Regain Some Hope, All Ye Who Enter Here!

China’s property market appears to be turning some very important corners.

Growth in floor space under construction growth is slowing， while housing sales growth is recovering.

Inventories are already declining in the biggest cities， though Tier 2 cities still look very oversupplied.

There was a point of view that China’s real-estate sector is a gigantic bubble in the midst of popping horribly， but we think the worst is probably over. This is not to say that apartment prices will now start to rise (the shortterm outlook for prices in most cities is flat to lower)， or to say that developers’ cash pressures are ending (there are indications that trust companies are seeing a deterioration in their real-estate loan portfolios). The good times are probably a year or more away — as we show today， it will take time to absorb inventory， particularly in some Tier 2 and Tier 3 cities. But the drivers of the current downturn are now turning.

1. National construction numbers are turning

Figure 1， our first piece of evidence， shows year-on-year growth in national floor space at various stages of development. Note three apparent turning points:

a. Growth in completed housing is decelerating and is back below 20% y/y. This suggests that the boom in new housing supply growth will end at some point soon.

b. The fall in the growth rate of floor space sold has bottomed out， apparently at a more shallow level than in 2008-09. This suggests that buyers are coming back into the market to take advantage of discounted prices offered by developers. This is significant， and suggests that the return of buyers to Tier 1 and 2 cities that began in Q1 is continuing and is spreading nationwide.

c. The collapse in growth in floor space under construction suggests that the boom in new supply will end in the foreseeable future.

China’s housing sector is clearly in for continued tough times. In the last few months a big disparity has opened up between floor space completed and sold， so we are still looking at high inventory levels. Moreover， completed floor space is still growing and sales are down on last year， so inventories do not appear to be falling. But their rate of growth is now likely decelerating.

These trends will take time to work through before inventories return to a normal level-probably at least a year， possibly more. In this environment， small and medium-sized developers and large-leveraged players will continue to experience tough operating conditions.

Weaker construction will hit GDP. Housing investment accounts for some 8% of GDP and has wide-ranging secondary impacts on commodity demand and the products that fill living rooms and kitchens. It will continue to drag on growth.

But the good news is that so far， apartment prices are coming down in a controlled fashion and attracting buyers who are being encouraged by quiet policy loosening by city governments.

2. Sales volumes are rising in key cities

Figure 2 shows apartment sales volumes in the top 25 cities. We showed in Figure 1 that the slide in y/y growth in nationwide floor space sales moderated in Q2-2012. We are now seeing an actual uptick in apartment sales in the top cities. The People’s Bank of China’s 25bps interest rate cut on 8 June helped. Sentiment has turned as developers have cut prices for many projects， banks have made first-time mortgages easier to get， and city governments have offered various incentives for buyers –ranging from lower transaction taxes to residency permits and even direct subsidies in a few places. Such policy loosening has to be done quietly. On 26 June， a number of newspapers reported that Henan province had launched a 30% discount on the mortgage rate for first-time home buyers， among other supportive policies. The 21st Century Herald reported that the Zhengzhou City Finance Office denied such a policy was introduced (suggesting that the central government intervened.) We do not expect overall purchase restrictions to be relaxed before year-end， but the central government is likely to tolerate measured， quiet easing by local governments that is focused on “real” (rather than speculative) demand. Higher sales volumes mean more cash flow for developers.

3. Inventories are high but falling

Our third and final piece of evidence is presented in Figure 2， which shows our estimate of residential apartment inventories， calculated in terms of months of supply. This chart only includes the top 25 cities for which we have data (Figure 1 shows official national data).

To arrive at this estimate， we simply track land sales and guess that the developer will have apartments ready for sale within three years following a sale (most developers pre-sell before or during construction). This is our supply function. For demand， we project the average of the previous three months’ sales into the future to estimate future sales. We then calculate the gap between supply and demand as our monthly inventory number， calculate a 12-month running sum of those inventories， and show the sum in terms of how many apartments are currently selling per month. Thus， lower land sales in the previous three years and higher apartment sales in the previous three months will bring down our inventory number.

We have long argued that the Tier 1 cities of Shanghai， Beijing， Shenzhen and Guangdong were unlikely to have much of a housing inventory problem — these are “global cities”as far as many in China are concerned， and land supply is limited.

We think inventories could turn negative in Tier 1 cities towards the end of 2012， after reaching only five months of inventory at their highest point. Other cities are doing less well. Tier 3 cities — places like Shenyang and Nanchang — have lower inventories than Tier 2 cities like Hangzhou and Chengdu. We suspect the reason is that Tier 3 markets are relatively underdeveloped and fewer speculative funds are involved there. As we have long argued， though， Tier 2 cities are doing the worst — here， inventories peaked at 20-25 months’ worth. Developers operating in the suburbs of both Tier 2 and Tier 3 cities are suffering， especially in places like Dalian， Tianjin and Wuhan， we believe.

To focus on the positive， we compare where Tier 2 and Tier 3 city inventories were at the beginning of 2012 with where they are now. Tier 2 cities peaked at nearly 25 months’worth of inventory and are now down to 12 months. The situation varies from city to city， but the main point is that the worst seems to have passed. Our estimates suggest that inventory levels will continue to trend down until end-2013 if the current level of sales continues.

In sum: Have a little hope

Far from abandoning hope for China’s real-estate market， we believe the foundation for a recovery is being laid. Our muddle-through story for the sector is working out so far. We will still have to wait until mid-2013 before inventories come down to a normal level， so the bad times are not over yet. But sentiment should now improve at the margin.

(Authors: Economists with Standard Chartered Bank)