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China’s Real Estate Slowdown and What It Means For Investors

New limits on Chinese real estate are finally putting an end to soaring property prices, putting pressure on overleveraged developers and the economy. Here’s what’s going on and what it means for investors.

China’s real estate sector has boomed over the last few decades as hundreds of millions of rural residents have moved to the cities.  As a result, property values in Tier 1 cities such as Beijing and Shenzhen have soared in recent years, with many speculators having made millions of dollars from flipping houses.

Today, average housing price-to-income ratios in cities such as Beijing and Shenzhen are now over 40x, compared to just 10x in New York, according to Numbeo. This has incurred the wrath of many who have emigrated to the large cities; many people in China believe home ownership to be a key indicator of success and it’s often a prerequisite for marriage.

Now, the government is trying to cool housing price growth as it looks to make home ownership more affordable for young couples.

Curbing Housing Speculation

Government measures to curb housing price growth have included setting price caps on new flats and limits on house flipping by speculators. Other local governments have raised the down-payment requirement on new houses.

Beijing became the first to cap prices on new flats in 2016, with many other localities following in the years after. In other cities, buyers were required to put down up to 80% of the housing value for down payments.

In March 2017, Xiamen became the first city to ban speculators from selling flats within two years of purchase. Numerous cities, such as Qingdao and Chongqing, placed similar bans afterward.

In 2019 these curbs are finally starting to affect the market. China International Capital Corporation (CICC) believes that this year property sales across China are likely to fall for the first time in five years, with prices expected to decline 10%.  Home buyers are delaying their purchases until prices fall further, putting pressure on overleveraged real estate developers who use pre-payments to help pay back debt.

Things are so bad for these developers that Country Garden Services (SEHK:6098), China’s largest property management service firm is investing 80 billion Chinese yuan in the robotics sector in a bid to diversify into the tech industry.

Muted Growth

And yet real estate and related services account for one-third of China’s GDP. There are many stakeholders who stand to lose from a slowing real estate sector.

Commodities, basic materials companies, and white goods (electrical appliances such as refrigerators and washing machines typically white in colour) companies are all dependent on the real estate sector for demand, so a slowdown in this sector affects these other sectors, all of whom provide an important source of employment in China.

Home ownership is also a prerequisite for access to the best public schools and many Chinese citizens have pooled their entire life savings to buy a home in prime areas. From an investment standpoint, they see it as a safe and reliable place to put their money, especially when compared to the country’s volatile stock and bond markets.  Flat growth could anger those who have already taken out massive mortgages to pay for a house.

Lastly, local governments obtain a large portion of their revenues from selling land to property developers. They are not allowed to levy taxes on their residents without approval from the central government, so land sales and other real-estate-related taxes can account for over 40% of revenues in some regions.

So, for a variety of reasons, China’s real estate market is unlikely to stop growing completely. Instead, it will simply grow at a slower pace in the future. Demand will be particularly strong in Tier 1 cities, since the nation’s best companies and jobs are in those cities and more people will continue to migrate to them.

Going forward, investors should consider looking at real estate developers that have less debt and have diversified into commercial real estate or rental housing.

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