China Bubble

Anyone reading about China would probably have heard about its housing market bubble. Many are talking about it yet no one is able to truly understand the issue.

The Chinese property sector has been a cause of concern over the past few years. Negativity has pushed the stock price of several HK-listed China developers such as Agile Property Holdings (HKSE: 3383.HK), Longfor Properties (HKSE: 0960.HK) and Country Garden Holdings (HKSE: 2007.HK) lower since last year. Are there investment opportunities or is it a value trap for investors?

With more than 30,000 real estate developers in the mainland, these companies use excessive leverage to acquire land and build houses. Property prices have soared over the last decade as the Central government encouraged the development of the private housing market in the late 1990s as shown in the figure below. In early 2000, several real estate companies were allowed to be listed.

China Housing

Source: Milken Institute, China’s Housing Market: Is a Bubble About to Burst?

The housing market became a critical driver to China’s double-digit growth over the past 10 years. As China’s financial markets are still underdeveloped, real estate is seen as one of the few asset class which provides investors a store of value. As the PBOC (China’s central bank) tightened liquidity on banks in order to rein in credit growth, developers suffered from refinancing constraints. Borrowers naturally found their way into the shadow banking market (non-bank lenders) in order to obtain easy yet expensive credit. Such underground lending was largely driven by various companies and investors wishing to participate in the speculative boom of the property market. This had not only increased the systemic risk to the financial system but have shifted capital away from the non-property sectors.

As property developers continued building, the risk of an oversupply heightens. An unexpected housing market crash would eventually force under-capitalized developers into insolvency. Heavy discounting in property inventories and the inability to service debt obligations would inevitability put strains in both the banking and shadow banking sectors.

On the flip side, China is home to roughly 1.3 billion people and the Central government is determined to increase the country’s urbanization rate from 54% (739 million* people) in 2013 to 60% (841 million*) by 2020. That is shifting approximately 100 million rural citizens into newly built cities. Such structural transformation requires the need for additional roof in the middle kingdom. Moreover, national savings rate in China is high (35-45% of GDP) with household leverage still at a relatively low level (40-50% of GDP) versus its global peers. Lastly, the Central government has one of the largest foreign reserves (US$4 trillion) in the world, which could potentially provide a liquidity put for its financial sector. Bears might not necessarily be right.

Value in Action

Overreaction in the markets create opportunities for investors if we look hard enough. In this case, China’s property sector.

*Estimates are based on IMF forecasts

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The information provided is for general information purposes only and is not intended to be any investment or financial advice. All views and opinions articulated in the article were expressed in Willie’s personal capacity and do not in any way represent those of his employer and other related entities. Willie doesn’t own shares in any companies mentioned above.

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