Moody’s decision to change the outlook for China’s property sector to stable from negative on November 29 was based on the expectation that property sales will grow in the single digits — in percentage terms — year-on-year over the next 12 months.
Solid underlying demand, continuing urbanisation, easing mortgage financing for first-time home buyers, and the increasing development of mass-market housing should drive sales and transaction volumes for developers.
As the exhibit below shows, the trend of declining property sales in China bottomed in February 2012, and developers began recording positive year-on-year growth from June 2012. This shift was partly because the firms changed their product mix to target mass-market home buyers, who are less constrained by the home-purchase restrictions that the central government implemented in 2010 to curb speculative demand.
On the other hand, an inevitable consequence of the shift in the companies’ focus toward mass-market housing and away from luxury homes is the decline in average property prices. But we expect the decrease to be mild, at less than 5% year-on-year in most cities.
Among Moody’s-rated Chinese property firms, China Overseas Land and Investments Ltd (Baa2 stable), Longfor Properties Company Limited (Ba2 stable), Central China Real Estate Limited (Ba3 stable), Country Garden Holdings Company Limited (Ba3 stable), Shimao Property Holdings Limited (Ba3 stable), and Evergrande Real Estate Group Limited (B1 stable) should benefit from their focus on the mass market and their well-established market positions.
In contrast, small companies that lack strong brands to promote the sale of luxury housing units or have less flexibility in transforming their business models to focus on the mass market will continue to face difficulties in growing sales. These companies include Zhong An Real Estate Limited (B2 negative), Coastal Greenland Limited (B3 negative), SPG Land (Holdings) Limited (B3 negative), and SRE Group Limited (B3 negative).
The stable outlook for the sector also reflects our view that the Chinese government is unlikely to impose further restrictions to tighten the property market. While the existing restrictions have been effective in curbing speculation, any additional measures may have the undesirable effect of adding stress to already weakening GDP growth, given that investment in the property sector is closely correlated to China’s economy (see exhibit below).
In addition, inventories are at a manageable level. As of June 2012, rated developers’ total inventory — which includes completed properties for sale and projects under development — was 2.3 times their aggregate revenues over the 12 months that ended in June. This level is below the peak of 2.8 times seen during the last downturn in the industry in 2008, but is slightly higher than 2.1 times in full-year 2011 and around 2.0 times in 2010.
Inventories, as a percentage of revenue, should continue to decline in 2013, as sales for most of the rated property developers have increased and more presales will be recognised as revenues when the projects are delivered to their buyers.
Moreover, the number of land acquisitions made by developers began declining during the second half of 2011, when companies felt the effects of the government’s home-purchase restrictions. We also expect companies to undertake a more cautious approach in developing properties, as they prioritise liquidity management and only invest in projects that show a track record of promising pre-sales.
As a result, developers have a lower level of capital locked up in projects, which will in turn strengthen their cash flows.
Finally, property companies should be able to meet their refinancing requirements over the next two years.
In 2013, offshore bonds worth around $600 million will mature. The amount will increase substantially to $4 billion in 2014. Still, these figures are manageable when compared to the property sector’s bond issuance of over $8 billion per year in 2010 and 2011, and $7.3 billion from January to November 2012.
A variety of funding channels, such as offshore bond financings and asset sales, are now available to property developers. In addition, increased sales have strengthened their cash flows and other internal liquidity resources.
We also expect domestic bank lending for most rated developers to remain stable in view of the improvement in their sales performance.
It is unlikely that the outlook for the sector will change to positive in the next 12 months because we believe that the existing restrictions on home purchases will not be relaxed during this period. If sales show strong growth or prices increase rapidly, then the government would likely impose additional restrictions.
We would consider changing the industry outlook back to negative if the government implemented further restrictions, such that we would expect sales to drop by 10%-15% year-on-year for six months. Before we changed the outlook for the sector to stable on November 29, the outlook had been negative since April 2011.
Kaven Tsang is a vice-president and senior analyst, and Franco Leung is an assistant vice-president and analyst. They are a part of Moody’s corporate finance group in Hong Kong and cover a portfolio of property companies based in China and Hong Kong.