Recent volatility tied to the pandemic has led to questions from investors about the health and prospects for the China property market. We provide a few high-level observations below.
How did COVID containment affect property sales?
Lockdowns from the end of January through late March, designed to contain the coronavirus outbreak, caused a sharp decline in China property markets in January and February, with reductions of 35% and 39% of sales and volume on a year-over-year (YoY) basis (see displays).
That said, developers quickly adapted and started selling properties online in February, which has continued even as COVID restrictions have largely been lifted in China. This helped the sector avoid a major collapse and contributed to the subsequent V-shaped recovery. Indeed, without online sales, we believe that the first two months of the year would have seen a roughly 50% YoY decline. Instead, sales only declined 35% YoY and, once the lockdown was lifted in end-March, property sales quickly rebounded to -12% (YoY) in March and -3% in April, before turning positive in May. Year-to-date through August, property sales are now +4% (YoY), driven by a contraction of 2% in volume versus a 6% rise in home prices at the national level. Based on a sample from 45 major cities, we have observed that the rebound was most pronounced in Tier 3 cities, followed by Tier 2, and, finally, Tier 1 (the only exception being Shenzhen, where the rebound was very strong).
National Residential Sales by Value
Source: CEIC, National Bureau of Statistics.
National Residential Sales by Volume
Source: CEIC, National Bureau of Statistics.
What contributed to the V-shaped recovery?
First, the response by regulators was very proactive. Once COVID-19 hit, local regulators eased property policies in early February. Soon after the lockdown, they announced a variety of supportive measures, including: delaying land cost payment; delaying new housing starts/completion; allowing homebuyers to delay mortgage payments; relaxing pre-sale permit standards; and supporting financing for developers.
Second, as guided by central government, credit and liquidity were readily available to homebuyers and developers: Mortgage rates dropped, and loan disbursements were accelerated.
Third, and most importantly, consumers adapted rapidly to purchasing homes online. There are no readily available official national statistics for online sales, but the better-than-expected sales numbers for February and March (when China was under almost full lockdown) provide a good indicator of houses sold online.
Traditionally, consumers have tended to buy houses only after they have viewed them physically. But that seemed to change in the midst of COVID-19. We believe consumers overcame their reluctance to purchase houses online, helped by developers offering money back guarantees when online sales first started. That said, these incentives have largely been removed today, given that consumers have grown comfortable with such purchasing channels. Anecdotally, Evergrande, one of the top five developers in China, started conducting online sales in February, and managed to sell 68,000 units in just six days; through September, the company is leading the sector with Rmb 530 billion in sales year-to-date, having benefited from a first-mover advantage. Today, about 60% of its sales are online.
Currently, about 151 of the top 200 real estate firms in China have adopted online marketing and 143 have online “sales offices.” According to Alibaba, more than 5,000 real estate counselors from nearly 100 cities have entered its live-streaming rooms, enabling homebuyers to view houses, consult and make deals all at home. The swift change in homebuyers’ consumption behavior has been surprising, but very positive, in light of crisis conditions. We believe the behavior of buying houses online is here to stay, even after COVID, as developers continue to broaden their online sales channels.
What comes after the V-shaped recovery?
Contrary to what one would expect in an economic downcycle, the V-shaped recovery has not been driven by price cuts. At the national level, home prices grew 6% (YoY) year-to-date through August. In high-demand cities like Shenzhen, home prices have risen by double digits in the secondary market, which has prompted tightening by regulators.
In addition, land sales have heated up, which is a key driver for rising home prices. After accelerating in May, their transaction value reached a historical high in June, and the average premium over auction base price has increased rapidly to about 20%, and as high as 50 – 60% for land in good locations.
Due to upward home price pressure and high land prices, it is likely that regulators will continue implementing targeted policies to stabilize home prices, in order to ensure healthy long-term growth and fulfill their objective of keeping housing’s function as “for living and not for speculation.” We also believe that developers are likely to be subject to more regulation going forward, in light of pilot programs focusing on select developers. Moreover, after the rapid growth of trust and local corporate bond issuance since COVID-19, financial channels are likely to become incrementally tighter, especially for highly levered companies.
A good example is the rumored implementation of the “three red lines” rule to ensure stability in the sector. Akin to a “credit health system” for developers, the rule’s three red lines refer to:
- Liabilities/assets >70% (excludes presales deposits)
- Net interest-bearing debt/total equity >100% (excludes lease liabilities; minority interests and perpetuals treated as equities)
- Unrestricted cash/short-term debt <1x
Under this rule, developers can grow their debt by 5% per annum (in steps of 5% up to maximum of 15%) in exchange for passing each of the three financial ratio tests, and will be labeled in four categories: Green (if all three ratios are achieved); Yellow (if two are); Orange (one); and Red (if none are achieved). We expect such implementation to require developers to de-lever their balance sheets and accelerate sector consolidation further.
All in all, we believe the bias in tightening policies in the coming months is meant to ensure healthy growth and stability in the housing market, economy and financial system toward the end of 2020 and 2021. We believe the property cycle will continue to be milder than before, and expect property sales growth to end the year higher than GDP growth.