China's property market may be set to turn a corner again. A flurry of supportive policies introduced by the government since early 2015 has revived the sector, after a downturn in recent years. Growth in nationwide property sales so far in 2016 has reached a new high of about 40%. Property prices have skyrocketed in tier-1 and select tier-2 cities.
However, S&P Global Ratings expects the property sector to slow down over the next 12 months as a result of tapering policy effect and a high base in the second half of 2015 and the first half of 2016. Rapid price increases in prime cities have fueled fears about the sustainability of the trend and the health of the property market. Some local governments have therefore tightened home and land purchase requirements in the past few months to cool down the market.
- China's property sector is likely to slow down over the next 12 months as a result of tapering policy effect and a high base in the second half of 2015 and the first half of 2016.
- Fierce competition for land in higher-tier cities has pushed up land prices to record highs, denting profitability and cash flows of developers.
- We expect large property developers to expand increasingly through mergers and acquisitions.
- The rating trend for the next 12 months continues to have a negative bias. We see a low likelihood of significant deleveraging by developers, given their strong aspirations for scale growth.
At the same time, strong sales have led property developers to reinvest their cash flows into new projects. Many of the developers we rate have stepped up land acquisitions and expansion plans, which have contributed in pushing land prices to record highs in a wide range of tier-1 and tier-2 cities.
In addition, organic expansion is increasingly giving way to consolidation as China's economic growth has slowed to its lowest level in two and a half decades. Developers are increasingly procuring land by acquiring project companies and smaller developers. We believe the land grabbing frenzy will hurt profitability and cash flows of more aggressive developers. Any faltering in property prices could place those developers between a rock and a hard place.
Despite the strong physical recovery so far this year, financial risk profiles of developers haven't recovered in parallel. Rather, credit profiles have deteriorated for many developers that rushed into the next cycle of investment by expanding land banks and construction. The credit ratios of a number of developers may continue to weaken, as their interim results already reflected.
The rating trend for the next 12 months continues to have a negative bias. We see a low likelihood of significant deleveraging by developers, given their strong aspirations for scale growth. In our view, developers would need a dramatic shift to pursue quality growth while maintaining sound capital structures and healthy cash flows, rather than aggressive debt-funded expansion.
Strong Sales Are Set To Slow Down
We expect a slowdown in property sector growth over the next 12 months because the Chinese government hasn't and isn't planning to launch any significant stimulus measures in the next few months.
The Chinese property market has maintained strong sales growth year-on-year, resulting from supportive government policies and abundant liquidity in the market (see chart 1). National property sales increased by 39.8% to Chinese renminbi (RMB) 5.8 trillion in the first seven months of 2016, driven by a 26.4% increase in the area sold and 10.6% growth in average selling price (ASP), according to the National Bureau of Statistics.
In our view, the high growth cannot be sustained because the effects of loosening home purchase restrictions and easing credit conditions--the two major supporting factors for the recovery--will taper off as pent-up demand wanes. Also, the high base in the second half of 2015 and first half of 2016 would make it difficult to achieve a stronger year-on-year growth.
Moreover, we anticipate tightening policies from local governments to address overheating in select cities. Local authorities of a number of cities with surging property prices have started to implement stricter restrictions on home purchases, funding, or land prices since March 2016, aiming to cool down the markets and maintain a more sustainable growth. We note that the cooling measures have been mild and calibrated so far as the government also wants to prevent a serious property market downturn (see table 1).
We estimate that the industry is likely to grow by about 20% in 2016, well supported by both price and scale, and growth may further reduce to about 10% by mid-2017.
The rated developers achieved stronger sales than the industry average so far this year, reflecting the consolidation in the industry. Total contracted sales in the first seven months of 2016 for the 30 rated developers that report monthly performance figures was 59.3% of their aggregate full-year target, versus 42% in the same period in 2015. Contracted sales of these developers rose 54.7% on average, higher than the national average of 39.8%.
|Key Local Government Policies Since March 2015|
|Date||City||Year-on-year growth in average selling price (ASP) as of August 2016 (%)||Policy detail|
|August 2016||Xiamen||28.31||Suspends selling homes to local buyers who already own two residences; bans non-residents from buying a second house. The restriction will be effective Sept. 5, 2016, to end-2017. The newly-unveiled home-purchase curbs apply to residences smaller than 144 square meters in area.|
|August 2016||Wuhan||23.26||Strengthens regulation of property market. Pre-selling without permission is prohibited. The ASP should be publicized within 10 days of the pre-sale permission. The down payment for second home purchase increased to 40%.|
|August 2016||Suzhou||25.65||Second-home purchase is limited for residents who have paid income tax and social security premiums in Suzhou for more than one year.|
|July 2016||Xiamen||28.31||Down payment for first-home purchase with no mortgage loan record will be 25%; down payment for second-home purchase raised to 60% from 40%; no mortgage loan for third-home purchase.|
|June 2016||Hefei||31.56||Developers need to pay off the land purchase premium within one month from land sales for land transactions with historically high land price; the down payment for first-, second-, and third-home purchase will be 25%, 50%, and 60%, respectively; no usage of housing provident funds for third-home purchases.|
|June 2016||Tianjin||17.94||Housing provident fund loan capped at RMB600,000 and RMB400,000 for the first- and second-home purchase respectively; no usage of housing provident funds for third-home purchases.|
|May 2016||Beijing||15.22||Tongzhou government introduces measures to restrict the purchase of commercial apartments, subject to different requirements.|
|May 2016||Suzhou||25.65||Sets price caps on land sales. The land sales will be terminated if the bidding price exceeds the pre-set price cap.|
|May 2016||Nanjing||32.67||Sets price caps on land sales for residential properties across prime locations.|
|April 2016||Guangzhou||5.95||Issues measures to regulate the housing mortgage market. The local government does not allow down payment of loans.|
|April 2016||Nanjing||32.67||Establishes price growth caps: (1) for projects with ASP below RMB20,000 per square meter, the annualised ASP growth rate should not exceed 12%; (2) for projects with ASP between RMB20,000 and RMB30,000 per square meter, the annualised ASP growth rate should not be over 10%; (3) for projects with ASP over RMB30,000 per square meter, the annualised ASP growth rate should not be over 8%.|
|March 2016||Langfang||35.33||Increases down payment to more than 30% for first-home buyers and to more than 60% for second-home buyers.|
|March 2016||Suzhou||25.65||Does not allow developers to raise the price of housing projects within three months after applying for the pre-sale permit. Asking price should not be over 6% and 12% (vs. current ASP) within 6 months and 12 months, respectively; the price increase of the next development phase should not be over 6% compared with the ASP of the same type houses in the last phase.|
|March 2016||Shanghai||22.64||Non-local buyers must have paid income tax and social security premiums in Shanghai for five consecutive years, up from two years under the previous requirement. Home buyers with one housing unit must make at least a 50% down payment for ordinary home purchase and at least 70% down payment for non-ordinary home purchase.|
|March 2016||Shenzhen||43.01||Non-local buyers must have paid income tax and social security premiums for three consecutive years, up from one year under the previous requirement. Home buyers must make at least a 40% down payment (instead of 30% under the previous requirement) if they: (1) own no housing unit in Shenzhen but have borrowed home mortgages over the past two years; or (2) already own one housing unit in Shenzhen but have paid off mortgages.|
|Source: Local gorvernment, S&P Global Ratings.|
Overheating In Land Market Is Inviting More Risks
We expect developers' appetite for land acquisition to move in tandem with the property market. Land acquisitions rebounded significantly in 2016, supported by robust sales and abundant onshore liquidity. The area of acquired land only declined moderately by 7.8% year-on-year in the first seven months of 2016, compared with a 30% decline throughout 2015 (see chart 2).
Rising housing prices in tier-1 and select tier-2 cities has also solidified developers' confidence in making land-purchase decisions. Developers flocked to higher-tier cities that have lower inventory months to optimize and replenish their land bank to underpin future growth. Most developers are also frontloading their purchase in anticipation that land prices will continue to rise, given they have relentlessly increased throughout the down cycle. The portion of land purchases from tier-2 cities increased while exposure to lower-tier cities reduced, compared with 2014 and 2015 (see chart 3).
However, the fierce competition for land in higher-tier cities has pushed up land prices to record highs, leading to new "land kings" or land purchases either with the highest total cost or highest unit price. Our data shows land acquisitions of more than RMB4 billion in 47 transactions from January to August of 2016, compared with 50 for the whole of 2015 (see chart 4, chart 5, chart 6, and table 2). Many of the land acquisitions in 2016 are in tier-2 cities such as Suzhou, Nanjing, Hangzhou, and Hefei. Transactions in tier-1 cities dropped to 40%, from 66% in 2015, mainly because of lack of supply, e.g. in Beijing.
|Comparison of Top 10 Residential Land Parcels In Terms of Unit Price|
|City||Land cost (RMB/square meter)||City||Land cost (RMB/square meter)||Acquired companies|
|1||Shenzhen||79,907||1||Shanghai||100,218||Ronshine China Holdings Ltd.|
|2||Shenzhen||51,331||2||Shanghai||67,409||Future Land Development Holdings Ltd.|
|3||Shanghai||49,236||3||Shenzhen||56,781||China Jinmao Holdings Group Ltd. and China Railway Construction Corp. Ltd.|
|4||Shanghai||48,935||4||Shanghai||53,727||COFCO Property Group Co Ltd.|
|5||Beijing||45,120||5||Shanghai||52,840||Ronshine China Holdings Ltd.|
|6||Shanghai||43,790||6||Hangzhou||45,368||Greentown China Holdings Ltd.|
|7||Shanghai||40,279||7||Nanjing||45,213||China Gezhouba Group Corp.|
|8||Shanghai||38,062||8||Shanghai||43,659||Cinda Real Estate Co Ltd.|
|9||Shanghai||34,871||9||Shanghai||43,607||Beijing Capital Land Ltd. and Poly Real Estate Group Co. Ltd.|
|10||Beijing||34,841||10||Nanjing||42,561||Shanghai Construction Group Co. Ltd.|
|*As of Aug. 31, 2016. Excludes a small land parcel sold for RMB600 million in Shanghai in August. RMB--Chinese renminbi. Source: Wind, S&P Global Ratings.|
The overheating land market also fuels concerns over the sustainability of current housing prices. If property prices don't increase in tandem with land rates, profitability of developers would be hit. Property developers are now ever more reliant on price hikes to achieve reasonable returns.
In addition, large land acquisitions will weigh on developers' cash flows and leverage, particularly for regional companies with strong aspirations to grow rapidly in a buoyant market. The recoup of such considerable cash outflows hinges on favorable market sentiment and supportive government policies. For smaller developers, land premiums could take up half or even a majority of their cash proceeds from property sales. An overheating market could also lead to more stringent policies from local governments, such as increasing mortgage down-payment, tightening home purchase restrictions, or restricting selling prices. Consequently, homebuyers' affordability may weaken and developers may have to delay sales launches to wait for a new cycle, both posing a risk to developers' property sales and cash flows.
Consolidation Is Under Way
We expect large property developers to expand increasingly through mergers and acquisitions (M&As). Their significant property sales lead to sizable demand for land replenishment. Acquisitions could enable these developers to scale up at a lower cost compared with buying land through public auction. Also, acquisitions could bring quality land bank with good locations, which cannot be obtained in the land market otherwise. China Evergrande Group has been very active in such acquisitions since 2015 as it seeks good projects to optimize its land bank and boost property sales (see table 3).
|Major Mergers And Acquisitions In China's Property Sector In 2016|
|Developer||Date of announcement||Projects||Consideration|
|China Evergrande Group||August 2016||Acquired 6.82% stake in China Vanke in the onshore "A-share" market.||RMB14.57 billion.|
|China Evergrande Group||August 2016||Acquired 15% shares of Langfang Development since April 2015.||RMB 957 million.|
|China Evergrande Group||July 2016||Acquired 52.78% shares of Zhejiang-based developer, Calxon Group.||RMB3.6 billion.|
|China Evergrande Group||July 2016||Acquired land parcels with gross floor area of about 1.6 million square meters in Chengdu from Rising Group.||Not disclosed.|
|Yuzhou Properties Company Ltd.||July 2016||Acquired an SOE developer with three land parcels with GFA of 0.3 million square meters in Hangzhou.||RMB4.1 billion, including RMB1.8 billion shareholder loans.|
|Poly Real Estate Group Co. Ltd.||July 2016||Proposes to acquire around 70 property projects from AVIC Group. The land bank of AVIC Group was around 9 million square meters.||No more than 15% of Poly Real Estate’s net assets.|
|Beijing Capital Land Ltd.||June 2016||Acquired four projects located in Beijing, Chongqing and Shenyang from the parent Beijing Capital Group Co. Ltd.||RMB4.2 billion, including RMB1.7 billion shareholder loans.|
|China Vanke Co. Ltd.||June 2016||Proposes to purchase three parcels of land in Shenzhen from Shenzhen Metro Group.||RMB45.6 billion through share offering to Shenzhen Metro (pending on board approval).|
|Sunac China Holdings Ltd.||May 2016||Acquired seven projects in Shenzhen, Shanghai, Nanjing etc. from Top Spring International Holdings Ltd,' the total gross floor area was 1.25 million square meters.||RMB4.39 billion.|
|China Evergrande Group||May 2016||Acquired a property development project in Shenzhen with gross floor area of 85,700 square meters from Kingboard Chemical, a Hong Kong listed company.||RMB2 billion.|
|China Overseas Land & Investment Ltd.||March 2016||Acquired a portfolio of properties located in 25 cities from CITIC Ltd.||RMB31 billion, including share consideration of HK$29.7 billion (RMB24.9 billion) and asset consideration of RMB6.1 billion to CITIC. In addition, COLI will take shareholder loans of HK$41 billion and project loans.|
|RMB--Chinese renminbi. Source: Company announcements, S&P Global Ratings.|
We also anticipate more consolidation among state-owned enterprises (SOEs) in the property business as the Chinese government urges SOEs to focus on their primary business with competitive edge, and merge similar businesses as part of the ongoing SOE reform. This creates opportunities for strong state-owned developers to acquire the non-core property business from the SOEs that traditionally do not focus on property-related operations. For instance, China Overseas Land & Investment Ltd. (COLI) announced plans in March 2016 to acquire property development projects from CITIC Ltd. Similarly, China Poly Group Corp. and Aviation Industrial Corp. of China proposed to restructure their property businesses in July.
However, acquisitions may involve hidden risks and contingent liabilities that are not apparent without careful due diligence. Many Chinese developers, in our view, do not have proven successful acquisition and integration track records. For example, several of Sunac China Holdings Ltd.'s acquisitions have resulted in low margins. Large-scale SOE mergers will also test developers' ability to improve the efficiency and profitability of the acquired projects.
Inventory Overhang Has Moderated But Divergence Remains
In our view, China's lower-tier cities are still laden with property oversupply, although there is moderate meaningful improvement in inventory clearance from 2015. We expect supply discrepancies between upper-higher and lower-tier cities to remain. Hence, we believe developers need to have differentiated policies for different markets.
In our view, inventory turnover rates may underestimate the inventory overhang because the turnover rate reflects the current strong sales performance. The inventory turnover could deteriorate quickly if monthly sales decline from existing high levels. The inventory overhang could also exacerbate with an increase in new construction starts as a result of a strong market recovery. In the first seven months of 2016, new construction starts increased by 13.7%, in contrast with a decline in the same periods in 2014 and 2015 (see chart 7).
Offshore Bond Issuances May Regain Momentum
We believe overall funding conditions in China will remain supportive in 2016 as the government will continue to maintain a loose monetary policy to stimulate economic growth. Favorable credit conditions have provided developers with abundant low-cost funding. As such, the sector's refinancing risks have receded (see table 4).
|New Issuances In 2016 With Comparison To The Last Issuance|
|Issuer||Issue date||Currency||Amount (In million)||Coupon (%)||Duration (years)||Issue date||Currency||Amount (In million)||Coupon (%)||Duration (years)||Coupon rate difference|
|New Issuance||Last Issuance|
|China Evergrande Group||Jan 15, 2016||US$||300||8||3||Feb 17, 2015||US$||1000||12||5||4|
|China Evergrande Group*||Jan 15, 2016||US$||400||7.8||3||Feb 17, 2015||US$||1000||12||5||4.2|
|China Vanke Co. Ltd.||Apr 13, 2016||HK$||3650||2.5||3||Jun 04, 2014||US$||400||4.5||5||2|
|China Aoyuan Property Group Ltd.||Apr 25, 2016||US$||250||6.525||3||May 26, 2015||US$||250||10.875||3||4.35|
|Fantasia Holdings Group Co. Ltd.||May 04, 2016||CNY||1600||9.5||3||Jun 01, 2015||US$||200||11.5||3||2|
|Greenland Hong Kong Holdings Ltd.||Jul 28, 2016||US$||450||3.875||3||Aug 07, 2014||US$||500||4.375||3||0.5|
|Road King Infrastructure Ltd.||Aug 09, 2016||US$||450||5||3||Dec 03, 2013||CNY||2200||6||3||1|
|Sunshine 100 China Holdings Ltd.||Aug 11, 2016||US$||200||6.5||5||Oct 08, 2014||US$||215||12.75||3||6.25|
|Xinyuan Real Estate Co. Ltd.||Aug 30, 2016||US$||300||8.125||3||Dec 06, 2013||US$||200||13||5.5||4.875|
|Road King Infrastructure Ltd.||Sep 06, 2016||US$||500||4.7||5||Dec 03, 2013||CNY||2200||6||3||1.3|
|China South City Holdings Ltd.||Sep 13, 2016||US$||200||6.75||5||Jan 29, 2014||US$||400||8.25||5||1.5|
|Greenland Holding Group Co. Ltd.||Sep 06, 2016||US$||300||3.5||3||Sep 16, 2015||US$||300||4.3||2||0.8|
|*Private issuance. CNY--Chinese yuan. HK$--Hong Kong dollar. Source: Bloomberg.|
Our rated developers have 15 offshore senior notes amounting to US$4.8 billion due this year, compared with 11 notes worth US$3.4 billion due in 2015. Of these, 14 notes (other than China Vanke Co. Ltd.) have already been repaid or refinanced. We believe that China Vanke will be able to repay its maturing notes, given the company's strong financial position.
The robust onshore credit conditions have changed the funding mix of Chinese property developers. Some developers have taken advantage of the fluid onshore issuance conditions and early redeemed offshore bonds to reduce exposure to foreign currency risk (see table 5).
|Early Redemption Of Offshore Bonds So Far In 2016|
|Issuer name||Coupon||Maturity||Call announced date||Called exercise date||Issued amount (Mil. US$)|
|Future Land Development Holdings Ltd.||10.25||Jan 31, 2018||Dec 03, 2015||Jan 31, 2016||200|
|Sunac China Holdings Ltd.||12.5||Oct 16, 2017||Dec 04, 2015||Jan 06, 2016||400|
|Powerlong Real Estate Holdings Ltd.||11.25||Jan 25, 2018||Dec 24, 2015||Jan 25, 2016||250|
|China SCE Property Holdings Ltd.||11.5||Nov 14, 2017||Jan 06, 2016||Feb 04, 2016||350|
|China Aoyuan Property Group Ltd.||13.875||Nov 23, 2017||Jan 10, 2016||Feb 11, 2016||225|
|Hopson Development Holdings Ltd.||9.875||Jan 16, 2018||Feb 16, 2016||Mar 17, 2016||300|
|China South City Holdings Ltd.||13.5||Oct 17, 2017||Mar 10, 2016||Apr 15, 2016||125|
|CIFI Holdings (Group) Co. Ltd.||12.25||Apr 15, 2018||Mar 17, 2016||Apr 15, 2016||500|
|SOHO China Ltd.||7.125||Nov 07, 2022||Apr 07, 2016||Jun 06, 2016||400|
|Greentown China Holdings Ltd.||8.5||Feb 04, 2018||May 03, 2016||May 31, 2016||700|
|Yanlord Land Group Ltd.||10.625||Mar 29, 2018||May 18, 2016||Jun 17, 2016||400|
|Agile Group Holdings Ltd.||8.875||Apr 28, 2017||May 30, 2016||Jun 27, 2016||650|
|China Aoyuan Property Group Ltd.||9.25||Apr 01, 2018||May 31, 2016||May 31, 2016||100|
|Sunac China Holdings Ltd.||9.375||Apr 05, 2018||Jul 06, 2016||Aug 05, 2016||500|
|Source: Bloomberg, S&P Global Ratings.|
However, we expect an increase in offshore issuances because access to onshore capital markets is likely to tighten for the property sector, in our view. Onshore bond issues and approvals, both for public issuance or private placement, have also declined substantially. Most developers have used up the quota of onshore bond issuance. At the same time, the coupon rates of offshore bond issues seem attractive due to lack of supply. Therefore, offshore issuance are likely to continue to be a part of developers' funding structure for refinancing needs as costs converge, especially for smaller players.
Although China is likely to maintain generally loose credit conditions for the whole economy, the government would like to steer further liquidity away from the overstimulated property sector. For example, the Chinese government has banned developers from using proceeds from equity placements for land acquisitions and debt repayment. It has also placed localized controls on housing and land prices.
Credit Standing Remains Fragile
Our rating actions on Chinese property developers in the first eight months of 2016 continue to have a negative bias. Negative rating actions outnumbered positive ones. The negative rating actions included 11 downgrades and 10 outlook revisions. In contrast, we upgraded one developer and revised upward two outlooks over the same period (see chart 8).
We took a number of rating actions in the annual results season in March and April, but the number of negative rating actions ebbed after May. We revised the rating outlook on Shimao Property Holdings Ltd. to negative from stable in July because of the company's weak sales and rising leverage. We took a similar action on China Vanke in August due to increased uncertainty stemming from an ongoing tussle between management and key shareholders. We also revised the outlook on China Jinmao Holdings Group Ltd. and Sunac due their more aggressive land banking strategy, which impacted their leverage.
We expect overall margins in contracted sales to stabilize or bottom out in the next 12 months, supported by growth in ASP. Companies with good legacy land bank in higher-tier cities have the most to gain, while those with high exposure to lower-tier cities will continue to face margin pressure. However, the margins for some may deteriorate again when the land plots purchased at record highs this year transform into recognized sale over the next two to three years.
Although property sales have improved in the past 12 months, we believe sales performance will not be enough to strengthen the credit profiles of rated Chinese developers. As competition for land in higher-tier cities has intensified, some developers have already stepped up land acquisitions and construction expenditure to match the cycle. Such spending will increase these companies' leverage before the offsetting impact of improved sales kicks in over time. These companies include Evergrande, Sunac, Greenland Holdings Group Co. Ltd., Country Garden Holdings Co. Ltd., Yuexiu Property Co. Ltd., and Jinmao. Their elevated leverage continues to put pressure on the ratings.
At the same time, some developers continue to demonstrate good operating performance while controlling debt and leverage. These include leading names such as COLI, China Vanke, Poly Real Estate Group Co. Ltd., China Resources Land Ltd., Longfor Properties Co. Ltd., and also some midsize developers such as Future Land Development Holdings Ltd., CIFI Holdings (Group) Co. Ltd., Powerlong Real Estate Holdings Ltd., and Yuzhou Properties Co. Ltd.
In our view, a solid recovery of Chinese developers' credit profiles depends not just on good sales execution but a commitment to disciplined land banking and proactive leverage control. These characteristics differentiate not only speculative grade companies but also investment grade developers, which could lead to more fallen angels and rising stars, changing the competitive landscape.
We believe striking such a balance between sales growth aspirations and leverage control is vital to developers' credit profiles. Pent-up demand has been absorbed by increased sales in the past 12 months and, with more restrictive government policies in place, property sales will likely decelerate to a very modest growth of 10% or lower over the next 12-18 months, in our view.
Past industry cycles lasted only about three years, suggesting a downturn could always be on the horizon. However, competition will only get more intense, and a sudden jolt in market trajectory will disrupt developers' plans and budgets, resulting in slimmer chances of them attaining healthier financial positions.