Warning signs in China's property market

So far this year, China's property market has been on the rebound. Between January and July, property transactions were up by 60% year-on-year in terms of value and 37% in terms of area, according to a research note by Moody's.

Underlying the recovery is strong support in the form of government policy. Soon after the financial crisis broke, the Chinese government was quick to react. At the end of last year it made it easier to buy a starter home and it also removed some obstacles to buying a second property. The latter measure is especially noteworthy because speculators picking up multiple properties took a lot of the blame when the market overheated a few years ago.

Now that the market has gathered momentum, it looks as though the government could be starting to backtrack on policy. The first signs came last month, when local media reported that Hangzhou, the capital city of eastern Zhejiang province, increased the minimum deposit on a second home to 40%, up from 20%. On top of that, a mortgage for a second property in this city carries a higher interest rate than other mortgages. There was also media speculation at the time that similar measures were going to spread across the country.

Investors were spooked and share prices in the real estate sector took a dive. As of mid-August, the average discount to net asset value for Chinese property stocks was 13%, up from just 3% a month earlier, according to research issued by Citi. But the bank believes such worries are overplayed: "We do not expect to see significant change to broad-based fiscal and monetary policies as economic recovery is still in an early stage," said the Citi report.

Hangzhou may have been nothing to worry about, but now the local government in Shanghai is causing concern with another announcement. In early August, the mayor said that the government would start selling land for the construction of residential property. The aim is to provide affordable housing, which should help counteract price inflation. This suggests that those in charge of China's economic powerhouse want to ensure that housing does not become too expensive, too quickly. But developers will be unhappy at the prospect of competing with government housing.

In a research note published at the time, Macquarie said that the move was made to address under-supply issues. Shanghai has five months of supply to sell in the next year. And under-supply could become more pressing since the urban planning bureau has proposed halting construction during the eight months next year when the city holds the World Expo.

The effects, however, are not imminent. While the government is trying to increase land supply and increase government housing, "[it] is unlikely to change the under-supply of residential housing in the near term", Macquarie analysts said in the report.

Bad news, especially poor sales volumes, are par for the course at this time of year. Wait a week or so and the situation could change, as the market enters its busiest period, referred to as "Golden September, Silver October". "We expect to see potential positive share price catalysts for the sector to come from sales volume after the end of the summer," said the Citi note.