How have Chinese developers fared so far in 2015?
Chinese developers are largely on the road to recovery. We predict that the Chinese government will continue to release more supportive measures in the coming few quarters to prop up growth and staunch the deceleration in real estate investment.
For the first 10 months of 2015, residential housing sales increased a healthy 18%. Average selling prices (ASPs) in many cities moved into positive month-on-month growth. We estimate that most of our rated developers will be able to meet their annual targets in 2015, paving the way for credit profiles to stabilise. But individual players in the sector will likely face some rocky patches.
What is the forecast for credit quality in 2016? Are we likely to see more debt defaults?
There are likely to be fewer negative rating actions in 2016, compared to the more turbulent second half of 2014 and 2015. Sales should grow between 0%-5%, mainly driven by increases in the average selling price. Developers will continue to benefit from improving market sentiment and are generally achieving stronger sell-through rates at stabilised or improved prices.
As the property sector sees an uptick in consolidation, developers appear to be diverging along two separate tracks.
Large players are consistently gaining market share throughout the cycle. These developers generally have better access to funding, more favorable cost structures, and greater financial resources to compete and expand.
On the other hand, smaller players will find it difficult to compete because of their comparative disadvantages. The small-to-medium size players are more likely to focus on a particular region, or form joint ventures to reduce risk and investment burdens as they expand.
Which developers are at risk of missing sales targets?
The majority of rated developers will achieve their sales targets in 2015. Apart from a few companies that set aggressive targets ranging from 20% to 50%, many developers had a moderate growth target of less than 20% this year.
A few developers are less likely to fulfill their full-year objectives, which could result in lower cash inflow and higher leverage than we earlier anticipated. These developers — including Guangzhou R&F Properties, Sino-Ocean Land Holdings, Dalian Wanda Commercial Properties, China Overseas Grand Oceans Group, and Central China Real Estate — achieved only about 65% of their annual targets by the end of October.
The low percentage relative to the average of rated developers is mainly attributable to the heavy back-end loaded sales plan, aggressive sales targets, and slow sales execution due to extensive exposure to lower-tier cities.
How will inventory and land purchases fare?
We view a 35% year-over-year decline in land purchases and reduction in gross floor area (GFA) available for public auction over the first 10 months of 2015 as part of the government's strategy to stabilise prices. Prices have dropped because of oversupply and an industry downturn in late 2014 and 2015. The strategy has partly contributed to an overall decline in supply and a recent price recovery in many cities.
We believe the contracted GFA growth is supported by developers' destocking strategies and recovering market sentiment beginning from the second quarter of this year. The residential GFA sold continued to grow 7.2% over the first 10 months of 2015.
In our view, most of our rated developers have sufficient land reserves for development in the coming few years, as proven by their ratios of total land reserves to GFA sold between July 2014 and June 2015. As such, the reduced land purchased should not alter the supply-and-demand equilibrium in the near term.
In response to the uncertainties over economic prospects in China, we anticipate developers may continue to reduce inventory and hence the capital tied-up in development. Some companies are expanding overseas or into non-property business segments to diversify their property development business.
For example, Evergrande Real Estate Group recently spent HK$12.5 billion ($1.61 billion) for an office building in Hong Kong, and it is also continuing to expand into consumer product segments. Additionally, China Vanke acquired a 20% stake in a real estate project in London.
We do not expect this geographic and business expansion to have an immediate rating impact because the investments are still small, relative to developers' revenues from property development.
What role will China’s domestic bond market play in the property sector?
In our opinion, the domestic bond market will remain open in 2016, providing a crucial funding channel to developers.
We view the opening of the channel to be part of the government's measures to support the industry. S&P-rated developers have issued about Chinese renminbi Rmb137.3 billion ($21.8 billion) in domestic corporate bonds and Rmb40.3 billion in medium-term notes so far in 2015.
Domestic bond issuers typically are part of listed groups with long operating records, and have annual sales of above Rmb10 billion. We expect to see more small-to-mid-sized developers issue in the coming few months.
However, domestic bonds are unlikely to account for a major component of a developer's capital structure, since the issuance size is capped at 40% of the net assets of its onshore China-registered operating companies. As a result we believe domestic issuance will only moderately improve developers' overall funding costs, despite the fact domestic bonds possess coupon rates substantially lower than offshore deals with similar maturities, particularly for speculative-grade-rated issuers.
Some rated developers that have yet to issue onshore bonds would not be able to benefit from low-cost borrowings with longer maturities. Generally, these developers have small operating scale, such as Golden Wheel Tiandi Holdings and Redco Properties Group. Such companies may remain at a disadvantage when competing in the market.
We also believe that most developers will not see their leverage greatly rise as a result of issuing domestic bonds or MTNs. Our view is based on our assumption that issuers will mainly use the proceeds for refinancing, especially for the repayment of high-cost trust financing. In our view, many developers are cautious about aggressively expanding under the current business environment.
The author is Dennis Lee, an associate director in the Corporate Ratings practice at Standard & Poor's Ratings Services.