Chinese Property stimulus - premature excitement?

As a lover of fine wines, particularly from Burgundy and Champagne, I am all too familiar when you open a bottle with a lot of excitement, only for disappointment to then hit as either it is faulty or just doesn’t taste in line with the quality you would expect from that bottle. Premature oxidation (premox) used to be a very common problem in white burgundies, so bad I remember one weekend having no choice but to pour bottles down the sink. More recently I’ve brought some bottles to restaurants (I have a few favourites which allow corkage – read on for more details on one) and I’ve had a couple of nicer bottles disappoint slightly in terms of complexity, concentration or the finish. Similar to markets, that uncertainty and unpredictability keeps things interesting and expectations play a key role.

There has been a bit of excitement lately around the Chinese property market, where in a bid to support the property market, the Chinese government has come out with a series of recent measures, namely:

• Interest rate floors for mortgages for the purchase of first and second homes will be scrapped
• The minimum downpayment ratio will be cut to 15% from 20% for first-hand purchases, and 25% from 30% for second-homes
• The PBoC will establish a RMB300bn re-lending program for social housing, at a rate of 1.75%, which could be amplified to RMB 500bn of bank lending
• Governments in cities with excess home inventories should purchase unsold property and turn it into social housing, and recycle idle land parcels held by developers
• Individual housing provident fund loan rate will be cut by 0.25%

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Our China L/S team acknowledges some of these measures on the demand side, like lowering the minimum downpayment ratio to 15% in tier 1 cities (the lowest level historically seen), if it can implemented (no tier 1 cities have officially announced implementation as of now), is an unexpected but positive development. Given consumers limited appetite to increase leverage, cutting downpayment ratios and mortgage rates can be helpful. Analysis from Goldman Sachs, titled “More effective policy support starting…” on 20 May shows that the new round of mortgage rate cuts could be meaningful as they could be equivalent to 4-5% savings on the household’s income in terms of reduced burden to service the mortgage.

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It is on the supply-side policies where we are more sceptical about the positive impact, especially considering some of the recent market chat had been that this RMB 500bn program from the PBoC would be more like RMB 1-2 trillion. Some commentators have suggested at least RMB 1.5 trillion (and our team think it could be multiple times higher) of financing would be required in the current property de-stocking cycle to properly address the excess inventory. There are several other issues besides this:

• There will be a comparatively short period of funding support (maximum of 5 years) compared to the long payback period for rental housing
• The inventory purchase via re-lending facility can only be executed via SOEs and not local government financing vehicles
• Local governments need to find eligible local non-listed SOEs who would be willing to step up and help with purchases (there is no central government participation)
• Commercial banks drawing down on the PBoC relending facility will be voluntary and they will have to bear the risks
• There is risk for local government officials in terms of future potential corruption investigations after the fact if they deal with troubled private developers
• Demand for affordable housing naturally gravitate to tier 1 and 2 cities but it is lower tier cities that will typically have higher levels of property inventory
• A steep discount would be needed for the purchase price to incentivise buyers but also given low rental yields; we think as much as 30-40% discount may be required. A number of these private projects are highly levered, so with that magnitude of discount, you could have a situation where the equity value is zero or negative
• Post acquisition if SOEs re-sell to the market with a lower price (as encouraged by policymakers), that may have a negative benchmarking effect on home prices
• Given officials won’t want to hold assets for too long, they may be willing to accept even lower prices and that may cannibalize demand from other parts of the market not focused on the affordable housing segment
• We don’t think many privately owned developers will have much of an incentive to sell to SOEs given it may uncover insolvency risks to the market
• There will be a time lag for local governments to map out who is willing and able to buy and sell

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GS actually lowered their forecast for property sales and starts following this policy and recent industry sales data which continues to be very soft. Compared to the four year average April sales were 40% below, worsening from the 29% decline seen in March (according to National Bureau of Statistics of China). The chart below from Bloomberg Intelligence illustrates very little y/y respite for Chinese residential sales.

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To be fair, there has been some positive response to the policy news. UBS China property team carried out channel checks on the weekend immediately after the policy stimulus news, and agents saw increased foot traffic by 10-15% week on week on average. Secondary listings in tier 1 cities have also dropped in response, falling 1.3% week on week as of 19th May following the announcement.

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Bulls will also point to the signalling effect around all of this. The Politburo meeting on 13th April first mentioned that the government was carrying on a comprehensive study on how to digest the inventory in the physical market, suggesting it was at still early stages, yet only a few weeks later we have had these policies come out. Hence bulls believe this policy pivot was effectively endorsed by Xi himself, which bodes well for further measures.

For now, the principle “apartments are to be used for living rather than speculation” still rings most true and we don’t believe the authorities want to get China back onto another binge of leverage and asset bubbles. However, if Xi comes out and says this principle is no longer relevant, this would be a game changer. Our team sees this as a very high hurdle as would it impact credibility. Abandoning restrictive Covid policies was about protecting the future ability to govern, not a position Xi is obviously in right now with the property market.

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Bernie’s weekend eats – Hunan, Belgravia

A Chinese restaurant established in 1982 which has no menu, serving lots of small sharing plates, but where there are typically regular appearances from dishes like steamed bamboo cup soup, chive cake dumplings, crispy garlic chilli beans, chilli ribeye beef, pork in a bag (texture and flavour of this is so good!), black cod in vinegar reduction alongside about 12 other dishes. Ask for fried rice or lobster noodles or the dover sole for the main. Family run, Michael Peng oversees the front of house (his father has been the main Chef for most of these years) and is very knowledgeable about wine and has an extensive wine list, with reasonable prices. They also allow you to bring your own wines and pay corkage and I find Champagne and white Burgundy go very well with the food. Service is friendly and there are many regular customers. I have started bringing my two children to eat here as a family on Saturdays for lunch - they each eat a full adult’s menu and love it!