China’s property sector has been in the dog house for years.
Real estate companies have been barred from issuing debt since 2009 and equities since 2010. They’ve seen the loan market close to them while borrowing rates became more competitive for other industries. They’ve been burned by rules that force home owners to pay higher down payments for their second homes, and force buyers to pay higher taxes. They’ve also been blamed for inflating a property bubble, pricing the neediest out of the market, and have been accused of hoarding land.
Yet while the above concerns are still valid for many property companies, the measures taken to limit companies’ cash supply have truly helped to stablise the market. This has led China to consider allowing real estate developers back into the capital markets – a decision that may worry some, but frankly, is something that China should do.
The lingering fear, it seems, is that once companies have easier access to cash they will resume their land-buying activities and fuel speculative investing. But there are a lot of advantages to giving the right companies access to debt and equity financing, and there are ways that China can help steer the direction of its policy-loosening to foster the best outcome.
Before considering the latter, the China Securities Regulatory Commission (CSRC) and Ministry of Land and Resources should address the advantages of freeing up financing channels for these companies.
One of these advantages regards China’s overall economic growth. Chinese authorities are targeting a 7.5% rise in gross domestic product (GDP) this year, but the country cannot continue relying on its increasingly spotty export business to achieve this. Likewise, regulators hope that China will transform into a consumption-led economy rather than an investment-led one, but achieving this is a long way off. China cannot bank on consumption to underpin GDP growth just yet.
However infrastructure and development can help China reach its target, creating jobs and boosting industry in emerging cities and business centres. As China undergoes its costly urbanisation scheme and shifts to become consumption-led, real estate and infrastructure growth will help offset growing pains in other areas.
Likewise giving property companies access to the capital markets can help diminish activity in the shadow banking sector. Right now many of China’s property developers are tapping the shadow banking sector for loans, sometimes paying well above 20% interest to finance their projects. Shifting their primary financing channel to the public markets will help shrink the off-balance sheet lending sector further, which has been a main priority for China this year.
And it will also reduce the issuance of wealth management products (WMPs). These high-yielding products are often sold by banks off their balance sheet as a means to finance construction and infrastructure projects. While these WMPs come with the risk of default, banks have historically backed these products, paying the principal and interest on WMPs by issuing new ones. This has left many mid-tier banks stuck in a cycle whereby they funnel liquidity off their balance sheet to meet their payment obligations rather than use the capital for more productive lending, to small-to-medium-sized enterprises, for example.
If these products disappeared and were replaced by high yield bonds issued by real estate companies in the CSRC-regulated corporate debt market, these costly obligations for banks would also dissolve away.
The trick, however, is not to throw open the doors to any and all property developers. This would not only be chaotic for investors, who could be inundated with new issues that require a lot of credit research, but would undo much of the good created by regulators closing the market to these companies in the first place.
Rather, China shouldn’t be afraid to give the companies that are most worthy of the capital access to both the debt and equities markets. These companies – many of which have already proven to be appealing credits in the offshore market, complete with credit ratings and transparent financial records – should be able to raise capital as needed, provided that they are using the cash for the right reasons.
The ‘right reasons’ include financing for social and affordable housing, rather than meaningless commercial space that may never be fully occupied. There should be an application process where regulators decide whether a developer qualifies to issue debt or equity placements based on their projects, and monitor their activity to ensure the funds are being properly used. This should help boost infrastructure development in areas that the State Council prefers to target, and gives investors a high yield choice that isn’t a WMP.
This would also bring names such as China Overseas Land & Investment, China Resources Land, Country Garden and Guangzhou R&F Properties back to the onshore capital markets arena. As these companies are among the best picks by analysts, it’s possible that their presence onshore will serve as a strong model for other companies hoping to make their own foray into the market, and will certainly attract investors seeking diversity.
In short, allowing these companies to participate in the capital markets can promote capital market development, and give investors more choices. It will also lead to the development of important infrastructure which supports the government’s urbanisation plans – all while shrinking China’s shadow banking sector and promoting GDP growth. It’s not an obvious win-win for China, but opening the market would certainly be helpful in many key areas.
Instead of deliberating, China should act.