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As recent events have shown, property developers have become systemically important in China. According to a report by Goldman Sachs Group Inc, the total value of the Chinese real-estate market hit $52 trillion in 2019. This is twice the size of the US residential housing market and accounts for an estimated one-third of China’s economy.
The sector is also increasingly highly leveraged as well as more concentrated. Back in 2013, the top 50 developers in China accounted for approximately a quarter of property development. By 2019, this figure had increased to 60% of new building activity and UBS estimates that in 2021, the top 50 developers are likely to account for around 70% of new building activity. This highlights the importance that the government acts to ensure they are financially viable.
To balance the strong demand for housing whilst slowing the spead of over-leveraging and preventing firms from taking on more obligations that they are capable of repaying, the government has in August last year, introduced rules on property sector leverage which became known as the “three red lines”. These rules are aimed at limiting property developers’ debt according to three balance sheet metrics: the ratio of liabilities to assets; net debt to equity; and cash to short-term borrowings.
Based on a Financial Times analysis carried out last month, almost half of China’s 30 biggest developers were in breach of at least one of these metrics on property sector leverage. If developers breach the rules, they face caps on their ability to raise new debt. However, developers that are currently failing some of the rules still have time until 2023 to fully comply with the requirements.
It is estimated that 65 million homes, or 20% of the total supply in China are unoccupied. Homeownership rates in the country are also high. More than 90% of households in China are homeowners compared to 65% in the US. Over the past two or three decades, the price of Chinese real estate has generally moved higher, generating a popular belief in China that real estate is always a safe investment.
The average cost of a home varies vastly depending on the region and the city. In China’s tier-one-cities – like Beijing, Shanghai, and Shenzhen – housing costs around 14 times as much as the average salary. In tier-two cities, homes cost roughly seven times the average salary, while in tier three, four, and five cities, home prices are about five times as high as the average salary.
According to Moody’s estimates, 70-80% of Chinese household assets are tied to real estate which is high compared to any other developed country. While in the west, people diversify their investments and the majority goes to capital markets, in China, where the capital markets are less developed and highly volatile, people keep much more of their wealth invested in real estate.
Property has always been a highly regulated sector within China and policies have been fine-tuned along the years both at a local and state level. Deleveraging remains a key goal for the overall economy and therefore we would expect the property sector to face restrictive policies over the medium term. However, it is worth point out that the policy environment in 2021 has created broader economic stress that may have gone beyond the level where policy makers will remain tolerant of lower growth, given the likely pressure that it will create in reducing household wealth and incomes, rising unemployment and potential social stability concerns. This will probably require a refinement in policy in the coming months to stabilise the economy.
In conclusion, it is highly unlikely that real estate will be pushed as a growth driver in the way as past cycles, but equally a stabilised property market is key for China’s overall macro stability and this will probably be the focus for policy direction in 2022.
Disclaimer: This article was written by Stephen Borg, Head of Private Clients at Calamatta Cuschieri. The article is issued by Calamatta Cuschieri Investment Services Ltd and is licensed to conduct investment services business under the Investments Services Act by the MFSA and is also registered as a Tied Insurance Intermediary under the Insurance Distribution Act 2018.
For more information visit https://cc.com.mt/. The information, view and opinions provided in this article are being provided solely for educational and informational purposes and should not be construed as investment advice, advice concerning particular investments or investment decisions, or tax or legal advice.
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Calamatta Cuschieri Investment Services Ltd is licensed to conduct investment services business under the Investments Services Act by the MFSA and is also registered as a Tied Insurance Intermediary under the Insurance Distribution Act.
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