China rate cut bad for distressed debt?

China’s recent rate cut is a boost for mainland property developers, but it could mean fewer opportunities for distressed debt investors in the country, said industry observers.

The People’s Bank of China cut its one-year lending rate to 5.6% from 6.0% on November 21, meaning mainland developers are less likely to be forced to sell commercial property assets, said Frank Chen, property services firm CBRE’s head of China research.

The central bank move had come after year-on-year property sales growth turned negative in the first two quarters of this year, prompting hopes of a bonanza for distressed-asset investors. But even before the rate cut, there had been doubts that this would materialise.

“Everyone’s waiting for distressed debt opportunities to emerge in China, but they aren’t coming through yet,” said David Raven, regional director for Asia-Pacific capital markets at property services firm Jones Lang Lasalle. He was speaking at the AVCJ's Annual Private Equity & Venture Forum in Hong Kong earlier this month, prior to the China rate cut.

On the same panel, Jason Lee, head of Asian real estate at PE firm Carlyle, said he was not seeing distressed opportunities in China. But a period of credit tightening has provided an opportunity for private equity investors to get better terms, he said, though the rate cut suggests that there may be fewer such windows of opportunity next year.

During a recent visit to Hong Kong, Nick Crockett, Asia-Pacific head of CBRE Capital Advisors, also said he did not see distressed opportunities arising. More secondary-market activity and fund restructurings, resulting in discounts being available, he said, but these discounts will be smaller than those available two to three years ago and based on liquidity rather than distress.

Larry Hu, China economist at Australian bank Macquarie, confirmed the latest cut was positive for China’s property market. He anticipated a 100-basis-point decline in mortgage rates in the coming months and said a similar rate cut had been key to the property sector turning around in 2012. Property sales growth had turned positive mid-2012 after two sequential quarters of negative year-on-year growth.

Greg Wells, who runs a mezzanine debt fund for real estate investor Forum Partners in Hong Kong, was also upbeat on China’s property market, speaking before the rate cut. "Sentiment is changing already," he said.

The firm is raising capital for its fourth Asian real estate fund, and the investment period for its $374 million third fund will finish at the end of this year. That fund’s investments are split roughly equally between Australia, China and Korea.

There will not be enough inventory next year, noted Wells, because construction starts and land acquisitions are down, and supply is dwindling. “There’s plenty more that has to be built,” he said, adding that residential development hadn’t kept up with demand.

Wells noted that the residential market had boomed in 2012-13 despite restrictions intended to prevent an asset bubble developing. Policies include higher downpayments for second home purchases. As those restrictions have been rolled back, apart from in tier-one cities, sales could pick up, he said.

But others are less positive on China’s property market. Credit ratings agency Moody’s said in a report last week that the rate cut wouldn’t have a meaningful impact on developers’ financial health.

Moreover, the agency sees property sales growth tailing off further next year. The protracted decline in home sales and rising land prices is squeezing developers’ margins, it noted, putting pressure on smaller property developers in particular.