Weathering the Storm

Escalating trade conflict with the U.S. and mounting debt among domestic developers, combined with unprecedented deleveraging, have prompted critics to claim that tough times are ahead for China’s property market.

The reality is far more nuanced. While some sectors may endure some short-term discomfort, the market is resilient and likely to emerge unscathed from the current turbulence.

In fact, recent government measures, such as those which open up the financial sector to qualified foreign investors and relax FDI restrictions in selected industries, are likely to offset much of any negative impact.

Recent months have seen the U.S. and China engage in a tit-for-tat tariff battle that has raised fears of a global economic downturn.

We foresee that U.S. tariffs could shave between 0.1 to 0.3% from Chinese GDP growth in 2018, with Chinese exports to the U.S. in sectors such as machinery and parts, electrical equipment and iron and steel set to be the hardest hit.

Trade conflict will have the strongest bearing on the industrial and office sectors, although both have seen minimal impact thus far.

In the industrial sector, while the coming months may see some China-based manufacturers outsource production or shift component assembly to markets not subject to U.S. tariffs, recent central government moves to relax foreign direct investment regulations could offset much of the impact.

Several companies including Tesla, which in July received approval to construct a production centre in Shanghai, have already moved to take advantage of the new regulations opening up foreign investment across a number of sectors.

In the office sector. U.S. companies operating in sectors subject to Chinese tariffs account for just 1.5% of total leasing volume, as do Chinese trading companies engaged in import/export business with the U.S.

While activity by such companies could weaken, leasing demand could be set to benefit from a timetable for financial market reforms announced on April 10, 2018, by Yi Gang, the newly appointed governor of the People’s Bank of China (PBoC).

Key components of the timetable include opening the insurance industry and related businesses to qualified foreign investors and allowing foreign insurance companies the same scope of business as local companies, effective the end of H1 2018. The government will also ease a restriction requiring foreign insurers to have a representative office in China for two years before they can set up a company. Also included was an end to foreign ownership caps for banks and asset management companies.

Ultimately, the direct short-term impact of U.S.-China trade conflict will be manageable. Any longer-term impact is set to be offset by the government measures outlined above, together with additional steps including increasing domestic liquidity via further RRR cuts; loosening domestic investment; easing the implementation of new regulations on the financial sector; and accelerating the Belt & Road Initiative to enhance trade partnerships and geopolitical ties with emerging markets, particularly those in the Association of Southeast Asian Nations (ASEAN).

Listed Chinese developers face around US$ 110 billion of debt repayments between 2018-2021 and remain subject to restrictions on financial borrowing. Despite widespread talk of mounting credit pressure on developers and an industry under severe strain, the risk of a market-wide collapse is very low.

The limited number of default cases to date have mainly involved smaller local and private developers. Despite the government’s deleveraging initiative, listed developers have succeeded in finding alternative funding channels, with new issuances of Asset-backed Securities (ABS), such as Quasi-REITs and CMBS, exceeding US$12 billion over the past 12 months.

However, the government recently tightened rules covering new ABS issuance and has also banned developers from selling bonds overseas unless the proceeds are used to repay maturing debt or prevent defaults.

We expect smaller developers to continue to come under strain, which could force them to sell projects (or stakes in them) to larger competitors and may stimulate some M&A activity. Selected medium-sized developers, many of which have borrowed heavily in recent years in an attempt to scale up, may also be vulnerable. Major national developers, which continue to dominate the residential market, are likely to emerge unharmed amid strong demand for residential units in good locations.

Latest CBRE Research data reveal the China property market to be in healthy shape, with occupier markets reporting strong leasing momentum and the country remaining a magnet for investment. Commercial real estate transaction volume totalled RMB 84 billion in H1 2018, a decline of 19% y-o-y, but still above the average for the same period over the past three years.

While trade conflict with the U.S. has added a layer of uncertainty to the market, its impact will be manageable and largely offset by central government measures to loosen foreign direct investment regulations and open the financial sector to qualified foreign investors, which could eventually emerge as a new source of office leasing demand.

Debt maturity remains a concern but market-wide default risk is unlikely. Major national developers are in healthy shape and alternative funding sources are in place.

Although the central government remains committed to cracking down on speculative activity, with 60 cities still enforcing Home Purchase Restrictions (HPR), we foresee that the high housing price to income ratio, particularly in Beijing and Shanghai, will encourage foreign and domestic investors to consider investing in build-to-rent multi-family apartments, supported by government policies to create a rental housing market.

By Henry Chin, PhD, Head of Research, Asia Pacific, and Sam Xie, Head of Research, China, CBRE.