Soaring home ownership has become one of the hallmarks of China’s remarkable growth story – the liberalisation of a run-down economy which brought millions from rags to riches in just three decades.
But real estate prices have surged fast enough in recent years that the government can no longer afford to allow the sector to crash – even as it seeks to squeeze out speculators in the market, said Shuang Ding, chief economist for Greater China and North Asia at Standard Chartered.
“The property sector has become too big to fail,” he said. “It directly accounts for about 10% of China’s GDP. In terms of contribution to GDP growth, real estate and sectors related to it account for about one third.”
A slowdown in the sector will not only put pressure on economic growth but also shake the financial sector, which is deleveraging following a long period of balance sheet expansion.
“A correction in property prices will have an impact on financial stability,” he said. “Loans to property sector is about a quarter of China’s total loan outstanding. Banks’ exposure to this sector also includes shadow banking. They have also used properties as collateral when extending loans.”
However, as sales in the property sector slowed down in the past year, economic growth was not significantly affected, said James MacDonald, head of research at Savills. He reckons this is a new phenomenon in the Chinese economy – and an opportunity for the government to rebalance the economy.
“We may be starting to get to a point where other drivers [other than real estate] are supporting the economy,” he said. “This may give the government more flexibility in terms of implementing regulations on the property market.”
Chinese property developers are also pressured by rising borrowing costs in the onshore debt market.
To their dismay, developers may not have seen the end of this upward trajectory yet, said Franco Leung, senior credit officer for Corporate Finance Group at Moody’s.
He noted that many issuers have sold bonds which with a put option after three years, should investors choose not to extend the bond for two years with a new coupon. With onshore liquidity remaining tight, investors are likely to put the bonds issued by smaller developers, even if they are offered at relatively attractive coupons.
“It is likely that there will be an increase in average borrowing cost, with onshore bonds extended with high coupons,” said Leung.
Nevertheless, as long as growth in real estate sales continues – albeit at a slower pace – the bond market still offers developers the best option to raise funds, said Paddy Ran, portfolio manager at China Life Franklin Asset Management.
“Most developers can raise a bond lasting three to five year at 3%-6%,” he said. “That is very cheap funding compared to the double-digit growth they can achieve onshore in contract sales.”