A slump in China’s property market will have a knock-on effect on related sectors like steel, iron and cement and will likely lower average home selling prices by up to 5%.
Analysts looking at the downturn say the $2 trillion market is resilient enough to rebound – but point out that 2022 will be a tough year – both for the market itself and for vendors.
Fitch Ratings noted last year that a third of China’s property portfolio was under pressure with a possible 30% drop in residential home sales year-on-year in 2022.
In a recent roundtable, subject matter experts from Fitch Ratings provided an overview of the Chinese market, detailing an ongoing downturn in the real estate market that threatens to ripple through other business sectors, local government finance and banks.
“The strong growth we’ve had in recent years is coming to an end and we’re now reaching a turning point where in the real estate sector you’re going to see a continued downturn over the next few years,” Adrian Cheng said. , co-head of China real estate at Fitch Ratings. He predicted a 10-15% decline in sales value for 2022, with the ASP (average selling price) taking a hit of around 5% in higher tier cities and a bit more in tier cities. inferior.
A vicious circle
China’s property market has entered a vicious cycle of weak sales, liquidity crunches and defaults, leading to a further drop in sales as confidence in the market has been shaken, analysts said.
“Over the past few months, you’ve seen a huge liquidity crunch, and that’s led to a big crisis of confidence in the industry,” Cheng said.
“We saw some developers defaulting, which surprised the market and led to lower sales. It’s a vicious circle.”
Thanks to this crisis of confidence, developers find that access to funds is drying up, whether it is selling to entrepreneurs, the capital market, banks or fiduciary loan financing.
Cheng added, “It is becoming difficult to make money from contractors’ sales as sales have dropped. And even if they manage to generate contractor sales, the proceeds are now sitting in so-called depots in regulator accounts where the government has been stricter, especially in lower-tier cities.
“The capital market has been closed for the past few months. It will remain so for the majority of developers. Bank financing will remain relatively stable.
Ying Wang, head of the Energy and Utilities group at Fitch Ratings, warned that some construction contractors may not be paid even for completed work on sold projects. “We believe that this year many small private entrepreneurs are likely to die out,” Wang added.
“Even public contractors, with better access to finance and greater exposure to infrastructure projects, are more likely to underperform in tier two cities,” she said.
Risks also spread more widely. Some worry that contagion risk has spread to higher-quality stocks in the sector.
“It’s a matter of market confidence,” Cheng explains. “It’s important for developers to increase transparency and increase communication with investors about what’s true and what’s not.”
Risking other sectors
The distress in the real estate market could also affect other business sectors and municipal finances.
“We expect risk of contagion to a number of other sectors,” Wang said. “Demand for basic materials like steel, iron ore and cement will be impacted.” She added that appliances, furniture and similar real estate-related sectors all face contagion risk.
“We expect a broad corporate loan default rate to be pushed higher by more real estate defaults.”
The risk of contagion has also spread to municipal finance or the broader LGFV (Local Government Financing Vehicle) sector.
Samuel Kwok, senior director of the International Public Finance (IPF) team at Fitch Ratings, warned that local government capital income could suffer.
Kwok said for local government bodies, revenue from concessions as a source of funding is likely to be affected. A third of this comes from capital income, which is mainly land sales. Private developers do not buy the same volumes of land, which means that an important source of revenue for local communities is affected. “Given the current state of the real estate market, we expect capital income (from local bodies) to decline,” Kwok said.
With declining revenues, there is also a real possibility of default by state enterprises. “We don’t expect high-level state-owned companies to default like what happened in 2020, but government-owned entities in less-developed regions, as well as those with more ambiguous profiles, are likely the most vulnerable,” Wang said.
With various sectors affected by tensions in the real estate market, there is also the question of whether the capital base of the Chinese banking system is sufficient to absorb the depreciations related to the real estate sector.
For now, Grace Wu, Senior Director and Head of Greater China Banks at Fitch Ratings, considers banks’ overall exposure to the real estate sector to be “quite manageable”, but added: “For banks exposed in lower-tier cities, the risk is going to be significant.” Interest rate cuts, for example, will impact banks’ margins and therefore their ability to generate profits and, therefore, will make retention of the capital all the more difficult.
Banks also face capital constraints and need additional capital.
Although concerned about the current tensions in the real estate sector, experts agree that its intrinsic strength will allow it to get through this.
“Even with the decline in sales value, in terms of the absolute value of the Chinese real estate market, you’re still talking about RMB 13 trillion to 14 trillion – a huge market,” Cheng said.
“If you compare the United States or Europe, the Chinese real estate market is huge and I think it will continue,” Cheng added, pointing to the fact that urbanization and urban wages in China are still lower than. those of more developed countries. As urbanization continues to accelerate, demand will also improve, he added.
Yang added that “the demand for basic materials like steel, iron ore and cement will be affected to some extent, and infrastructure-related demand may provide some support.”
More importantly, the industrial sector could remain largely unscathed and its profit margin intact. “This year, we expect the average profit margin for the basic materials sector to be lower than last year, but average industry profit margins could be quite acceptable.”
Regarding bank exposure and the looming possibility of real estate sector defaults, Wu said he believed there was “enough room for banks to absorb some of the real estate stress.” , adding that direct lending to the real estate sector amounts to 7 percent of the system and the mortgage to around 20 percent. Among mortgages, the loan to value ratio in residential mortgage is only 40-50%.
Faced with the slowdown in real estate, the approach of the government and the banks is one of restraint with an emphasis on stabilizing the sector.
While taking a tough stance on the property market amid high developer indebtedness, the government, Fitch noted, has implemented policy easing such as the two RRR (Reserve Requirement Ratio) cuts. Opening green channels for onshore finance to flow offshore and easing mortgage approvals are among other measures taken.
Even though bank financing in the real estate sector is expected to remain stable, Cheng pointed out that “the majority of fiduciary loans will still be refinanced and/or extended” and that “the decline in real estate sales will be relatively moderate.”
However, Wu said she does not believe there will be any easing when it comes to credit support in various sectors.
“At the moment, we still expect banks to be quite restricted in some of their lending. They will be quite conservative in managing the credit risk and the currency risk of the assets.
“Banks are focusing on stabilizing the sector cautiously. Despite all the economic challenges facing banks, we expect loan growth of around 12% this year and fairly stable earnings,” Woo said.
She sees only moderate easing targeted at specific sectors, similar to the provisions made for residential mortgages in 2021. On lending to LGFVs and SEOs, she predicted tight restriction from banks, “in accordance with the deleveraging efforts that the authorities have put in place. »
Yang said “tougher regulatory scrutiny of companies and industries that have flown under the radar while making excessive profits” will continue, particularly in the fintech, data security and live streaming sectors. , all of which will continue to be subject to increased regulatory scrutiny. However, she noted, the market reaction this year to any further regulatory changes will be less drastic.
Analysts are watching closely how the caution and restraint shown by the government and banks are actually managing to stabilize the economy and how much of the intrinsic strength of China’s real estate sector is stabilizing the recession.
“At this point I may sound a little pessimistic but, to be honest, I think we really don’t know what’s going to happen in the next one to two months, and it’s hard to say if the outlook will change. ‘here,’ Cheng said.
“Not just growth – they will also try to manage decline,” he added.
(Reporting by SA Kader; Editing by Anoop Menon and Charles Lavery)