China Real Estate ETF TAO

To answer a question, TAO hasn't been a great indicator for Chinese real estate because small and midsized developers have suffered the most (along with SMEs in various sectors). Until now, most of the companies in TAO have benefited from smaller developers' pain.

Developers See Decent 2015 Overall

China Daily: One third of real estate developers suffered a loss in 2015

Among 50 mainland-listed property developers, 23 reported profit decline in 2015, said Beijing Times on Tuesday.

Fifteen Chinese real estate companies projected a loss, accounting for nearly 30 percent of the developers that have released their preliminary earnings report.

Iron Ore and Copper Slide

A test of the $3 level is in play again with copper breaking down. Iron ore is already sinking to new lows. Most investors are still not paying attention to China, but a breakdown to new lows will be a wake-up call. Chinese developers are right near their all-time high as measured by TAO, but in the A-share market they are flatlined. Those lines will converge one way or another. The performance gap since 2008 is about 50%.

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.

China developer "price cut wave"; price declines reach third tier cities

New apartment prices are being cut 30% in Shanghai. Prices are also falling in Beijing, with industry leader Vanke (万科) cutting some prices by just under 20%. There's talk that Vanke's price cuts could lead to a wave of selling, but it looks like the wave is already forming.

Below are some Chinese articles, with a roughly translated headline and my summary/comments.

万科再降价：楼市价格拐点已经发生? (Vanke cuts prices again: has the real estate prices already turned?)

1926亿存货压顶 万科全线降价？！ (192.6 billion in inventory Vanke cuts everything?!) This article discusses Vanke moving quick to offload property. The firm does a high turnover and with sales slowing, lower prices will move units. If a major slowdown in commencing, this also allows the firm to sell ahead of the competition, though the article doesn't explore this angle.

开发商“储粮过冬” 不缺钱也降价自保 (Real estate developer's "winter grain", not short on cash but cutting prices to protect themselves) This one is interesting because one of the developers (Fantasia; 1777.HK) discusses how the action of the individual firms to protect themselves can lead to a self-fulfilling deflationary cycle as developer cash is pulled out of the real estate market. The bubble is both a demand and supply driven phenomena, for example developers bid up land prices at auction.

I'm keeping my eye on prices in cities other than Shanghai and Beijing, including the smaller third tier cities. These areas can still grow and their development lags the rest of the country. Price declines should be concentrated in the most expensive and overbuilt cities, but if this turns into a major crisis, the smaller cities will also be impacted.

楼市速递大话武汉“降价潮”将在11月来临 （Wuhan price cuts coming in November)

As real estate policy control continues, first and second tier cities have all seen different degrees of discounts, after Shanghai's 30% discount emerged, Beijing, Shenzhen, Guangzhou, Hangzhou, etc. price cuts have continuously grown in number. Wuhan's real estate deals were down in October, following the 34% drop in September. Real estate insiders believe the price cutting wave is coming in November.

在房地政策的不断调控下，一二线城市各大楼盘都出现了不同程度的打折现象，上海涌现出的“7折降价军团”后，北京、深圳、广州、杭州等地降价楼盘不断增多。武汉楼市成交量继9月下跌34%后，10月持续低迷。业内人士认为，武汉楼市“降价潮”将在11月来临。

青岛10月成交量创近三年最低 (Qingdao October contracts hit three-year low)

Here's news from Hebei, a province that surrounds Beijing, but that isn't nearly as wealthy. 河北多市房价跌幅加深，唐山市房价趋于下行 (Hebei multi-city price declines deepen; Tangshan trend is down) In October, price declines reached 1.6% in Langfang, a city that borders Beijing; prices in Tangshan fell 1.3%, while a sample of 7 cities in Hebei saw prices down 0.3%. Prices were flat in several large cities. (These are average prices in each city, not the price for new homes, which are also seeing similar double digit drops.)

地产龙头降声不断廊坊跌幅全国第一 This article says Langfang was the first city to see price declines in China, with prices now below July levels. This article also notes that the price declines are about 1% or less in most cities, but many cities are still seeing price increases including, of all places, the famous "ghost city" of Ordos. However, the article notes that only 40 cities saw rising prices in October, down 14 from September.

银十消逝 保定楼市提前入冬 (Silver October fades, Baoding market enters early winter) This article mentions a phenomena we saw in the U.S. just past the peak: discounts and special deals.

开发商：优惠+打折=真金白银

金九结束，不甘心的开发商纷纷绞尽脑汁在银十创新出形形色色的优惠活动，如力推“特价房”、“买房送家电”、“买房送旅游”、“买房送Ipad”、“买房抽大奖”或不时搞一些演艺活动等噱头纷纷出现，根据新浪乐居保定站统计，10月份，保定市内所有楼盘都推出了优惠活动，而绿城小镇、万和城等楼盘推出了降价幅度不小特价房，最高每平米降价500元

Developers: Deals + Discounts = Real Money

At the close of Gold September, developers racked their brains in Silver October and brought forth all manner of deals such as "Specially Price Homes", "Buy a House, Get Home Appliances", "Buy a House, Get a Vacation", "Buy a House, Get an iPad", "Buy a House, Win a Grand Prize", they also had artistic performances and comedy shows, [the developers] also cut prices, the highest was 500 yuan per square meter.

Baoding has much lower prices than Beijing, but that cut is at least 5% and could be 10% or more depending on the area. Overall, the national average price changes were mixed in October, but prices have declined in smaller cities. The government has said it would keep real estate regulation tight at least until the end of the year. In the next couple of months, we'll see whether this trend turns into a serious real estate crisis, or just another growth hiccup for China. Below is a chart of Guggenheim China Real Estate (TAO).