China residential and investment markets review 2010

25 January, 2011

International property adviser DTZ reviewed today the residential and property investment markets of mainland China in 2010. The launch of austerity measures, with the aim of cooling down the red-hot property market, was the focal point last year. New homes sales recorded a sharp decline in 2010 while transaction prices continued to fetch a new peak level. The decreased home sales affected the cash flow of developers and prompted them to dispose of more non-core assets and to take part in more joint-venture deals in order to diversify their fund raising channels. Despite the policy effect, the residential market still commands a positive outlook as the fundamental demand for both investment and self-occupation is solid. Purchasing interests will be more inclined to Tier-2 and Tier-3 cities which have less restriction and are at the same time benefited by urbanisation policy. The investment market can look to emerging forces of domestic investors and continues to mature, taking advantage of the growing economy.

Macro factors and the anti-speculation measures

China’s economy continued to grow strongly in 2010, so as its inflation, bringing the prevailing "negative interest rate" to 1.85% level. In view of the growing concern over the inflation hike and more quantitative easing measures in Western economies, the People’s Bank of China raised the bank reserve ratio for seven times since 2010 to historical high  level of 19% for major commercial banks. Bank’s tightening lending policy has urged developers to diversify their financing vehicles. Developers’ self-owned fund rose by 48.8% year-on-year in 2010, mainly through placements in the stock market.

Two major rounds of austerity measures were introduced in last April and September, coupled with further details by various local governments and authorities. These included 30% down payment for first time buyers and tightening of the concessionary home purchase mortgage interest rate from 30% discount to maximum 15%, 50% down payment and 1.1 times of standard mortgage interest rate for second home purchases, suspension of mortgages for the third home purchases, ration order on home purchases in 16 cities, as well as restricting developers from using sales proceeds of pre-completed projects in cities such as Beijing, Qingdao and Tianjin. Mr Alan Chiang, DTZ’s Head of Residential, Greater China, commented: "Judging from the intensity of the austerity measures rolled out last year, the central government’s intention to curb asset bubble was never clearer."

Home sales volume down but prices remain firm

According to DTZ’s survey, new homes sales in Tier-1 cities have dropped annually by 41.8% in 2010 whereas Tier-2 cities by 20.0%. Mr Chiang commented: "Buyers in Tier-1 cities have become more cautious as prices are relatively high, and the local ration order has also suppressed their purchases. Tier-2 cities, on the other hand, remain active."

One of the side effects of the ration orders, particularly in Tier-1 cities, is that it has urged buyers to confine their target to only high end and luxury stock, which has further pushed up the city average price. New homes prices in Tier-1 cities recorded a sharp increase of 35.4% year-on-year to RMB18,853 per sq m in 2010, whereas that for Tier-2 cities by 26.1% to RMB7,015 per sq m. The price levels of both Tier-1 and Tier-2 cities have surpassed their respective peaks in 2007/08 just before the global financial crisis. Mr Chiang commented: "Strong demand for high-end and luxury properties for both self-occupation and investment as a result of the booming economy and city re-generation was an important factor that fuelled the price growth. In Tier-1 cities, the proportion of up-market properties sold (in units) among the top-10 sales chart has reached 53% in 2010. More buyers turned to high-end and luxury units because the austerity measures limited their number of new purchase."

New supply set to boost sales, more so in Tier-2 cities

Newly commenced construction has up-surged by 35.4% year-on-year in 2010 as local governments have been taking serious steps in dealing with delayed construction sites, and in many occasions have re-gained possession of idle lands. Mr Chiang said: "New supply is expected to increase in 2011 which will also boost sales. It is expected that new homes sales in Tier-1 cities will rebound by 15% and Tier-2 cities by 25% this year. We are expecting more interests shifting to Tier-2 and Tier-3 cities where there are fewer restrictions and the cities at the same time benefit by the urbanisation policy and city re-generation."

The increased new supply will suppress price rise in 2010 but cities with little, or even negative unsold inventory, will be less affected. That includes Shanghai, Chengdu and Changsha.

Mr Chiang continued: "Although price growth in 2011 is expected to be slow, Tier-2 cities will outperform Tier-1 cities. To this end, DTZ forecasts that new home prices for Tier-1 cities will be up by 5% and Tier-2 cities by 8% in 2011. Property market will benefit by the booming economy and improving infrastructure across the nation, and will command a positive outlook in the long run."

Property investment market gains despite cooling policies

The property investment market was also under the influence of the cooling policies regarding the residential market and foreign investment during the first half of 2010 but recovered towards year-end. The investment market recorded a total of 1,221 major deals (each with a consideration of over RMB70 million), up 44% from the 845 deals of 2009. In terms of consideration, the 1,221 deals notched a total value of RMB947 billion for the entire 2010. This represented an increase of 67% from the RMB565 billion recorded in 2009.

Mr Alvin Yip, Co-Head of Investment, China pointed out that investment sales dropped sharply in Q2 2010 after the announcement of austerity measures in April. Along with tightened credit from banks, the overall volume and consideration of investment deals dropped almost by half in Q2. "However," Mr Yip said: "The market picked up in the second half of the year and recorded a moderate recovery. As at Q4 2010, the transaction consideration was back to the level of a year ago."

Developers seek more fund raising channels due to sales revenue drop

Mr Yip noted that the austerity measures launched in the residential market that reduced the home sales revenue of developers, and a restriction on loans provided to developers from banks or from trust companies etc, undermined developers’ cash flow. Mr Yip said: "As a result, developers tended to sell their non-core assets (non-residential properties), or to joint venture with institutional investors in order to improve their cash flow. Buyers of these non-core assets included insurance companies, banking institutions and private equity (PE) funds etc."

Foreign investment restricted from speculation

Foreign investors have been seeking opportunities to participate in the China residential development. In fact, the number of foreign-invested real estate enterprises set up in China had increased from 991 in 2009 to 1,091 in 2010. On the other hand, the central government has been cautious against a possible increase in speculation due to foreign investors’ involvement. Policies were launched to tax the offshore transactions of foreign investors and to call for more scrutiny against the approval of foreign investment by national and local authorities. This had raised the difficulty for foreign investors to form wholly owned foreign enterprises (WOFEs) to engage in speculation activities. The situation is reflected by a still limited proportion of foreign investment in the property market in 2010, which amounted to 8% of the total consideration. Mr Yip said: "In face of the challenges, more foreign investors are looking to set up onshore RMB-denominated PE funds as an investment vehicle to participate in the property market and to pool domestic RMB capital commitment."

Insurance companies to lead the pack in domestic investment

By contrast, domestic investment still dominated the property investment market, and it has accounted for 92% of the total consideration in 2010. Among the major domestic institutional investors, insurance companies are expected to lead the way in their participation, thanks to a change in policy in September 2010 that allows domestic insurance companies to invest 10% of their total assets as of the end of the preceding quarter in all sectors of real estate except for residential. Mr Yip commented: "Before the change in policy, insurance companies purchased properties mostly on a self-use basis, but now they will be able to invest in the properties. Based on the sum of RMB4,890 billion, which is the total asset of insurance companies in mainland China as of the end of October 2010 according to the China Insurance Regulatory Commission (CIRC), the 10% of the sum potentially available for property investment would mean an insurance investment capital as much as RMB489 billion could flow into the real estate market in 2011.

"After the launch of the policy, several major deals of office/mixed-use properties purchase were clinched late last year by insurance companies that dared to seize the new investment opportunity. As the market matures and offers more choices of non-residential properties, it can be foreseen that insurance companies will warm up to the idea quickly and be a leading force in domestic property investment in 2011," commented Mr Yip.

There remain a few concerns for the property investment market this year, including the possible full launch of the property tax, tightened credit and restriction against certain aspects of foreign investment, which are expected to affect investors’ decisions in the market. They will also face the situation of yield compression as the return rate of prime properties is bound to decrease as the market matures. "Policy effects aside, ample liquidity, the need to hedge against inflation and sound fundamentals will continue to underpin the demand for properties in mainland China. The rising profile of insurance companies, the expected emergence of RMB REIT funds and other domestic institutional investors will also be promising for the development of the Mainland market as China achieves economic progress," concluded Mr Yip.

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