China's new house rules

As sales volumes drop, the Chinese government is trying to make its residential property sector as safe as houses.
China's property sector is a foundation stone of the economy, accounting for almost a quarter of the country's fixed asset investment. But things have turned tepid recently especially compared to last year's hot housing market: figures from the National Bureau of Statistics released in September showed that sales of residential houses were down 31% year-on-year.

ôStatistics show that in 2008, commodity house sales suffered the first negative growth for the past 11 years, and China's real estate industry is now facing the most difficult situation since the mid-1990s,ö says Chinese securities company Guotai Junan in a recent report.

The gap between supply and demand is at a new high. The first half of 2008 saw 670 million square metres of new house construction, compared to 346 million sqm of house sales. Assuming the average number of house sales in July and August is maintained, it will take two years to empty the current real estate inventories in the larger urban areas, leaving developers with plenty of empty properties on their hands.

ôPrices are going down, but not to the extent of a market crash," says HingYin Lee, east China director of research and consultancy for Colliers. "There is no panic selling.ö In the last three or four months, Lee has seen prices at some developments in Shanghai drop by 15% to 20%. He has however seen high levels of demand when properties are sold at deep discounts û suggesting that, as with other asset classes, there's always demand for a bargain.

To prevent the dip from developing into a crisis, the government has stepped in with measures designed to prop up the market. Two weeks ago, the central government made a string of policy decisions which became effective as of November 1. The most significant change is the reduction of the down payment on owner-occupied houses to 20% from 30%. And families with a low income will, under certain circumstances, be able to receive a 0.27% interest rate reduction.

Other measures include: a reduction of the deed tax to 1% for first time buyers of apartments smaller than 90 sqm; a stamp duty waiver for both buyers and sellers; and a waiver of the land value-added tax for individuals. Furthermore, local governments have been encouraged to address the problem with local policy changes.

Using policy to manipulate the property market is nothing new in China and the latest measures could be viewed as the government throwing coal into the flames to counteract regulations introduced just over a year ago, which perhaps proved too effective. The turning point in the market is generally considered to be September 2007, when the government not only increased the down payment on mortgages for second homes to 40% from 30%, but also raised the interest rates on housing loans by a considerable amount, especially for second homes.

The most obvious beneficiaries of the recent government action are the highly leveraged property developers who have been suffering severe cash flow problems since they have been unable to offload properties as quickly as they expected.

ôIn our view, developers will likely take this opportunity to introduce more significant promotions to boost volume sales,ö says a recent report by Citi. ôTherefore, we do expect to see further price corrections. As a reference, our estimates have in general factored in 20% to 25% price decreases from here. We believe that rebounding sales volume would now be more important than rebounding prices.ö

The government support has not been able to stop the decline in Chinese property stocks, however. Take Shenzhen-listed China Vanke and Hong Kong-listed China Overseas Land & Investment for example, whose shares are down 15% and 27% respectively since the announcement, further compounding already steep drops. VankeÆs shares have dropped 73% in the past year.

A property sector in the dumps affects more than just the developers: local governments are poorer because they get less revenue from land sales and taxes on real estate transactions, while industries that produce the raw materials used in construction see less business.

It can also affect the balance sheets of banks û in the first half of this year China's 14 listed banks disbursed Rmb16.25 trillion ($2.4 trillion) of which 15% was mortgages and 9% money lent to real estate developers. The liability ratios of real estate developers are usually more than 70%. Banks that lent to developers who bought land at a high price during the boom only to experience poor sales as things slow down could be looking at big borrowers defaulting on their loans.

And then there are the millions of Chinese citizens who have moved on to the property ladder over the past decade. Along with the stock market, owning a house has been a key way for Chinese to make money. With the A-share market having already tanked this year, the government will be keen to make sure that property does not go the same way.

In other words, trouble in the property sector could have ramifications across the entire economy. And with the Chinese economy slowing down, the government will be hoping that it can avoid a US-style property collapse, because if that happens, it could be the event that makes the slowdown into something much, much worse.
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