national number. T2 cities, on the other hand, show severe oversupply. By 2011, housing production per 1000 people reached 30 in T2 cities, excluding the construction of affordable houses. A persistently high figure such as this for T2 cities should cause alarm. A high ratio for T3 and T4 cities is also a warning sign, because these cities are not as capable of attracting investors as higher tier cities.
Overall, I believe that China has reached its capacity limit for new construction of residential projects. Only those coastal T3/T4 cities have potential for capacity expansion. We consider a housing price surge highly unlikely, especially in the cities with large housing inventory. Beijing and Shanghai have already been listed among the most expensive cities in the world in terms of the medium central city property prices.
Another critical measure to monitor a potential property bubble is the total land value over US GDP during the same period. In 1990, Tokyo’s total land value accounts for 63.3% of US GDP, and while Hong Kong reached 66.3% in 1997. Now, the total land value in Beijing is 61.6% of US GDP, touching a dangerous level.
China’s new government has developed a distinct approach from the last government. Monetary policy has become the main tool for economic stimulus, which in turn caused the money to flow back to real estate sector. Investment in infrastructure and fixed assets can only provide a temporary stimulation in economic activity; they can’t create value in the future. Without investment in R&D and the private sector, Chinese economic growth won’t be sustainable.
The second critical issue is the demographics in China. Our research shows that by 2033, the total population aged 60 and above will reach 400 million, as well as an additional 270 million people living on social welfare. That is, by the end of 2033, there will be approximately 670 million people, or 50% of the Chinese population, will be living on social welfare. Assuming that each working person can contribute 60% of the living expenses of one person on social welfare, 50 million people will need to feed 90 million people in 18 years. Currently, 90 million working people contribute to the living expenses for 50 million people on social welfare. If China fails to develop technology as a driving force for its economic growth, the country will be in trouble. We estimate that housing prices will reach a peak within 18 years.
Credit to Li Junheng of jlwarrencapital.com. If you do not read her research, you should.