As Chinese regulators tighten scrutiny on the property sector, experts generally believe valuations remain attractive, but investors should take precautions such as avoiding smaller names with weak cash flow and focusing on equity over bonds, which have mounting default risks.
The property sector has come under pressure in China. The China Banking and Insurance Regulatory Commission (CBIRC) ordered Ping An Insurance to stop selling alternative investment products, which are typically tied to the property market, according to a Reuters report last week.
Ping An said in a statement that its real estate exposure was significantly lower than the regulatory cap and its chief executive Xie Yonglin said that the market has misunderstandings about the insurer’s real estate investments.
Large developer China Evergrande Group has also warned for the first time that it may fail to repay its debts unless it is able to attract new investors and sell assets. Its total liabilities reached RMB1.97 trillion ($304.45 billion) as of June 30.
Maturing or puttable bonds by Chinese property developers are likely to fall slightly over the next year and some weaker developers’ liquidity position may stay tight, according to a Fitch Ratings report.
Despite these, fund managers told AsianInvestor that the property market remains healthy and valuations are currently cheap. But they also caution against several headwinds such as Covid-19, Sino-US relations and rising wealth inequality that cast uncertainty on the sector.
AsianInvestor asked fund managers how investors can lock in opportunities in the property sector and the major risks to look out for.
The following contributions have been edited for clarity and brevity.
Winson Fong, senior portfolio manager, Greater China Equities
Manulife Investment Management
We believe the Chinese physical property market remains healthy as prices and home buyers’ leverage ratio are not stretched.
Weaker developers however will still be under pressure given restrictive measures such as PBOC’s “3 red lines” and the centralised land auction programme in key cities. National players that have scale, quality landbank and strong balance sheets will in fact benefit from the current end-users-oriented demand/supply dynamics, and thus we remain comfortable with equities and bonds of top tier players.
Based on our fundamental research on the overall macro and regulatory environment, interest rates and liquidity, we prefer to be overweight on property bonds over equities at this juncture as the risk-adjusted return of the former is more stable and predictable. Despite the negative news flow, we remain confident about market leaders as their management had gone through numerous cycles and accumulated ample intellectual and financial resources to continue delivering returns to shareholders and creditors.
The key risk in the short term, in our view, would be macro-economic shocks due to either deterioration in the pandemic or unexpected geopolitical events. That might trigger more liquidity stress on weak developers. In the longer term, we believe environmental issues such as rapid climate change are genuine risk factors that are underestimated by the developers and investment property landlords.
Koh Shern Ling, portfolio manager
Principal Real Estate Investors
The government policy tightening towards the residential property market has weighed heavily on the share prices of listed property companies and their bonds, especially the more highly levered property developers. Continued policy tightening remains the major, near-term risk as it would potentially trigger more property company debt defaults, which could cause a contagion effect on the rest of the sector and make it more difficult to refinance upcoming maturities.
That said, valuations in the listed property space are very cheap and there are opportunities to buy high-quality developers with sound balance sheets and unique advantages in land sourcing at discounted prices. Some of these better-quality developers have expertise in transit-oriented developments negotiated directly with the government or urban renewal projects that should help protect them from the margin compression the sector is experiencing. There are also opportunities in both the private and public credit markets that have been thrown up by the government’s push to de-lever the property sector.
However, with GDP growth slowing and the Covid-19 situation globally remaining uncertain, the government needs to strike a fine balance between excessively cooling the property market and maintaining growth since property is an important contributor to China’s GDP. At some point in the not-too-distant future, the government is likely to take its foot off the property tightening pedal – or at least not tighten incrementally further. Signs of this could help trigger improved sentiment and drive a rally in both property equities and bonds.
Jessica Tea, senior investment specialist, Greater China equities
BNP Paribas Asset Management
In our view, the long-term outlook for China property sector remains uncertain.
Beijing has attached national strategic importance to reining in property bubbles, and directly intervening in the credit supply for the property sector. What we observe since 2018 is that China has faced three key challenges related to property: 1) Sino-US China tensions, 2) Rapid decline in birth rates, and 3) increasing wealth inequality. China’s determination to roll out unprecedented property curbs is strongly linked with its desire to address these challenges.
China plans to implement comprehensive policies to facilitate common prosperity, aiming to increase labour income share and create channels for various property income growth. The authorities aim to change the pre-sell model of property completion, which will change the business model of property developers. The objective is to encourage healthy developments and further industry consolidation. Besides, China aims to expand the property tax system from some trial programs in some large cities to the whole country, mostly as homeownership is one of the major causes of wealth inequality in China.
As China tries to keep property prices stable and discourage investment from flowing into property excessively, household wealth may move to build up more long-term financial assets. As part of the “dual circulation” strategy, Beijing aims to divert more funding away from property and into high-end manufacturing.
We continue to monitor the risks associated with the sector, and remain focused on our bottom-up stock picking to identify the highest and sustainable growth companies with sound or improving ESG profiles.
Hei Ming Cheng, Asia Pacific vice-chair and mainland China chair
China’s top officials have always maintained a consistent policy that “residential is for people to live in rather than for speculation”. I believe this consistent policy will lead to a more stable residential price growth and hence more stable communities as well as a stable economy.
China’s newly announced China real estate investment trusts (C-Reit) will further support investment and growth in new asset classes such as business parks, life sciences, logistics and data centres. To counter affordability housing issues, rental apartments are also allowed to be listed as C-Reit. Investing in these supported asset classes through either Reit or private funds will likely provide good risk-adjusted returns.
The latest announcement on urban regeneration policies in both Shanghai and Beijing will offer more investment opportunities for asset managers with strong local teams on the ground.
The prolonged closure of the border due to Covid-19 will likely be the near-term risk due to its overall negative impact on the whole economy.