Standard Chartered are on the ball as ever when it comes to developments in the Chinese real-estate market.
In their latest note they warn about the scale of possible over-supply that’s set to hit the market.
Take as an example the following chart, outlining their supply forecasts:
Read it together with the following chart, showing the pace of recent inventory builds, and you start to feel a little queasy:
We stress they’re not actually setting out to be alarmist. Standard Chartered are actually being very level-headed. Sales of new apartments may be down, but the analysts — Lan Shen, Stephen Green, Li Wei — emphasise that these sales do come against an extremely robust performance in the second half of 2010. Most importantly, developers’ land-buying and construction activity still remain at high levels, suggesting they are not in severe pain (at least not yet).
That said, there are still plenty of good reasons to be concerned, say the analysts (our emphasis):
Nationwide, inventories turned positive at the beginning of H2-2010, and have climbed more sharply since February 2011. We forecast that they will continue to build in the coming months, peaking in Q4-2011. Our estimate of inventories in 35 major cities is currently already higher than the peak in 2008, the last time the central government forced a slowdown in the sector.
We are now starting to hear stories of large numbers of built and unsold apartments in some cities. The Beijing Morning Post has reported that Tongzhou, a satellite town near Beijing, has 20,000 unsold apartments. This is equivalent to seven years of supply, on the basis of 3,000 units being sold a year.
Secondary market prices in Tongzhou are off some 20% from their peak, and we assume they have further to fall. We expect such stories to grow in number – which will be, to mix our metaphors, a red rag to the China bears. Rising inventories should push developers to cut prices, after their initial moves to offer non-price inducements such as cash rebates, free parking spaces and furniture vouchers, which are already becoming common. We also hear the odd story of developers discounting headline prices. Prices were cut by around 15% for one Chengdu project we heard about recently, after which the apartments were sold.
As the market learned in the 2009-10 cycle, a quick cut in prices finds demand – and if sales bounce back, inventories should be absorbed over the course of 2012. For the moment, though, with the central government signalling a continuation of its market-cooling policies, we expect the limited sales volumes seen in the last couple of months to continue into Q4. We foresee price cuts of 10-20% in many cities.
As always with China, you also can’t generalise about the national market. Tier one cities present very different fundamentals to Tier two and Tier three cities.
In this instance, the analysts say the oversupply situation is mainly a problem concerning the Tier-two sector.
As they explain:
This is the national story – but as real-estate agents love to tell us, location is everything. Using the same methodology outlined above, we have found that the inventory situation varies widely across the country. In short, we believe the Tier 1 cities, the target of the authorities’ measures, do not have an inventory issue – and this should be supportive of prices. In some (we emphasise only some) Tier 2 cities, excessive inventories are a serious issue. In the Tier 3 category, situations again differ across cities, but the overall inventory situation does not seem as bad as in the Tier 2 universe.
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As a general rule, Tier 2 cities have the worst emerging inventory problem, but again, it varies across cities (to the extent that we are reluctant to even refer to ‘Tier 2’ cities as a category). If pushed, we would put forward the following hypothesis for Tier 2 cities: developers have been active there for five years or so, and ample land for sale has boosted supply. However, there is less demand from outside these cities than in Tier 1s. Although recent central government measures have focused on Tier 1 cities, many measures – including fewer second- and third-home mortgages and restrictions on nonresident owners – have impacted Tier 2 cities more than Tier 3 cities, which has affected demand. Thus, a large supply overhang is developing in some Tier 2 cities.
Though, even within the Tier-two city band itself, there are also better and worse off metropoli. Cities like Nanjing, Suzhou and Xiamen, for example, should fare okay in the analysts’ opinion, while cities like Dalian and Tianjin will experience the biggest inventory builds and be most affected.
How developers continue to fund as-yet unfinished projects in a tight money environment, meanwhile, may also play a big part on the scale of inventory that will hit the market.
As the analysts note:
Developers’ finances are coming under more pressure. Based on the cash flow/investment ratio, they are almost worse than during the 2007-08 down-cycle.
That said, the evidence currently suggests developers are still willing to spend the cash they do have (or can get) on development.
There could well be a significant slowdown in construction activity in H2 – but so far at least, it is not showing up in the data. And given land sales, it seems that many large developers are still aiming for a high level of construction activity.
Continued construction at the current pace would obviously only make the situation worse.
Related links:
Goldman warns of significant China slowdown – FT Alphaville
Fate of China property is global concern - FT
China’s trusts – still booming - FT Alphaville
