Outlook China: will the wood dragon bring luck or is the crisis endless?
10 February 2024 marks the beginning of the Year of the Wooden Dragon in China, which symbolises good fortune and the achievement of goals. Will the Wooden Dragon bring a boost to China's property sector in the new year? MainFirst Emerging Markets expert Andranik Safaryan is sceptical.
More than three years have passed since the Chinese authorities took the first measures to curb speculation on the property market. "Although Beijing is now taking the downturn in the property market seriously, more needs to be done. There is political room for manoeuvre," says Andranik Safaryan, head of the Emerging Markets/Corporate Debt team at MainFirst Asset Management. "An improvement in the outlook for the economy and the labour market, as well as in price expectations in the housing market, is essential in the short term". Monetary policy and banks must remain accommodative over the medium term to avoid a credit crunch that would affect the whole economy, similar to what happened in Japan in the 1990s.
"We are currently exercising caution with regard to the sector. However, investors who are patient and have a sufficiently long investment horizon can identify good investment opportunities in individual cases," says the portfolio manager. According to Safaryan, the main short-term challenge for the Chinese authorities is to improve household sentiment and boost private investment in order to improve house price expectations and stimulate demand.
No sustainable recovery on the property market in sight
In August 2023, the Chinese government decided to lower the minimum down payment for the purchase of first and second homes. Other measures included a lower mortgage interest rate and the granting of authorisation to local governments to expand the definition of a first-time home buyer. But the effect was rather small in the short term, says Safaryan. However, political measures would only have an effect after a certain period of time.
Moreover, the recovery is likely to be limited to the most developed cities (ranked 1 and 2), including Beijing, Shanghai, Guangzhou and Shenzhen, says Safaryan. "The main beneficiaries are state-linked property developers with strong balance sheets who have exposure to first-tier cities, as these cities still have policy space to boost demand."
Beneficiaries are state-owned companies, private investors stay away
Some of the largest property developers in tier-one cities are state-owned companies. Some of these have benefited from the property market turmoil by increasing their market share at the expense of private companies. "As they are owned by the public sector and have more solid balance sheets, they are favoured by homebuyers. This is because they trust that the projects will be completed," explains Safaryan.
However, investor demand is proving difficult to revive: "There is some resistance that is preventing the market as a whole from recovering. We are seeing ongoing insolvencies among property developers, and there is still uncertainty as to whether projects will be completed at all. There is also the expectation of falling house prices". An uncertain economic outlook would do the rest.
Starting points for investors
But there are also positive examples. For example, the restructuring of SUNAC, a property developer with a large property portfolio in tier one and two cities, provides a good template for other companies: SUNAC went bankrupt in 2022 and subsequently converted foreign debt into equity or linked instruments such as convertible bonds in order to improve its capital structure. "Investors should keep an eye on state-owned property developers that are prepared to undergo a similar restructuring process," advises Safaryan. The same applies to companies that sell projects and can use the proceeds to repay bondholders. The low liquidity of the bonds could lead to a higher redemption rate in the medium term.
"The good news is that companies have bonds in circulation. However, these are not being traded at attractive prices, especially in view of the macroeconomic and sector risks," Safaryan categorises. Property developers such as COLI and China Resources Land (CR Land) met the requirements, but their bond valuations are not particularly promising with yields of between 5.5 and 7.5%. On the other hand, the bonds of many private property developers are trading at weak valuations of around 1 to 15 cents.
Caution with property developers with portfolios in lower-ranked cities
In general, the emerging markets expert recommends that investors remain cautious about the segment, given the short to medium-term challenges: "We advise against large exposures at this point, as volatility remains high and sentiment could change quickly." Many developers are largely engaged in lower-tier cities where the supply-demand ratio is very unfavourable, he said. "Some companies are unlikely to survive as they have a low inventory of completed sales, are highly indebted and are hampered by short-term difficulties," Safaryan expects.
