Lessons from China on speculation and supply

Times flies when you are watching a potential property crunch and we have now been watching Chinese property behemoth Evergrande teetering on the edge of collapse since August so what lessons can we learn from the Evergrande situation?

Many commentators argue there are no lessons for western markets and contend that comparisons with the 2008 collapse of Lehman Brothers in the US overlook the fact that Evergrande is a product of state-controlled, not market-controlled, capitalism.

I beg to differ. Property investors around the world can learn from the evolving and ongoing situation in the Chinese property market. Evergrande has managed in recent days to somehow pay a bond coupon ahead of its deadline. Some market watchers are pointing to central government intervention to stave off the collapse.

Either way, the lessons we can learn from the current, live Chinese case study are twofold. The first is that speculative property investment and development comes with risks directly related to timing and liquidity.

The second is that, underpinning the risks related to timing and liquidity is what we might call the supply slippery slide.

Successful speculative property investment and development depends on a slide with a very high ladder – a ladder as high as the Jack’s beanstalk in the old fairy tale. It needs a constant stream of buyers prepared to keep climbing that ladder in the belief that the capital value of the property they purchase will continue to grow.

The trouble is, the higher the ladder, the steeper the slide. The slightest inkling of over-supply slows buyers down – that leads to investors and developers holding costly projects for longer periods of time and that has a direct result on cashflow.

Evergrande flooded the market. Perhaps that strategy was influenced by the central government but, in any case, it was not a sound strategy. Too much property equals not enough buyers, more time to sell, cashflow difficulties, a slowing down of the project pipeline and, potentially, a meltdown.

Talk to Acuity Funding so we can soften your slippery slide landing - email [email protected] or call 02 9484 0609.

Ranjit Thambyrajah