Is Chinese real estate nearing a tipping point? | FT Alphaville

Is Chinese real estate nearing a tipping point?

China’s property developers — who last year contributed a collective 13 per cent of GDP — seem determined to hang on.  Despite months of falling prices in most cities, completions are powering ahead.

Chinese real estate investment reportedly rose 23.5 per cent in Q1, year-on-year. And yet new construction rose only 0.3 per cent and sales of residential and commercial property fell 14.6 per cent. As Patrick Chovanec points out, despite accounting for the aforementioned 13 per cent of GDP, there was little questioning of the incongruence of these Q1 2012 numbers which showed steeply rising investment in a sector that was actually shrinking in terms of revenue.

And yet, while we and others have wondered about a wave of developer defaults was imminent, there’s been only the occasional reports of smaller developers running into difficulties.

It *might* be about to change, however. Inventories are well past the 12-month mark and are forecast to reach about 36 months by the end of this year, according to Standard Chartered. Last week we wrote about some research from Nomura arguing that a month-on-month collapse in housing starts in April (down 27 per cent) signalled a turning point.

Standard & Poor’s are also dubious about the sector’s health (our emphasis):

In our view, sales prospects are likely to remain muted for the rest of this year. The key issues remain high inventory and competition, which could lead to a price war. In our view, the government is unlikely to materially change its stance on curbing speculation in the property sector. This is because there are lingering concerns about inflation and the government’s social housing program has made limited progress in addressing the needs of low-income families. Nevertheless, we believe policy fine-tuning will continue as the Chinese economy softened in the first four months of this year; exports and domestic consumption are weak. We expect the government restrictions on home purchases to remain in place for the rest of this year in many Chinese cities.

Meanwhile… funding is becoming a big problem, says S&P: refinancing risks are high for many of their rated developers.

The debts maturing in 2012 form about 31% of total outstanding debts of our 30 publicly rated China developers–not a high percentage. However, about 42% of the debts maturing this year are offshore bonds, offshore bank loans, and onshore trust loans, which some developers are finding difficulty refinancing (see charts 3-6).Unlike onshore project loans, which have been a stable source of funding for developers, offshore debt is sensitive to market sentiment and trust loans are subject to regulatory intervention.

S&P-rated China developers - outstanding debt - as at end 2011

So, almost a third of debt matures this year, and roughly half of that either (mostly offshore) corporate bonds, offshore loans, or trust companies.

Bond markets are small and undeveloped domestically, while offshore bond markets are already looking more difficult than usual:

Only a few property developers have issued bonds in the offshore market this year. Funding cost has risensignificantly from one to two years ago. Agile Property, one of the sector’s established names, issued its 2017 bondat 9.875% in March 2012 compared with another bond at 8.875% in April 2010. In the offshore bank loan market, borrowing costs have risen too, and terms are shorter because the liquidity pool has shrunk. Only large and established developers have access to offshore bank loans, even in good times

Domestic bank loans are another option not looking great: property-related loans from the top five commercial lenders “grew at a significantly slower pace” in 2011 compared to 2010, and the slowing trend has continued so far in 2012, says S&P. It is “uncertain”, the report’s authors write, “if further credit easing would increase loans growth if banks are cautious about property credit risk.”

Trust company loans, meanwhile, are at punishing interest rates:

S&P-rated China developers - trust company interest rates - S&P May 2012

And that’s if you can get the things: S&P says increasing regulatory scrutiny and rising credit risk will make those trustco loans even more difficult to obtain and expensive.

S&P conclude that this will be a “year of polarisation” for Chinese property developers; one that necessitates large price cuts:

Property developers in China face tough choices in 2012. Those companies with large maturing debts and refinancing risks on their offshore debt and trust loans are likely to push property sales by cutting prices aggressively or sell assets. As a result, we stand by our base-case forecast calling for average selling prices to drop by about 10% in 2012 due to rising inventory and liquidity pressure.

A small upturn in sales in the past couple of months doesn’t inspire much confidence either:

When the pinch starts to bite, benign price discounting could turn into a price war. This may happen if the property sales recovery in the past two months lose momentum and volatile external events derail an orderly correction of the property market. Indeed, 2012 will test the survival of more than 80,000 property developers in China.

Indeed there are already plenty of signs of this. Here’s the latest one we’ve seen, from The Economic Observer this month:

Another developer has even cut the size of the “first down payment” to 5% of the home price for those first-home buyers. The remaining 25% – the largest available mortgages are for 70% of the home’s value – should be paid in installments within nine months.

The banks, apparently, do not recognise such agreements and are not terribly keen on developers adding most of the deposits to their existing risk.

Related links:
Beijing’s Credulous Home Buyers – The Economic Observer
China Real Estate Unravels – Patrick Chovanec
Chinese property developers hold their breath – FT Alphaville