Despite long-running international concerns about China’s property “bubble,” the market has proven quite resilient. The Chinese government has instituted various austerity measures to cool the market, but buoyant demand for property has helped avoid any serious downturn.
A number of factors continue to support the Chinese property sector, including the increasing urbanization rate, abundant liquidity and a lack of investment alternatives. As a result, although we expect the market to slow gradually in 2018, we see attractive opportunities for bond investors in the sector, particularly among larger real estate developers.
Urbanization and the demand for housing
Since 2000, the percentage of China’s population living in urban areas has risen from 36% to 58%. Over that period, 300 million Chinese have migrated from rural to urban areas, creating huge demand for new housing.
This demand varies substantially across regions and cities. Generally speaking, the real estate market along the East Coastal areas is the most robust, underpinned by positive population inflows and strong economic growth. However, it is also more exposed to policy tightening due to higher property prices. The fundamental outlook for most inland lower-tier cities is less attractive as a result of continued population outflows.
Government intervention helps keep market on track
China’s M2, which represents the broader money supply, has been growing at double-digits over the past two decades. China’s capital controls have largely restricted the Chinese population from investing this money in overseas markets, but there are limitations to the available onshore investment channels. Onshore interest rates remain low (both in terms of bond yields and bank deposits) and the domestic equity market is notoriously volatile. As a result, for many Chinese the property market has become one of the most attractive investment options. While this has led to concerns about a potential bubble, China’s property market is highly influenced by the government’s stance towards the sector.
The Chinese government tends to offer support when the market is cooling too fast (e.g., in 2009 during the global financial crisis). Mostly, however, authorities impose restrictions in an attempt to rein in run-away property prices, particularly in major coastal cities. The latest round of tightening started in late 2016 after the property market experienced a strong rebound, with policies ranging from home purchase restrictions, to a price cap on new developments, to tightening credit available to home buyers as well as developers. Annual growth in the market has since slowed from over 30% to low single-digits.
We see no sign of policy relaxation in the near future as Chinese authorities are determined to prevent property prices from rising too fast. As a result, we expect a gradual slowdown in China’s property market in 2018. We view a near-term market crash as highly unlikely given inventory is close to record lows and the government has plenty of room for policy relaxation.
Investment implications: Sector consolidation provides opportunities
Despite recent government efforts to rebalance China’s economy by stimulating domestic consumption and supporting high-tech innovations, property remains the most important sector in terms of its contribution to GDP growth. We estimate China’s property market to be worth around US$22 trillion, approximately 1.8 times the size of its GDP in 2017.
The most noteworthy trend in the sector over the last few years has been accelerating consolidation. The country’s top 10 property developers increased their market share from a mere 5.4% in 2006 to close to 25% by 2017. Large developers enjoy significantly better access to a broad range of funding channels at lower costs.
We believe the key investment opportunities for bond investors lie with larger developers that can benefit from sector consolidation, while at the same time demonstrating an improving credit profile. In recent years, Chinese developers have been active in the offshore U.S. dollar bond market, raising funds to support their rapid growth. Total outstanding issues for the sector amounted to over US$94 billion. Of that, approximately US$74 billion represents high-yield bonds, which account for over 30% of the J.P. Morgan Asia Credit Index (JACI) – High Yield.
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Frank Chen is a credit research analyst in PIMCO’s Hong Kong office.