“Houses are for living in, not for speculation,” has been a common refrain from the Chinese leadership in recent years.
We think the renewed focus on stability in the sector will mean curbing excesses in both directions. However, we see significant divergence at the local level, with scope to tighten or loosen policies as warranted by conditions on the ground. In the longer term, significant structural and demographic challenges are likely to weigh on underlying housing demand trends. But near-term winners are emerging and should only grow stronger as financing conditions remain favourable and they benefit from consolidation.
Source: World Bank, Fidelity International, April 2019
China’s ageing population will be one of the most important factors driving property demand in the next 20 years. People aged 25-45 account for the lion’s share of property purchases in China, but as seen in Chart 1, this cohort is gradually shrinking as a percentage of the population.
At the same time, China is transitioning from an investment-led to a consumption-led growth model, which means property-related investment and construction will become less significant as a tool for economic expansion. Moreover, as China continues to liberalise and modernise its capital markets, Chinese savers’ preference for physical real estate over other assets - such as a more traditional investment portfolio of stocks and bonds - is likely to change.
Because of these factors, we estimate that reasonable demand for new homes based on household formation has plateaued. That said, on a square footage basis, actual new home sales volumes have already surpassed our estimates of reasonable demand levels in recent years. Sales have been lifted beyond reasonable demand from household formation in part due to ample liquidity but also the predilection, as noted, for investing in real estate over other financial investments. We expect reasonable demand for new homes to gradually decline from current levels.
Significant near-term opportunities
Despite these long-run macro challenges, from an on-the-ground investor’s perspective we see three reasons to take a constructive view on China’s property sector in the near term.
First, while the common objective of policy-makers will be stability, we expect to see more divergence across the sector. This will invariably include some tightening and some loosening, but measures are likely to be quite localised and specific to individual cities and markets.
Source: CREIS, Citi, Fidelity International, May 2019
Second, in tandem with policy localisation, price performance will continue to diverge by city. From the buyers' perspective, sales volume in the year to date were up nearly 40 per cent in tier one cities (Beijing, Shanghai, Guangzhou and Shenzhen). By contrast, volumes in second tier cities were generally flat, whereas tier three and tier four cities saw declines of around 20 per cent. From the developers' point of view, the focus has also been on tier one and two cities, where land sales volumes rose by high single digits in the year to date, against a drop of 18 per cent in tier three and four cities.
This bifurcation of the marketplace is likely to continue, in our view. Ongoing reforms to the hukou, or national household registration system, coupled with various initiatives by local governments to attract and retain talented workers from other provinces, should only increase the pull of higher-tiered cities for China’s internal migrants.
Third, access to onshore bond markets has improved in recent months, especially those developers who already have access to offshore USD bond markets (meaning they are generally regarded as being higher-quality issuers). The onshore put ratio, or the value of bonds being put or sold back to the issuer over total amount outstanding, is a good indicator of this. In the first four months of this year, for developers who have accessed both onshore and offshore bond markets, the put rate for onshore bonds fell to 21 per cent, down from 44 per cent in 2018, as demand for such bonds rose. In comparison, developers without access to the offshore US dollar bond market are not seeing as much improvement, with their aggregate onshore put ratio falling to 47 per cent so far this year from 52 per cent last year.
How China’s demographic and other structural challenges will play out in the property market is perhaps an underappreciated risk to the sector, one that looms on the distant horizon. However, we are more sanguine on near-term market dynamics. Leading developers with exposure to China’s higher-tiered cities - and access to both onshore and offshore credit markets - are likely to be the biggest beneficiaries from the trends currently unfolding in China’s real estate sector.