China’s Property Market Shows Sooner Than Expected Recovery

With Hang Seng Mainland Properties Index down -8.04%1, the valuation of China’s real estate sector was extremely compressed in 2018, as most market participants worried about a continued decline in China’s real estate market. China saw a spike in the number of failed land auctions in the third quarter of 2018 as developers have turned cautious on the growth outlook of housing market against the backdrop of a tougher fundraising environment and tightening property policy. September and October are usually believed to be the high season for new home sales, but from January to October last year, nation-wide property transaction growth, measured by floor area, slowed to 2.2%2 vs. 8.2%3 in the same period of 2017.

Since last December, we’ve accumulated long positions in some select leading developers with low debt ratios and sound fundamentals as we expected to see a valuation recovery for them. When we invested in these companies, their valuations were extremely cheap, while some other investors seemed too pessimistic about the property market and the developers’ earnings. The Enterprise Valuation of some name that got hit the hardest was even up to 80% discount to its land cost4. We thought  the downside risk in China’s housing market would be well contained. Real estate contributed 9.4% to China’s GDP in 2017 and we didn’t think the government would like real estate to go down the drain5. At the end of 2018, although crackdowns on speculation continued, we saw some loosening policies starting to take place. Beijing was likely to give local governments more flexibility to fine-tune property polices depending on the market demand. Heze, a city in Shandong province, cancelled the three-year reselling ban imposed in 2017 and allowed developers to use more of the capital from pre-completion sales. Guangzhou, one of China’s largest cities, followed Heze to ease curbs on apartment sales, aiming to improve the liquidity of properties.

In 1Q19, Real Estate sector contributed substantially to our fund performance. High-frequency data show signs of property market acceleration. March property transaction picked up in larger cities. From March 1 to 29, 30-medium/large-cities property transaction growth accelerated to 24.1% YoY vs. -4.7% YoY in Jan-Feb6. We think the following three main factors drove the real estate market.

First, the housing policy was moderately eased, as no curbing measures were introduced at the National People’s Congress annual session in March. Also, local governments now enjoy a high level of discretion to adjust their property policies, including restrictions on home purchasing, resale and pricing.

Second, overall financing conditions for property developers have improved after the government’s continuous liquidity boost. The financing costs for real estate companies have declined, on the back of the market’s greater risk appetite which in turn is a function of the more dovish FED and ECB stances. As such, developers have been able to secure financing from various channels, e.g. offshore USD bonds, onshore RMB bonds and real estate development loans, which effectively alleviated the market’s fear that developers might turn aggressive in selling their inventory on tight cash flow and financing.

Third, the transaction data shows the property sales in 1Q19 was slightly better than expected and most of the company results indicate that 2018 earnings remained resilient, which restored market confidence.  After all, the low inventory level of residential real estates in most cities in China should have boded well for a sooner than expected recovery.

2019 earnings per share (EPS) estimates for state-owned and private enterprises combined are likely to reach 8%-10%, with real estate sector contributing to nearly 25% of the growth7. We still favor quality real estate names with high visibility and we expect these industry leaders to continue gaining more market share in the coming years.

[1] Source: Bloomberg, as of Dec 2018

[2] Source: National Bureau of Statistics, as of Jan 2019

[3] Source: National Bureau of Statistics, as of Jan 2018

[4] Source: iMoney, as of April 2019

[5] Source: Citi Research, as of April 2019; NBS, Citi Research estimates, REI Driving factor= 1.5-1.7X

[6] Source: CICC Research, as of April 2019

[7] Source: Goldman Sachs, as of Jan 2019; Factset, Goldman Sachs Global Investment Research


This document is based on management forecasts and reflects prevailing conditions and our views as of this date, all of which are accordingly subject to change. In preparing this document, we have relied upon and assumed without independent verification, the accuracy and completeness of all information available from public sources. All opinions or estimates contained in this document are entirely Zeal Asset Management Limited’s judgment as of the date of this document and are subject to change without notice.

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