China’s Property Sector Slump: Is Recovery on the Horizon?

For the past two decades, the Chinese property sector’s exponential growth has been a key GDP growth driver for China – until its rise ended abruptly in July 2021 when property sales slumped amid increased government policy tightening.

Compared with the previous year, 2H 2021 figures for residential property were down 15% in terms of transaction volumes, 35% for land sales across 300 cities, and 4% for property investment.^Footnote1

A wave of defaults has hit over-leveraged property developers. Since 2018, at least 30 developers have defaulted or conducted a distressed exchange offer – over 90% occurring in the last six months – with U.S. $82.6 billion total outstanding U.S. dollar-denominated bonds, or 57% of China high yield property sector’s outstanding bonds.^Footnote2

While the Chinese government has made dovish statements about the sector since late 2021 – emphasizing the "healthy development and virtuous cycle” of the industry – there was a lack of concrete follow-up measures at the national level. In our view, property sales will likely remain weak in 1H 2022 and we could see more defaults in the near-term, hence trading in the sector could remain volatile. In the absence of immediate and substantive policy, we believe that the sector could pose a serious risk to the government’s GDP growth target in 2022.

Material easing measures are required at the national level

Since the start of the year, over 100 local governments have announced various easing measures, including lower mortgage rates, lower down payment ratios, partial relaxation of home purchase restrictions^Footnote3 (HPR), and even relaunching the Shanty Town Redevelopment program in certain cities. However, so far, we have yet to see any turnaround in market sentiment. The recent resurgence of COVID in China and city lockdowns have further muted the potential impact from local easing.

We believe the central government faces a choice: Implement material policy easing at the national level in the next few months or risk further sector meltdown, both in the physical property and capital markets. If it decides to act, the government must address, in our view, how to stimulate housing demand and how to assist developers in regaining access to refinancing channels.

Key to the former, in our view, is making a universal cut to mortgage rates and in down payment ratios nationally, along with a partial relaxation of HPR in select cities. Improving access to refinancing channels for surviving developers is likely to require the central government to guide onshore banks not to pull back credit, while also reopening the onshore bond market to these developers to avoid any further defaults.

We expect any policy easing to take at least three to six months to translate into a recovery in the physical property market.

The property sector faces both headwinds and tailwinds

Looking ahead, challenges for the sector include weak housing affordability, slower urbanization, high housing ownership, a supply-demand mismatch, and overhang from worries about property tax. However, we believe the offshore USD bond market has largely priced in these challenges.

In our view, several factors could help to stabilize the sector’s long-term development, such as increasing demand from consumers to upgrade housing, low loan-to-value ratios and high household savings rates, the importance of the property sector to China’s economic growth and local governments, abundant liquidity in the system, and limited investment channels in China.

We expect transaction volumes to drop noticeably in the next couple of years, but they should stabilize from 2024 onwards, supported by demand from upgraders as well as first-home buyers. While a sharp correction in property prices is a quick fix to weak housing affordability, a sharp drop in housing value – which accounts for 59% of Chinese net worth – could lead to contraction in consumption. Given the sector is highly regulated by the government, we believe the Chinese government will likely induce a mild and gradual price correction in the coming one to two years. We project that property prices could drop by low to mid-single digit in 2022.

While the sector faces challenges, there is value to be found

We have grouped Chinese high yield real estate companies into three categories: survivors that should be able to weather the current market downturn even amid higher sector volatility; names on the borderline, whose fate largely depends on how soon the government will ease and how effective the policies are; and defaulted/distressed names.

We favor those we identify as survivors – and many of their bonds are trading at double-digit yields. We believe these companies have relatively strong fundamentals and are in the best position to survive or even gain share in the current sector downturn given their relatively better liquidity position and prudent financial management.

For a detailed picture of our outlook for China’s economic growth, please read our recent blog, ‘China Growth Outlook: Counting the Cost of Lockdowns’.