正文
China Property Sector Recovery Is for Real
May 18, 2009
By Qing Wang & Steven Zhang | Hong Kong
A Decent Rebound
The growth rate of property sales stopped declining at the beginning of the year and has since started to stage a decent rebound. By April, the year-on-year growth rate of floor space sold reached 39%, a sharp acceleration from nearly zero growth in December 2008. In the meantime, the decline of average property prices compared to the same period last year also appears to have stabilized in recent months, suggesting significant sequential month-on-month increases.
Property construction has demonstrated a similar trend. Both floor space under construction and floor space completed started to register positive growth at the start of the year after rapid deceleration in 1H08 and then negative growth in 2H08. They accelerated sharply to 10%Y and 28%Y, respectively, by April. The rebound in property construction has reflected substantial improvement in both supply and demand conditions. In particular, from the supply side, property developers\' financing conditions have improved dramatically since October 2008, when the monetary policy stance started to be loosened aggressively. Easy availability of bank financing support allows a swift resumption of construction projects that were suspended in 2008 due to lack of financing and/or uncertain prospects for demand, in our view.
Recovery for Real: The Catalysts
While the rebound in the growth rates of property sales and construction activity has lasted for only 2-3 months, we think that it represents the beginning of a sustainable recovery of this sector.
Several catalysts have helped to deliver this rebound. First, relative affordability improved meaningfully in 2008. We estimate that while the average price per square meter for residential property in 2008 was broadly unchanged compared to that in 2007, the average per capita income increase for urban households in 2008 was about 14%. As a result, the relative affordability - defined as the relative growth rate between property prices and income - registered its largest improvement in 2008 after remaining broadly stable between 2003-07.
Second, mortgage interest rates declined substantially. The five-year base lending rate - which is the benchmark rate for mortgage loans - was cut by 189bp from 7.83% in August to 5.94% in December 2008. Moreover, discounts of varying magnitudes have been applied to the standard rate, such that effective mortgage rates are actually significantly lower. For instance, the effective interest rate on a first mortgage is now at 4.16%, or about 250bp lower than the level in August 2008, which is a deep rate cut in a relatively short period of time.
Third, bank lending to property developers was normalized. The growth rate of lending to property developers declined sharply, from 28%Y in December 2007 to only about 7%Y by December 2008, as lending to property developers had been cut back drastically as part of the authorities\' policy to rein in the rapid expansion of this sector. Property developers whose access to funding (especially from the banks) has been greatly curtailed had to accelerate their sales by slashing prices in order to improve cash flow.
Expectations that the tight financing conditions facing property developers, and thus the pressures on them to cut prices, would persist contributed to the ‘buyers\' strike\' in the property market during most of 2008, in our view. The overall financing conditions started to normalize substantially in October 2008, when the policy priority shifted decisively to boosting growth and preventing an economic hard landing. In this context, expectations of a further property price decline started to ease, gradually bringing an end to the buyers\' strike, in our view.
Recovery for Real: The Bigger Picture
Besides the important catalysts that helped to kick-start the recovery, a key reason why we believe that the property sector recovery is for real is that the latest developments are consistent with our long-standing view - namely, that there has been no nationwide property price bubble in China in the first place, and that the fundamentals of China\'s property sector remain sound (see China Economics: Can the Property Sector Be Counted on as the Engine of Growth, September 2, 2008).
The property sector recovery has taken place against the backdrop of a major policy normalization, with the policy priority shifting away from keeping tight controls over property sector development. The Chinese authorities had adopted a series of austere policy measures, with the objective of arresting the rapid rise in property prices since 2005. We argued that these austere policy measures were aimed at addressing income/wealth disparity, which is a social issue, instead of a genuine, meaningful property bubble, which is an economic/financial concern.
Almost all these austere policy measures have been scaled back since October 2008. This is line with our expectation that the authorities will ease policy controls over the property sector when they start to appreciate the potentially serious downside risk posed by the property sector to the overall economy. This is because a deeper economic slowdown and the attendant unemployment will have much more serious and broader social implications than those associated with housing affordability (again see China Economics: Can The Property Sector Be Counted On As The Engine of Growth).
Our long-standing view is that there is no nationwide property price bubble in China, and that the fundamentals of this sector remain healthy. Specifically, housing affordability has been widely used as one of the key indicators for assessing whether property prices have been so high as to become a bubble. Relative to household income, housing prices have declined substantially since 1997. Although relative affordability deteriorated moderately in 2004-05, it has improved significantly since mid-2007. Therefore, despite much talk about rapidly rising property prices in recent years, property affordability has been broadly stable since 2003 and even improved significantly in 2008.
Some market observers argue, however, that a more relevant indicator of affordability should be the housing-price-income ratio (HPIR), which measures absolute housing affordability. The average HPIR in China was in the 8-9x range during 2003-08, which is much higher than the established HPIR norm of 3-6x. However, the HPIR in China may have overstated the seriousness of low absolute affordability, due to some China-specific factors, in our view. Adjusting for these factors would make housing more affordable than suggested by the current HIPR, lending further support to the argument that there has been no bubble in house prices.
There are at least two such factors at play. First, Chinese household income growth has been very strong on average, and this secular trend is expected to remain largely intact for the foreseeable future. During 2002-07, the average annual nominal growth of household disposable income per capita was about 12%, which is much faster than that in many emerging market economies, let alone developed ones. Factoring in the rapid income growth in the foreseeable future, the income-growth-adjusted HPIR (IGA-HPIR) (i.e., continued strong income growth with fixed housing purchasing prices) in China will decline substantially in the years immediately after a house purchase. We argue that when gauging housing affordability in a fast-growing economy such as China, the IGA-HPIR is a more appropriate concept than the HPIR.
Since the HPIR norm of 3-6x in developed economies should be a function of expected income growth in these economies, when estimating the IGA-HPIR for China, we use the difference in expected income growth between China and the developed economies. If we assume that China\'s nominal annual household income growth is 5pp higher than that in developed economies, which is by no means a strong assumption in view of the track records in the past five to ten years, the average HPIR for a house purchased in China today will drop from the current 8.3x in 2007 to 6.5x five years from now.
The second China-specific factor that helps to explain the seemingly high HPIR in China is the very high house- ownership ratio and the strong demand for housing upgrades. The house-ownership ratio in China is over 80%, one of the highest in the world - a legacy from the planned economy era. Under the planned economy, the vast majority of employees lived in public housing that were later privatized and sold to these employees at a heavy discount - even for free in many cases. In this context, the unusually high house-ownership ratio is a reflection of the distortion of the planned economy in the past, rather than the natural work of a market economy.
Most public housing in China - especially that inherited from the planned economy era - is of low quality. Given the rapid household income growth in recent years, this is the key reason for the strong demand for housing upgrades, despite the already high house-ownership ratio. We estimate that at least 30% of underlying housing demand in recent years may have reflected the need for housing upgrades. And the down-payment for this type of house purchase is typically financed by the proceeds from the sale of the first house. In other words, about 30% of home buyers already have a sizeable endowment - which reflects the wealth transfer from the state when the public housing was privatized - to allow them to pay the down-payment without tapping into their current income or savings. This is a quite different situation from that in developed economies, where there is a well-functioning property market and no pent-up demand for housing upgrades.
We assume that out of the need for housing upgrades, home buyers make a 40% down-payment (which is not a strong assumption, given that the current average amount of a down-payment is about 35%), and the down-payment is fully financed from the proceeds of the sale of the first house. Adjusting for this special factor, due to the demand for housing upgrades, we estimate that the HPIR could drop from the current 8.3x to 7.3x.
Factoring in these two China-specific factors, we estimate that the adjusted HPIR ratio would be around 5.7x, significantly lower than the current 8.3x.
Moreover, the relatively brief history of China\'s property market development has exacerbated the social aspect of the housing affordability issue. Deterioration in income/wealth disparity in China was an issue long before the rapid development of the property market in the past four to five years. However, the income/wealth disparity becomes more obvious when the majority of households start to realize that they cannot afford a decent house. In a sense, the property market serves as a mirror that reflects the underlying income/wealth disparity that existed long before the rapid rise of the property market. To the extent that the underlying income/wealth disparity has been revealed through the property market within a relatively brief period, it has constituted a shock to many low- and middle-income households in China, exacerbating the social aspect of the housing affordability issue.
Implications
Both the near-term catalysts and fundamentals suggest that the recovery in the property sector is for real and is sustainable, in our view. Despite much attention being paid to the sizeable fiscal stimulus undertaken by the Chinese authorities to boost growth, we think that the recovery in the property sector has been by far the most encouraging development in the Chinese economy.
The double-digit growth in China in 2003-07 has been driven primarily by two engines: exports and investment. With exports as an engine of growth shutting down, due to the recession in the G3 economies, the outlook for robust growth in China hinges critically on the strength of domestic investment, as consumption has not been the primary factor contributing to the stellar performance of the economy in recent years.
Domestic investment has so far held up quite well, reflecting an aggressive policy stimulus that has brought about a strong increase in investment in infrastructure projects undertaken primarily by state-owned or state-controlled enterprises. Whether resilient investment growth is sustainable beyond 2009, when the effect of the policy stimulus is phased out, has been a key concern among many market observers. In this context, a property sector recovery offers hope that private, market-based investment and its attendant positive impact on other activity (e.g., consumption, increased local government revenue as a result of resumption of land sales) will be able to offset the eventual phasing-out of policy stimulus, helping to sustain organic growth, especially in the event of a prolonged recession in the G3 economies beyond 2009.
Reflecting the significant pick-up in property sales, the property inventory in major cities has started to decline rather rapidly. Morgan Stanley\'s Property Research team estimates that the current inventory level in major cities ranges from about three months of sales in Shanghai to about 11 months in Beijing (see Morgan Stanley Property Team\'s weekly publication, China Property: Transaction Tracker, May 11). Using an alternative indicator, we estimate that the nationwide inventory level - as defined by the vacant area in the primary market adjusted for sales - has recently stopped rising after a rapid increase for most of 2008.
As inventory stops rising and even starts to decline, the sizeable pick-up in sales will eventually translate into a significant recovery in new projects launched, in our view. While the year-on-year growth rate in floor space started remains in negative territory, we expect it to bottom out and start to show positive growth in 2H09. The historical pattern suggests that it takes about six months before new projects started begins to respond to sales.
A buoyant property market would also help to underpin private consumption. Despite new property construction remaining sluggish, the recovery in property sales appears to have already had a positive impact on property-related retail sales, which has been instrumental in underpinning the resilience of overall retail sales. For instance, retail sales of construction & decoration materials and furniture - both of which are closely related to purchases of new houses - have registered a strong rebound since the start of the year.
What\'s Next
A stable policy environment is critical to healthy, sustainable development of the property sector in China. Looking ahead, we expect the authorities\' current policy stance vis-à-vis the property sector to remain unchanged. In fact, we view the policy change since October 2008 as policy normalization, rather than discretionary, counter-cyclical policy easing, which tends to be temporary.
The authorities\' current policy approach features two tracks: 1) encouraging market-based commercial housing by removing unduly austere policy measures that artificially depress its development; and 2) addressing the housing issue for low-income households by developing the low-cost, low-rent, affordable housing program financed by public funds. This is an effective and sustainable policy approach, as a viable affordable housing program is predicated on a buoyant commercial housing program, in our view. In view of the property sector\'s importance in supporting an economic recovery and sustainable growth, any concern that the policy shift might potentially hurt this sector is unwarranted, in our view.
Risks
An affordable housing program features prominently in the Chinese authorities\' stimulus plan, and Rmb400 billion out of the Rmb4 trillion spending package is committed under this program. While this is a key component of the current dual-track policy approach for the property sector, there is a risk that the publicly funded affordable housing program may creep into an overly ambitious public housing program. It could end up becoming a heavy-handed intervention by the government into the property sector under the pretext of an aggressive implementation of the pro-growth fiscal stimulus plan. This would run the risk of damaging the otherwise market-based, sound commercial housing sector by crowding out private investment, threatening the sustainability of the property sector as an engine of growth in the long run. China had a broad-based public housing program in the planned economy era, which proved unsuccessful.
For a list of policy announcements introduced since 2005 first aiming at curbing fast property price increases, and those introduced since 4Q08 to support this sector, please see the Appendix of China Economics: Property Sector Recovery Is for Real, May 15, 2009.
May 18, 2009
By Qing Wang & Steven Zhang | Hong Kong
A Decent Rebound
The growth rate of property sales stopped declining at the beginning of the year and has since started to stage a decent rebound. By April, the year-on-year growth rate of floor space sold reached 39%, a sharp acceleration from nearly zero growth in December 2008. In the meantime, the decline of average property prices compared to the same period last year also appears to have stabilized in recent months, suggesting significant sequential month-on-month increases.
Property construction has demonstrated a similar trend. Both floor space under construction and floor space completed started to register positive growth at the start of the year after rapid deceleration in 1H08 and then negative growth in 2H08. They accelerated sharply to 10%Y and 28%Y, respectively, by April. The rebound in property construction has reflected substantial improvement in both supply and demand conditions. In particular, from the supply side, property developers\' financing conditions have improved dramatically since October 2008, when the monetary policy stance started to be loosened aggressively. Easy availability of bank financing support allows a swift resumption of construction projects that were suspended in 2008 due to lack of financing and/or uncertain prospects for demand, in our view.
Recovery for Real: The Catalysts
While the rebound in the growth rates of property sales and construction activity has lasted for only 2-3 months, we think that it represents the beginning of a sustainable recovery of this sector.
Several catalysts have helped to deliver this rebound. First, relative affordability improved meaningfully in 2008. We estimate that while the average price per square meter for residential property in 2008 was broadly unchanged compared to that in 2007, the average per capita income increase for urban households in 2008 was about 14%. As a result, the relative affordability - defined as the relative growth rate between property prices and income - registered its largest improvement in 2008 after remaining broadly stable between 2003-07.
Second, mortgage interest rates declined substantially. The five-year base lending rate - which is the benchmark rate for mortgage loans - was cut by 189bp from 7.83% in August to 5.94% in December 2008. Moreover, discounts of varying magnitudes have been applied to the standard rate, such that effective mortgage rates are actually significantly lower. For instance, the effective interest rate on a first mortgage is now at 4.16%, or about 250bp lower than the level in August 2008, which is a deep rate cut in a relatively short period of time.
Third, bank lending to property developers was normalized. The growth rate of lending to property developers declined sharply, from 28%Y in December 2007 to only about 7%Y by December 2008, as lending to property developers had been cut back drastically as part of the authorities\' policy to rein in the rapid expansion of this sector. Property developers whose access to funding (especially from the banks) has been greatly curtailed had to accelerate their sales by slashing prices in order to improve cash flow.
Expectations that the tight financing conditions facing property developers, and thus the pressures on them to cut prices, would persist contributed to the ‘buyers\' strike\' in the property market during most of 2008, in our view. The overall financing conditions started to normalize substantially in October 2008, when the policy priority shifted decisively to boosting growth and preventing an economic hard landing. In this context, expectations of a further property price decline started to ease, gradually bringing an end to the buyers\' strike, in our view.
Recovery for Real: The Bigger Picture
Besides the important catalysts that helped to kick-start the recovery, a key reason why we believe that the property sector recovery is for real is that the latest developments are consistent with our long-standing view - namely, that there has been no nationwide property price bubble in China in the first place, and that the fundamentals of China\'s property sector remain sound (see China Economics: Can the Property Sector Be Counted on as the Engine of Growth, September 2, 2008).
The property sector recovery has taken place against the backdrop of a major policy normalization, with the policy priority shifting away from keeping tight controls over property sector development. The Chinese authorities had adopted a series of austere policy measures, with the objective of arresting the rapid rise in property prices since 2005. We argued that these austere policy measures were aimed at addressing income/wealth disparity, which is a social issue, instead of a genuine, meaningful property bubble, which is an economic/financial concern.
Almost all these austere policy measures have been scaled back since October 2008. This is line with our expectation that the authorities will ease policy controls over the property sector when they start to appreciate the potentially serious downside risk posed by the property sector to the overall economy. This is because a deeper economic slowdown and the attendant unemployment will have much more serious and broader social implications than those associated with housing affordability (again see China Economics: Can The Property Sector Be Counted On As The Engine of Growth).
Our long-standing view is that there is no nationwide property price bubble in China, and that the fundamentals of this sector remain healthy. Specifically, housing affordability has been widely used as one of the key indicators for assessing whether property prices have been so high as to become a bubble. Relative to household income, housing prices have declined substantially since 1997. Although relative affordability deteriorated moderately in 2004-05, it has improved significantly since mid-2007. Therefore, despite much talk about rapidly rising property prices in recent years, property affordability has been broadly stable since 2003 and even improved significantly in 2008.
Some market observers argue, however, that a more relevant indicator of affordability should be the housing-price-income ratio (HPIR), which measures absolute housing affordability. The average HPIR in China was in the 8-9x range during 2003-08, which is much higher than the established HPIR norm of 3-6x. However, the HPIR in China may have overstated the seriousness of low absolute affordability, due to some China-specific factors, in our view. Adjusting for these factors would make housing more affordable than suggested by the current HIPR, lending further support to the argument that there has been no bubble in house prices.
There are at least two such factors at play. First, Chinese household income growth has been very strong on average, and this secular trend is expected to remain largely intact for the foreseeable future. During 2002-07, the average annual nominal growth of household disposable income per capita was about 12%, which is much faster than that in many emerging market economies, let alone developed ones. Factoring in the rapid income growth in the foreseeable future, the income-growth-adjusted HPIR (IGA-HPIR) (i.e., continued strong income growth with fixed housing purchasing prices) in China will decline substantially in the years immediately after a house purchase. We argue that when gauging housing affordability in a fast-growing economy such as China, the IGA-HPIR is a more appropriate concept than the HPIR.
Since the HPIR norm of 3-6x in developed economies should be a function of expected income growth in these economies, when estimating the IGA-HPIR for China, we use the difference in expected income growth between China and the developed economies. If we assume that China\'s nominal annual household income growth is 5pp higher than that in developed economies, which is by no means a strong assumption in view of the track records in the past five to ten years, the average HPIR for a house purchased in China today will drop from the current 8.3x in 2007 to 6.5x five years from now.
The second China-specific factor that helps to explain the seemingly high HPIR in China is the very high house- ownership ratio and the strong demand for housing upgrades. The house-ownership ratio in China is over 80%, one of the highest in the world - a legacy from the planned economy era. Under the planned economy, the vast majority of employees lived in public housing that were later privatized and sold to these employees at a heavy discount - even for free in many cases. In this context, the unusually high house-ownership ratio is a reflection of the distortion of the planned economy in the past, rather than the natural work of a market economy.
Most public housing in China - especially that inherited from the planned economy era - is of low quality. Given the rapid household income growth in recent years, this is the key reason for the strong demand for housing upgrades, despite the already high house-ownership ratio. We estimate that at least 30% of underlying housing demand in recent years may have reflected the need for housing upgrades. And the down-payment for this type of house purchase is typically financed by the proceeds from the sale of the first house. In other words, about 30% of home buyers already have a sizeable endowment - which reflects the wealth transfer from the state when the public housing was privatized - to allow them to pay the down-payment without tapping into their current income or savings. This is a quite different situation from that in developed economies, where there is a well-functioning property market and no pent-up demand for housing upgrades.
We assume that out of the need for housing upgrades, home buyers make a 40% down-payment (which is not a strong assumption, given that the current average amount of a down-payment is about 35%), and the down-payment is fully financed from the proceeds of the sale of the first house. Adjusting for this special factor, due to the demand for housing upgrades, we estimate that the HPIR could drop from the current 8.3x to 7.3x.
Factoring in these two China-specific factors, we estimate that the adjusted HPIR ratio would be around 5.7x, significantly lower than the current 8.3x.
Moreover, the relatively brief history of China\'s property market development has exacerbated the social aspect of the housing affordability issue. Deterioration in income/wealth disparity in China was an issue long before the rapid development of the property market in the past four to five years. However, the income/wealth disparity becomes more obvious when the majority of households start to realize that they cannot afford a decent house. In a sense, the property market serves as a mirror that reflects the underlying income/wealth disparity that existed long before the rapid rise of the property market. To the extent that the underlying income/wealth disparity has been revealed through the property market within a relatively brief period, it has constituted a shock to many low- and middle-income households in China, exacerbating the social aspect of the housing affordability issue.
Implications
Both the near-term catalysts and fundamentals suggest that the recovery in the property sector is for real and is sustainable, in our view. Despite much attention being paid to the sizeable fiscal stimulus undertaken by the Chinese authorities to boost growth, we think that the recovery in the property sector has been by far the most encouraging development in the Chinese economy.
The double-digit growth in China in 2003-07 has been driven primarily by two engines: exports and investment. With exports as an engine of growth shutting down, due to the recession in the G3 economies, the outlook for robust growth in China hinges critically on the strength of domestic investment, as consumption has not been the primary factor contributing to the stellar performance of the economy in recent years.
Domestic investment has so far held up quite well, reflecting an aggressive policy stimulus that has brought about a strong increase in investment in infrastructure projects undertaken primarily by state-owned or state-controlled enterprises. Whether resilient investment growth is sustainable beyond 2009, when the effect of the policy stimulus is phased out, has been a key concern among many market observers. In this context, a property sector recovery offers hope that private, market-based investment and its attendant positive impact on other activity (e.g., consumption, increased local government revenue as a result of resumption of land sales) will be able to offset the eventual phasing-out of policy stimulus, helping to sustain organic growth, especially in the event of a prolonged recession in the G3 economies beyond 2009.
Reflecting the significant pick-up in property sales, the property inventory in major cities has started to decline rather rapidly. Morgan Stanley\'s Property Research team estimates that the current inventory level in major cities ranges from about three months of sales in Shanghai to about 11 months in Beijing (see Morgan Stanley Property Team\'s weekly publication, China Property: Transaction Tracker, May 11). Using an alternative indicator, we estimate that the nationwide inventory level - as defined by the vacant area in the primary market adjusted for sales - has recently stopped rising after a rapid increase for most of 2008.
As inventory stops rising and even starts to decline, the sizeable pick-up in sales will eventually translate into a significant recovery in new projects launched, in our view. While the year-on-year growth rate in floor space started remains in negative territory, we expect it to bottom out and start to show positive growth in 2H09. The historical pattern suggests that it takes about six months before new projects started begins to respond to sales.
A buoyant property market would also help to underpin private consumption. Despite new property construction remaining sluggish, the recovery in property sales appears to have already had a positive impact on property-related retail sales, which has been instrumental in underpinning the resilience of overall retail sales. For instance, retail sales of construction & decoration materials and furniture - both of which are closely related to purchases of new houses - have registered a strong rebound since the start of the year.
What\'s Next
A stable policy environment is critical to healthy, sustainable development of the property sector in China. Looking ahead, we expect the authorities\' current policy stance vis-à-vis the property sector to remain unchanged. In fact, we view the policy change since October 2008 as policy normalization, rather than discretionary, counter-cyclical policy easing, which tends to be temporary.
The authorities\' current policy approach features two tracks: 1) encouraging market-based commercial housing by removing unduly austere policy measures that artificially depress its development; and 2) addressing the housing issue for low-income households by developing the low-cost, low-rent, affordable housing program financed by public funds. This is an effective and sustainable policy approach, as a viable affordable housing program is predicated on a buoyant commercial housing program, in our view. In view of the property sector\'s importance in supporting an economic recovery and sustainable growth, any concern that the policy shift might potentially hurt this sector is unwarranted, in our view.
Risks
An affordable housing program features prominently in the Chinese authorities\' stimulus plan, and Rmb400 billion out of the Rmb4 trillion spending package is committed under this program. While this is a key component of the current dual-track policy approach for the property sector, there is a risk that the publicly funded affordable housing program may creep into an overly ambitious public housing program. It could end up becoming a heavy-handed intervention by the government into the property sector under the pretext of an aggressive implementation of the pro-growth fiscal stimulus plan. This would run the risk of damaging the otherwise market-based, sound commercial housing sector by crowding out private investment, threatening the sustainability of the property sector as an engine of growth in the long run. China had a broad-based public housing program in the planned economy era, which proved unsuccessful.
For a list of policy announcements introduced since 2005 first aiming at curbing fast property price increases, and those introduced since 4Q08 to support this sector, please see the Appendix of China Economics: Property Sector Recovery Is for Real, May 15, 2009.
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