China property market: drivers, challenges and opportunities

China’s property market can be an attractive one for long-term investors. Take the example of Beijing, a person buying a new 100 sq.m. house in 2000 at the prevailing average price in the city of around RMB 3,000 per sq.m., i.e. RMB 300,000 (EUR 36,100) in total, would today be sitting on an asset worth an estimated RMB 5.82 million (EUR 707,500) at current prices, an appreciation of close to 20x.

Three drivers for a long-term opportunity in China property market

And the drivers behind this performance are very much valid today.

First, urbanization propels demand in China’s property market. Between 2000 and 2020, an estimated 415 million new residents settled in China’s cities, and an estimated 208 million will settle by 2040, according to estimates by the United Nations.

Second, higher incomes support demand too. Per capita income in China rose 5.8% in 2019, with greater purchasing power, plus government programs like public welfare fund loans, more Chinese residents are entering China’s property market.

Third, Chinese buyers are keen on upgrading to better homes too. The IMF estimates that 24% of the housing stock in China’s cities are without private kitchens/bathroom facilities, and over a third dates from pre-1990.

These factors are estimated to drive 580 million sq.m of real estate demand per year, or just over two times the size of the city area of Frankfurt.

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China’s property market is still a challenge for overseas investors

But for all the promise of China’s property market, it remains hard for overseas investors to invest in. Foreign investors are banned from investing directly, China real estate companies aren’t widely listed on global stock exchanges, and analyst research is scant.

China’s property market is also undergoing massive structural change. China’s government is pressuring smaller developers with tighter financing and access restrictions to land auctions. M&A in the sector has steadily increased in recent years, totaling USD 163.4 billion in 2017 and 2018, according to PWC.

Outlook and opportunities

And sales are slowing. True, sales in April were up 8.9% y-o-y, according to S&P Global, but YTD sales for China’s top developers have slowed. In part, this is because of slower sales in Q1 2020 when Covid-19 lockdowns hit sales activities, but this is also because of long-standing government controls on property speculation, via policies like limits on second-home purchases and increased taxes on property sales.

But that doesn’t mean there aren’t opportunities for companies in China’s property market.

Amid slowing growth and massive industry change, many developers are evolving their business models – and property management, as well as development, is a growing trend.

Eastspring Investments notes that reforms and removal of fee caps have opened up a new industry for property managers and predicts earnings growth of 34.4% p.a. from 2019 to 2021.

Additionally, China’s government is opening up the market for real estate investment trusts (REITS) to invest in high-quality infrastructure projects, opening up a new channel of exposure for private capital to a range of new projects.

Asian high yield bond strategies could be what you need

How to invest in these trends within China’s property markets?

Asian high yield bond strategies may offer investors exposure to the sector. Asian high yield strategies typically make major allocations to China’s property sector, and China-focused strategies potentially much more, and have the potential to offer clear benefits to overseas investors, including:

• Access to both China’s offshore and onshore bond markets: China’s property companies list in offshore markets, like Hong Kong, and also onshore in China itself. Programs like Bond Connect and China Interbank Bond Market (CIBM) Direct, set up in July 2017 and February 2016, respectively, offer direct access to China’s onshore markets to institutional investors, like asset managers and insurance companies, but not to small-scale retail investors.
• On-the-ground expertise in China to guide market intelligence and decision-making: Corporate governance standards in China, such as disclosure requirements, differ markedly from developed markets in the US and Europe, so fund managers with on-the-ground teams in China may have an edge in terms of information gathering and bottom-up research.
• On-the-ground expertise in China to guide market intelligence and decision-making: Corporate governance standards in China, such as disclosure requirements, differ markedly from developed markets in the US and Europe, so fund managers with on-the-ground teams in China may have an edge in terms of information gathering and bottom-up research.
• Exposure to a diverse range of industry names: China’s markets are known to be volatile, and China’s property market is no exception. That means portfolio diversification across the top sector names is essential and, with top Asian bond strategies allocating to a selection of top names, investors may get the diversification they need away from newsflow-driven market volatility in single names.

So as bond prices for China’s top developers start to recover after a Covid-19-induced February sell-off, now might be a good time to take a closer look at this sector.