China Property: Hot or Not?

Approximately 23 Chinese cities recently announced real estate policies intended to limit home price appreciation.  Headlines have noted soaring home prices in Shenzhen and a few other markets.

• Fortune: China’s Property Boom Continues as Prices Rise at Record Rate
• WSJ: Chinese Cities Restrict Home Purchases to Cool Buying Frenzy
• SCMP: Regulators begin the delicate task of cooling, but not stalling or crashing, China’s sizzling property market

Conclusions from a detailed review of 100 top markets (using Soufun monthly price data):

• Strength is limited to a few cities in three regions
• Affordability is reasonable in most markets
• Weak real estate markets in most of the country explain tepid new investment in real estate and related commodity demand
• Weak real estate markets in most of the country highlight the importance of careful selection of investments in real estate companies

Home price strength is limited to a few cities in three regions.

Using a two year perspective to balance 2016 strength with 2015 weakness shows that prices have actually fallen in 57 of the top 100 markets.  Smaller markets not included in Soufun data are mapped below in white but nearly all would also be mildly negative blue if comparable data were available.  Top markets in the three strong regions are highlighted at right.  These areas have strong local economies with rising wages and growing populations that create genuine demand for new and better quality homes.

Affordability is reasonable in most markets

The average September 2016 home price in China’s top 20 markets was 20159 RMB/sqm, equivalent to $277,272 for a 1000 square foot home.  17 of these markets now have restrictions intended to limit further price increases.  Measures like higher downpayments and lower mortgage LTV ratios will only defer long-term demand from residents and migrants.  Some demand is shifted from expensive markets to lower priced nearby markets which can be reached by expanding transportation infrastructure (for example Kunshan next to Shanghai and Langfang next to Beijing).  Speculative demand may shift towards property markets without restrictions or to other asset classes like equity.

The average price in the next 80 markets was 6758 RMB/sqm, equivalent to $92,726 for a 1000 square foot home.  6 of these markets now have restrictions intended to limit further price increases.  Many of the markets with falling prices have weaker economies dependent on traditional heavy industries.  Local housing demand is supported by residents seeking to upgrade from old low quality buildings, but overall urban populations are not growing.  Some of these cities have significant oversupply of inventory.

International comparisons often ignore the extremely low ongoing cost of home ownership in China.  There are no annual property taxes.  Monthly apartment maintenance charges are typically under 2 RMB/sqm/month, equivalent to a total of just US$27.44/month for a 1000 square foot home.

National average urban incomes over the past two years have risen 14.9%, more than home prices in all but 21 markets.  Meanwhile average mortgage rates fell from 6.93% to 4.55% in the two years ended 6/30/16.

Weak real estate markets in most of the country explain tepid new investment in real estate and related commodity demand

Growth in spending on real estate construction has been relatively weak despite the strong gains in average home prices:

 

Weak investment has depressed demand for related construction equipment (e.g. heavy trucks) and building materials (cement steel copper etc..)  The government has cushioned the impact of the real estate downtrend by encouraging increased infrastructure investments such as Transportation (+11.9% YTD), Electricity Gas & Water Production and Supply (+16.15 YTD), Water Conservation and Cleanliness (+24% YTD).

Most of the housing market restrictions are intended to restrain prices by limiting demand rather than increasing supply.  Construction businesses cannot expect a surge in orders where home prices have risen, except to the extent that demand spills into adjacent markets without restrictions.  And most markets where prices have not risen are likely to remain weak.

Weak real estate markets in most of the country highlight the importance of careful selection of investments in real estate companies

Developers are enjoying booming sales and healthy profit margins to the extent that they operate in the strong markets.  Home price restrictions can defer demand to future periods, but long-term demand is supported by the fundamental economic advantages of leading cities.  Exposure to these markets varies considerably from one company to another.  Some details were provided in this article: September 2016 Housing Price Data in Markets of Selected Chinese Property Developers.

Some developers are changing their business models to retain a larger portion of their projects for long-term investment.  SOHO China is the best example with its plan to hold its prime Beijing/Shanghai CBD office properties.  A developer relying on a business model of high asset turnover may not be able to replace land inventory as finished projects are sold or only be able to acquire plots far from city centers.