China’s property stocks: policy shift to the rescue?

Sentiment towards the Chinese property sector has suffered significantly in the wake of a tight 2021 policy environment and fears of contagion sparked by the financial difficulties and default of Evergrande*, one of China’s largest developers.

There have been various drivers behind the real-estate market’s downturn. On the supply side, funding restrictions have led to a decline in property investment and construction activity, depleting the pipeline. From the demand side, homebuyers have become more cautious, causing sales to decline for months – and prices to follow suit. It is reminiscent of the Chinese property downturn in 2014/2015, when investment slowed sharply. Yet residential property inventories are relatively low now compared with then.

Market impact

It is vital not to underestimate the importance of property to the overall Chinese economy and the stability of the country’s financial system. This is why China’s property troubles have weighed so heavily on its stock market, which was already suffering from the broader regulatory crackdown associated with the ‘Common Prosperity’ drive. China’s main equity benchmark, the CSI 300 index, has dropped around 20% since its February 2021 peak.

This signals the index entering bear-market territory for the first time since the selloff induced by the US/China trade war in 2018. Given that Chinese stocks managed to avoid a bear market even throughout the pandemic, this is not the market stability Beijing would have hoped for around the Winter Olympics and the Lunar New Year holidays.

As a result, multiple levers are being pulled by the government and the People’s Bank of China to stabilise the economy and ease asset-quality concerns.

Policy shift

Within the property sector, financially stable developers are being encouraged to accelerate the acquisition of risky assets from their troubled peers, having been given comfort that some loans will not be included in the ‘three red lines’ debt metrics. Additionally, they may soon be allowed to access presale proceeds in escrow accounts, firstly to fund completion of unfinished buildings and secondly to fund onshore debt repayment. The government is also holding off plans to expand the trial of the property tax levy. All these relaxations, together with companies themselves embarking on debt restructurings, should improve the liquidity situation.

Within the banking sector, China is increasing both the availability and affordability of loans; lending has increased, liquidity has been injected into the system, mortgages are being approved faster, and mortgage rates should be lowered now that the five-year loan prime rate (to which mortgage rates are tied) has been cut. The looser monetary policy marks a divergence from the Federal Reserve’s hawkish overtures. Given the rising interest-rate environment in the US, it is reassuring that the indebtedness of Chinese property companies is not linked at all to US rates.

What next?

Now that previously overly tight policies regulating developers have been relaxed and extra easing measures have been implemented, our expectation is that more will follow. This seems likely given the government’s strategy of prioritising stabilisation over reform, so all eyes are now on Beijing to see what is announced next.

Despite this support for the economy, standard worries over higher input costs, supply shortages, COVID restrictions and trade tensions are still present. In particular, given that inventory levels need re-building, the risk is that future lockdowns to achieve China’s ‘zero COVID’ policy could hamper activity in areas such as construction, which would affect the recovery.

Against this uncertain backdrop, in our active equity strategies with exposure to this market, we find more comfort in the larger state-owned and higher-quality developers that have stronger balance sheets, such as China Overseas Land & Investment*.

It might take some time for local homebuyers to rebuild their confidence in the non-government-backed players, hence the state-owned companies may enjoy higher market shares in the short term.

*For illustrative purposes only. Reference to a particular security is on a historical basis and does not mean that the security is currently held or will be held within an LGIM portfolio. The above information does not constitute a recommendation to buy or sell any security.