BHP Take on Real Estate Sector Issues in China
Strategic Research Institute
Published on :
17 Aug, 2022, 6:24 am
Global mining giant BHP while announcing results for FY 2022 has provided in-depth view on real estate sector China, which to a great extant decided the health of Chinese steel sector. BHP’s Market Analysis & Economics Vice President Dr Huw McKay wrote “China’s housing market has often been at the centre of counter–cyclical policy shifts. It is also the biggest wild card in the remainder of calendar 2022 and into calendar 2023. Our current diagnosis is that what ails Chinese housing is not a demand problem, it is a supply–side problem. More specifically, the resolution of the current issue lies within the nexus of developer balance sheets, macro–prudential controls on the same and risk–averse financiers, who have lost confidence over the last twelve months or so in the face of high–profile defaults.”
Dr McKay wrote “It is instructive to compare the present situation to the extended real estate downturn of the mid–2010s. The earlier cycle was characterised by an excessive inventory of unsold properties, with substantial over–building in lower tier cities intersecting with tightening purchase controls on out–of–town investors against a backdrop of policy uncertainty under the anti–corruption drive, property tax pilots and the national housing ownership registry. Such was the depth of the issue that “housing de–stocking” that it became a macroeconomic priority in parallel with the execution of President Xi’s signature Supply Side Reform initiative.”
Dr McKay also wrote “The excess inventory problem at the national level was also the collective expression of hundreds of demand–supply mismatches across China’s various city tiers. The resolution required a transfer of real assets from the balance sheet of developers to the balance sheet of households, and that in turn required an increase in purchasing power and regulatory forbearance on the out–of–town investor question. The transfer was ultimately unlocked through a considerable expansion of mortgage loans and a more lenient approach to investors.”
Dr McKay wrote “The upswing began tentatively, with the average historical lag relationship between the leading indicators and building activity comfortably exceeded, but ultimately an enduring upswing in sales and starts was put in place. It had a lower peak but a longer tail than prior cycles. The shadow of this cycle is still visible in the pipeline of work under construction today, which is part of the problem. Developers have been incentivised to start multiple projects but not to complete them in timely fashion. This oddity stems from the fact that buyers need to compete for access to developments by paying very large down–payments, 100% up front, a practice that has evolved due to the extraordinarily high demand for property assets in China which has historically put developers in a very advantageous bargaining position. If they choose to, developers have been able to dawdle their way through projects after the initial phase without repercussion prioritising the majority of their capital instead for the acquisition of land and the initiation of new projects.”
Dr McKay wrote “The authorities have progressively recognized that this issue was creating unhealthy imbalances in the real estate market. For some years, the response was to tread relatively softly, reflecting the sector’s central role in employment, the credit–collateral system, and the storing of wealth. National level housing policies have been directed towards limiting speculation, modest direct interventions via public housing and shanty town reconstruction and the building up of rental markets. These measures did not tackle the root causes of the starts/completion imbalance, one of which was of course the incentive matrix faced by developers. The enormous wedge between the volume of starts and completions that opened across 2016–2019 made this abundantly clear. The response was to place developers into a traditional SSR template, with specific macro–prudential guardrails now known as the “three red lines” introduced in August 202016. These regulations, finally, increased the incentive for leveraged developers to complete projects in timely fashion, as running down their liabilities to off–the–plan buyers counts towards the –10 percentage point reduction in the liability–to–assets ratios required of the sector. This has seen completions out–perform starts. But with most of the sector coming under financing pressure since Evergrande’s problems came to light roughly a year ago, even working capital has become an issue for some developers. That has led to a very slow supply response to the easier policy measures enacted to boost the demand side of the housing market; a distinct lack of progress on many semi–finished projects; and disgruntled purchasers in multiple locations threatening mortgage servicing strikes. This latter factor may have been the final straw that forced the authorities’ hand to intervene directly on the supply–side. Not long after this story created a local media stir, it was made known that a state–backed vehicle would be created to backstop financially distressed developers and get liquidity flowing to the sector again. The Politburo meeting of late July released some high–level details, alongside a resolute statement to “stabilise the real estate market” and “ensure housing delivery”. ”
Dr McKay wrote “This episode shows yet again that at this stage of China’s development, real estate is so significant in terms of its impact on employment, local government finances and consumer confidence, not to mention the backward linkages into heavy industry, that anything more than a shallow dip is difficult to absorb whilst also retaining desired levels of macro stability.”
Major housing data as of June 2022
The volume of housing starts, the key indicator for contemporaneous steel use in real estate, has declined by 34.4%.
Sales volumes declined 22.2% weighed down by pre–sales at 27% as existing home sales rose 16%
Floor space under–construction was tracking at minus2.8%
Land area sold was minus 48.3% YoY
Developer financing was minus 25.3%.
Dr McKay wrote “A final observation on housing: the scaled inventory of unsold dwellings is close to historical lows as we move into this next cycle phase. A sustained period of weak starts has diminished the pipeline of work, and the needed focus on completions has been delayed. That implies that despite the challenges on the supply side of the industry, risks for housing prices are not skewed downwards. In fact, the reverse may well be true.”