China’s efforts to tackle soaring home prices and rein in its large property developers have sparked heavy asset price falls and concerns over a credit crunch. However, for our China specialists, there have also been signs of a gradual turnaround.
This article is part of our Investment Symposium Series, in which we present thinking on the big issues. For this series, we draw on the annual Investment Symposium. This is a central event where investment professionals from BNP Paribas Asset Management zoom in on the themes shaping the future. It is also a venue for high-level external speakers to cast a new light on the challenges of our time, testing our convictions and diversifying our thinking.
China’s high-profile clampdown on indebtedness in its property sector sent ripples across financial market,choking off financing for developers and leaving them struggling to meet their repayment commitments.
Changes in property market regulation in China are nothing new – 2018, 2015 and 2011 also brought significant policy interventions in the sector. What is new now is that the rollout of regulatory measures has not been confined to a single sector. It has been accompanied by similar action in sectors from technology to education as President Xi’s administration sought to tackle inequality through its ‘common prosperity’ agenda.
As a result, worries about the property sector have been compounded by concerns over the path of regulation in the economy as a whole. The latest intervention is different in that it appears to target both companies’ business models and their funding channels.
The company at the centre of the crisis is Evergrande, the largest real estate group in China, with USD 19 billion in offshore bonds outstanding. On top of its core property business, it has expanded into sectors from theme parks and sports to electric vehicles. Since Beijing took measures to limit debt in the sector, the company has been selling assets.
Importantly, unlike smaller players, the company has technically not defaulted – while its bonds trade at default levels, it has paid coupons within the usual 30-day grace period.
China property sector regulation has a positive side
Our emerging market debt team believes this is driven by action from the regulator. It sees this as a positive sign, showing that the regulator is aware of the threat to the funding channel for all issuers in the real estate sector and beyond if the company defaults. Maintaining coupon payments should keep the door from shutting on that channel.
Directly and indirectly, the real estate sector contributes up to 30% of China’s GDP. Its supply chain is vast and complex. It is a key sector for the economy – and in this respect too, the regulator will be mindful of triggering a crash.
Rather, the authorities have a clear goal: to deleverage the sector and ensure that it remains a pure property sector, rather than what it was becoming – a property sector with tendrils extending into many other industries.
These efforts have weighed heavily on asset prices and have fed through into steep declines in areas from land sales to unit sales. However, there have been tentative signs of a thaw in Beijing’s attitude, with piecemeal support for the sector, including looser credit controls. Local and central government officials have repeatedly sought to reassure markets that a systemic collapse is unlikely, although they have reiterated that reform remains a priority.
Our emerging market equity and fixed income teams do not expect a wholesale reversal of efforts to regulate the real estate sector. It appears to be clear that the authorities are looking for steadier growth in the future. They see more controlled property prices as central to that aim. However, our teams expect additional support to improve investor sentiment and stabilise the market, and are positioning accordingly.
Opportunities in property debt and (related) equities
After the sector has been deleveraged, our emerging market debt team expects its fundamentals to improve. Meanwhile, valuations of China high-yield debt in general and for property sector debt specifically are at levels that have historically been attractive entry points for selective investors.
Our equity teams see opportunities in related sectors. One example is providers of software to the real estate industry. They may benefit as property companies are forced to work harder and make increased use of technology to sell homes and office buildings in a more challenging market.
Here too, though, they believe selectivity is vital and a careful approach is warranted. China has demonstrated that it is committed to tackling its imbalances. This is not a short-term task, so periodic uncertainty over regulation is likely to be a ‘fact of life’ for investors in the property sector.