2012-02-26

Chinese real estate market on the verge of explosive price declines

上海开发商强势降价20% 第二波降价潮爆发? (Shanghai developers mighty 20% price cut, is the second wave of cuts breaking out?)

Developer Poly Group has slashed prices on a Shanghai development, a move the media is dubbing the first cut of 2012 and a sign that a new wave of price cuts may hit Shanghai. The property in question wase selling for 19,000 yuan/square meter. Today, the price is 17,000 yuan/sqm plus 2,000 yuan/sqm in furnishings. This amounts to a 10.5% price cut and a 21% total reduction.

Another property in the Baoshan Songnan area announced a 5,000 yuan/sqm price cut as part of a group buy promotion, cutting the price to 19,500 yuan/sqm, about 20% below the previous price.

New home inventory in Shanghai is headed for 10 million square meters. An analyst said this inventory would have been sold in 6 months in 2010, 3 months in 2009 and 13 months in 2008, the year of the crisis. At today's optimistic pace of 600,000 square meters sold per mont, it would take 15 months to absorb the inventory.

上周12大重点城市新房成交套数环比齐涨 (Sales in 12 key cities rose in the past week)

Real estate transactions increased in the past week for 12 major cities. This news is greeted warmly by the industry and media, but an analyst at the end of the piece says sales increases will depend on whether developers continue to give huge discounts.

招商地产掀全国降价风暴 自称“史无前例” (China Merchants Property Development country wide price cut storm "unprecedented")

[China Merchants Property is the real estate division of China Merchants bank (0144.HK); the real estate division has two share classes: A shares trade under symbol 000024.SZ; B shares 200024; and in Singapore: C03.]

China Merchants Property will cut prices by 20% in as many as 14 cities: Beijing, Shanghai, Guangzhou, Shenzhen, Suzhou , Nanjing , Chongqing, Chengdu, Zhenjiang, Xiamen , Zhangzhou, Foshan and Tianjin. There are 4 projects in Shenzhen; 3 in Chongqing and Tianjing; and 1 or 2 in the remaining cities. Internal sources place the value of the price cut at 1 billion yuan.

Real estate firms have enjoyed gross margins of 40% in China and up to 50% by mid-2011. According to an internal source, China Merchants Property 2011 sales reached 20 billion yuan, an all-time high, but inventory also reached an all-time high at more than ¥40 billion.

A look at their inventory shows rapid growth (data through September 2011):

Profit margin is about 20%. Last year net profit for 9 months through September was about 2 billion yuan. Even assuming 2012 is about even with 2011 in terms of profits, a cut of 1 billion yuan would lower earnings on the order of 35% or more. Their asset-to-liability ratio hit 66.9% in the third quarter of 2011, the first time it ever exceeded 65%. Analyst Liu Ning said if the market doesn't shift, the sales pressure will be enormous.

A Dongxing Securities report says that developers will change strategy: they will increase turnover to recoup capital, but it will put downward pressure on margins.

[End article summaries]

The news conforms to the various stages of real estate bubbles. Activity has slowed because buyers anticipate lower prices and developers are holding back from selling, hoping for lower prices. The more aggressive firms, such as Vanke, were first to strike last year with big price cuts in order to move inventory. Now, we may be entering the stage where financial pressure forces the weaker firms into dumping properties. This will exert a major downward pressure on prices and reinforce buyer's expectations of lower prices. This is why I anticipate declines on the order of 40%. Declines of about 20% still dominate the news as the price cuts spread, but the overall declines are still around this level. In stage one of the decline, developers hope the government will step in and most people do not believe the bubble has burst. In stage two (or wave 3 after a small rebound if you're going by Elliot Waves), buyers and sellers realize the magnitude of the problem and prices plummet as buyers vanish and sellers worry about solvency rather than profits.

In terms of a small rebound, property stocks have been climbing despite the worsening conditions in the real estate market. 地产股演绎绝地反击 (Real estate stocks strike back)

From this chart (shown are Poly Group and China Merchants; Guggenheim China Real Estate (TAO) has the same pattern) we can see that real estate stocks were bottoming in October. This is the month when stories of Shanghai residents protesting big price cuts made it into the mainstream press. At this time, I view the rebound in property shares as the move up before the big decline. Investors tend to overreact and things haven't been so bad since the first wave of price declines came; gross margins are still high and firms remain very profitable. Activity is picking up these past couple of weeks and that has people optimistic for a turnaround or at least stabilization, but as we see with China Merchants Property, some firms are in bad financial shape. I expect a turning point for the share market soon, perhaps in the next few weeks. Later, perhaps near the end of Q2, we will see much larger declines in home prices.

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