China’s actions to help its property sector out of woods: an opportunity for contrarian investors?

After two years of deep crisis in China’s property market, which contributed 25 to 30 percent to the world’s second-largest economy’s GDP, the Chinese government is finally determined to support the sector after a long delay. It is also trying to boost economy growth through strong fiscal measures and easing monetary policy.

The stress in the country’s heavily indebted property sector and ensuing economic slowdown have even led IMF economists to warn of spillover risks into the Asia-Pacific region. A booming decade of construction and borrowing has culminated in declining sales, prices and building activity, and in turn, rising defaults and a crisis that has left its banking sector exposed.

We believe the policies and actions mentioned above not only show that the Chinese government acknowledges the potential systemic risk from the property crisis spilling over into the wider economy but also its determination to support its economy and stop the spiraling deterioration in its property sector. We expect more supportive measures for sales growth and funding access to be released in the coming months.

The property sector is poised to only gradually recover after two years of crisis, but we expect bond prices to recover earlier and at a faster pace, driven by the market’s forward-looking pricing. While we don’t expect a sharp rebound as seen in November 2022, selected Chinese property sector bonds are set to bottom out.

We have a “buy” recommendation for China’s property sector for now, with a “strong buy” for some selected private-owned enterprises (POEs) and quasi-state-owned enterprises (SOEs) that have not defaulted yet. We believe these names, with the strongest credit fundamentals, will benefit the most from current government policies and rebound the fastest in the first half of 2024. On the other hand, special situation credits also offer a very attractive risk-return, although debt restructuring may take longer and bonds may only rebound in 2024.

Moving the needle?

The government’s announced additional CNY 1 trillion in special CGB for the rest of 2023 underpins public investment. PSL and banks’ credit support will further help local governments resume stalled property projects, initiate urban village renovations, and construct public housing – all of which will contribute to stabilizing confidence in the housing market.

We see these latest policies as part of regulators’ supportive actions to ease POEs' funding challenges ahead of the upcoming peak payment season in the first quarter of 2024. The biggest beneficiaries are the non-distressed POEs and quasi-SOEs that banks were reluctant to extend loans to before this policy change.

Prior to these major moves, China already had a package of policies to address property funding and sales challenges. These included mortgage-easing for homebuyers, down-payment reductions, income tax rebates, a push for urban infrastructure upgrades and affordable housing, and a CNY 200 billion special loan pledge to ensure projects are delivered. These measures, however, have failed to reverse the slump in the sector for most of 2023.

The sector may react positively to the latest policies in the near term amid improved investor sentiment, but it will likely still take time for fundamentals to fully recover. Bank loan officers’ risk appetite will be key.

The main challenge now is weak housing sales amid home buyers’ lack of confidence due to both weak economic growth expectations and painful experiences during the two-year-old property sector crisis. Homeowners and buyers currently have negative price expectations after watching property prices tumble, as suggested by the record number of secondary market offerings.

If all supportive actions are taken in the coming months, they would represent China’s most forceful attempt yet to plug an estimated USD 446 billion shortfall in funding needed to stabilize the industry and complete millions of unfinished homes.

Looking ahead

The PSL funding data will be crucial to watch for longer-term improvement, as will the local government’s 2024 target for urban village renovation and social housing. China’s State Council approved guidelines in August that enable social housing to be converted from commodity housing inventory if a city has too much inventory. This would accelerate the inventory digestion cycle.

We estimate the current national inventory under construction at 2.3 billion square meters, or 27 months, and we estimate inventory will return to a healthier level at 24 months, or a 15-year average, if inventory drops to 2 billion square meters. Developers should then see a higher sell-through rate and may even be able to raise prices, i.e., stop the negative spiral effect, which also echoes in commodity housing. Also, if the social housing conversion involves suspended projects, this helps resolve the social stability issue. Not-defaulted POE and semi-SOE names, such as Vanke, Longfor, or Seazen, would benefit the most.

Positive for commercial banks

We believe the news is also positive for commercial banks to improve future profitability and reduce non-performing loans (NPL), with PSL having a crucial role to play. While the PSL funding will be largely borne by the PBOC, we expect further financing to be provided by commercial banks. PSL funding will help complete stalled property projects and mitigate NPL risk on mortgages and corporate loans.

In addition, this could also help reverse consumers' negative sentiment towards property purchases.