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China Property Watch: Searching For A Bottom

Chart 1

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A double squeeze looms for China's property market. Structural factors are hitting rated developers, strains that are unfolding alongside a continued sales slide. S&P Global Ratings expects property firms will be digging deep to repay debt should cash flows turn negative, with many still locked out of capital markets.

We believe national sales continue to search for a bottom, but may find support at about Chinese renminbi (RMB) 10 trillion to RMB10.3 trillion this year. The range is a 10%-15% drop from 2023.

Regrettably for issuers, that is not the whole story. The structure of the market is shifting, and not in a positive way for rated firms. Sales are increasingly shifting to the secondary market, with little benefit to the developers. Secondly, the government is offering more social housing for sale. Volumes will count toward our sales projections but will likely cannibalize the sales of rated developers.

This downbeat projection for the market echoes our recent downgrades to speculative grade of China Vanke Co. Ltd. and Longfor Group Holdings Ltd.--two developers with established operating and financing records. Conditions remain tough.

A Structural Shift

We estimate Beijing will spend RMB3 trillion-RMB4 trillion on land and property development over 2024-2025 via its Three Major Projects initiative (see "China LGFVs' Bigger Housing Role: Risk Control Matters," published on RatingsDirect on March 27, 2024).

The country will provide 2 million social housing units for sale during 2021-2025 at subsidized rates, by our estimates. We believe the level of social housing for sale as a portion of total housing for sale in tier-one and tier-two cities will increase to 20% by 2026, from 8% in 2023. In providing such social housing, the government will be eroding the primary sales of developers.

Some of this supply of cheap new homes will come from the existing inventory of rated developers, we assume, assisting in their destocking. This would be a one-off, one-time benefit. Moreover, most of the new housing will likely be built and completed in the next one to two years. And these will be in competition for sales by property firms, particularly at the lower end of the market.

The other big shift is the move toward secondary sales. Such transactions will comprise about 40% of the total in 2024, a substantial increase from 25% about 10 years ago (see chart 2.)

Chart 2

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Last year, China's primary residential sales fell 12%. However, secondary residential sales rose about 17%, by our estimates. This outperformance shows that homebuyers still have appetite to buy residences. They just don't want to pay upfront for a new home from a developer that may lack the resources to finish and deliver the unit. Buying housing on the secondary market removes that uncertainty.

Buyers seeking residences in the city center are, in particular, buying through the secondary market. Developers are getting squeezed at the top end of the market by secondary sales, and at the bottom end by the state's provision of social housing.

Privately owned developers compete with the state-owned firms. As sales shrink, both sides are competing for a slice of a smaller pie. We view this change as largely negative to rated firms.

Chart 3

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Home Prices Likely Have Yet To Stabilize

Against the backdrop of these shifts, we forecast national home prices could further drop up to 5%-6% this year. While the secondary market has been active with more transactions, we believe the primary market will likely follow a trend of falling prices for homes in the secondary market (see charts 4 and 5).

The market continues to diverge. Home prices in first-tier cities should drop less and stabilize first, given the stronger demand and greater confidence in those centers. Home prices in lower-tier cities will fall the furthest this year, we assume.

Changes in product mix are also contributing to the drop in home prices. We believe government efforts to use existing housing stock to convert to social housing will increase transactions at the lower end of the market. While this will help developers clear inventory, it will likely also result in lower home prices, mainly in tier-two cities and below.

Chart 4

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Chart 5

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Table 1

Home prices are getting hit hardest in lower-tier cities
Year on year change
(%) 2022 2023 2024e 2025e
Primary housing prices (3) 6 (6) (2)
Tier 1 (2) 0
Tier 2 (5) 0
Tier 3 (9) (5)
Secondary residential housing prices (70 cities) (4) (4) (5) 0
Area sold (primary housing) (24) (18) (9) 0
e--Estimated. Sources: S&P Global Ratings, National Bureau of Statistics of China.

A funding squeeze will come on top of structural strains.  The state-owned developers and their controlled subsidiaries can continue to tap domestic bond markets. Such entities benefit from implicit government backing. The privately backed firms commonly do not have that option.

Only a handful of developers--China Overseas Land & Investment Ltd., China Resources Land Ltd., China Jinmao Holdings Group Ltd., China Poly Group Corp., etc.--retain access to public bond markets. The remainder mainly only have limited access to bank lending.

If there's a significant sales drop, developers will have to consider alternative ways to raise money, such as through the sale of noncore assets, or funding calls on shareholders. Most entities lack meaningful buffers and funding access: they can repay maturing debt or they can be cash-flow negative--they can't be both for long.

Chart 6

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The Market May Find Support At The RMB10 Trillion Level

Strengthening secondary sales can be viewed two ways. While it is clearly eroding demand for primary units, it also underscores strong underlying fundamental demand for housing. This bolsters our view that the market is nearing bottom.

China's property market could find support at RMB10 trillion in annual sales (including primary sales and social housing). Here, we point to our prior analysis, which looks at the state of the Chinese property market before it was overstimulated by shantytown development programs, and then sunk by the so-called "three red lines" policy (see "China Property Watch: A Slow, Sequential Recovery In 2024," Oct. 16, 2023.

Our analysis assumes that sales by gross floor area (GFA) over 2009-2015 reflect real, fundamental demand. We believe this GFA level acts a floor, and then discount current prices by 15%-20%, adjusting for the tier of city in which projects are based.

This leaves us with an assumption about RMB10 trillion in annual sales that stem from core demand. In the parlance of policymakers, the level will comprise the sale of homes for living, not for speculating.

Chart 7

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The RMB10 trillion threshold in annual sales may be breached.   This downturn has consistently surprised on the downside, and we don't discount the possibility it may do so again. Weaker demand amid a soft economy, persistent concerns among buyers about home delivery, policy execution risks, and a lack of coordination (and conflicting interests) among government bodies could yet pressure home prices, pushing sales to below our base case.

If home prices fell 16% instead of our base case of a 6% drop, property sales this year would slip to RMB9 trillion-RMB9.3 trillion.

China's first-quarter property sales were RMB2.1 trillion. Roughly--without adjusting for seasonality--that puts the market on track for RMB8.4 trillion in revenue this year.

Policy Easing Could Yet Turn This Crisis Around

Government measures are certainly turning more favorable toward the sector. The high-end of the sector (sales in first-tier markets) is already performing well. We retain our expectation that a recovery in the upper-tier cities will come first, and then flow through to the wider market (see "China Property Watch: A Slow, Sequential Recovery In 2024," Oct. 16, 2023.

Developers will need to lean into the structural changes now unfolding. This means focusing on higher-end projects in higher-tier cities, and offering better products and value-added services.

The government's social-housing push could help developers, who may be able sell down some of their ample inventory for use as subsidized housing. It would also benefit those firms that position themselves in the agency-construction business. The Chinese city of Zhengzhou in Henan province is initiating a pilot project to buy excess inventory from developers, for use as low-cost housing.

Likewise, the government's urban village redevelopment plan involves giving vouchers or cash to displaced individuals. The funds could be plausibly used to buy new residences (see "China's RMB350 Billion Policy Push May Help Developer Destocking," Jan. 24, 2024.)

Beijing has also established a mechanism for coordinating financing for the completion of housing projects at the prefecture-government level, along with a "white list" of projects approved for fast-track funding. As of end-March, planners had approved about 6,000 projects for such funding. The main aim is to restore the confidence of homebuyers that presold homes will be built. An ancillary benefit will be to bolster buyers' confidence in the ongoing health of developers.

There are many pieces, often moving in opposite directions. Government policies are both supporting developers and cannibalizing their sales. Primary sales continue to slide, but fundamental appetite is healthy, as apparent in strengthening secondary transactions.

We believe this market is drifting to the beginning of a long L-shaped "recovery". Along the way, particularly in the two years ahead, many firms will struggle with liquidity.

Writer: Jasper Moiseiwitsch

Digital Designer: Evy Cheung

Related Research

This report does not constitute a rating action.

Primary Credit Analysts:Esther Liu, Hong Kong + 852 2533 3556;
esther.liu@spglobal.com
Edward Chan, CFA, FRM, Hong Kong + 852 2533 3539;
edward.chan@spglobal.com
Secondary Contact:Lawrence Lu, CFA, Hong Kong + 85225333517;
lawrence.lu@spglobal.com
Research Assistant:Ivy Yi, Hong Kong

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