What keeps China's biggest property developer up at night
When Mao Daqing, the deputy chief executive officer of Vanke, the largest property developer in China spoke candidly at a closed session of property developers and analysts a week ago, he didn’t expect his speech to be leaked.
His candid assessment of the Chinese property market has sent shock waves throughout the country and especially to the challenged property sector. Vanke and Mao have been on the defensive since.
Mao, who thought he was speaking under Chatham House rules, revealed some of the biggest challenges facing the industry. He mentioned the anti-graft campaign as having an impact on sales in the high-end property market in Beijing.
In the last three weeks, he had to receive at least 14 inspection groups from the prosecutor’s office and from the central disciplinary commission of the Chinese Communist Party, which is waging a war against corruption under the hard-nosed Wang Qishan.
“For us developers, the impact of the anti-corruption campaign on the sales of high-end property is very serious. It does not only mean fewer corrupt officials are buying high end apartments but also directly and indirectly related people and industries,” Mao said according to the leaked transcript.
Serious as it is, the anti-corruption drive seems to be least worrying for Mao compared to other dire trends. One of them is the massive build-up of inventories across the country. According to Vanke’s data, it will take more than 12 months to sell its existing inventory in 21 major cities and more than 24 months to clear stocks in another nine cities.
In some smaller third and fourth tier cities, the build-up of inventories is simply mind-boggling. Mao used Tangshan, a major steel-making city in Hebei province as an example saying it would take more than 100 months to sell its entire inventory in the city.
Tangshan has the highest GDP in the entire province but its economic prosperity is largely based on heavy industries such as steel, coal and cement. Most of the companies in the city are either cosy monopolies or state-owned enterprises. Though the city has many millionaires, they usually have their homes in Beijing.
Mao says Tangshan is a typical city in China’s industrial belt, which is dominated by the state sector. Private enterprise and capital have not taken off and the new push to close down heavily polluting industries is making the problem worse. The only source of income for the local government is selling land and the problem will get worse.
Wang Tao, UBS’s chief China economist is also warning about the risk in the property sector. “Property supply has been growing faster than underlying demand, while investment demand for housing is being eroded and inventories are building up. We think a more persistent and sharper downturn in the property sector is the biggest risk for China’s economy in the next couple of years,” she said in a note to clients.
Another sign of weakness is how highly leveraged some of the property developers are. According to Orient Securities, the average debt to equity ratio is 65 per cent in the property sector and 43 per cent for leading developers in 2012. Their leverage is likely to have increased in the past year after their aggressive buying spree of over-priced land.
Chinese banks have been tightening their lending to developers as well. Mao has found out from more than 20 chief executives of banks that they have abandoned lending targets to developers. During good times, bankers are under pressure to lend a certain amount to developers but it is no longer the case.
Chinese banks like the Bank of China and the Industrial and Commercial Bank of China, which are some of the biggest lenders to the property sector, are setting up specialised departments with experts from the property sector to analyse project by project. It shows banks are getting more risk averse.
“Banks are using market criteria to judge and assess projects,” Mao said, “if they don’t meet the lending target, they will become picky.”
Given the real estate sector makes up 16 per cent of GDP, 33 per cent of fixed asset investment, 20 per cent of outstanding loans, 26 per cent of new loans and 39 per cent of government revenues in 2013 -- what happens in this sector will have a large bearing on the health of Chinese economy.
UBS thinks there is a 15 per cent probability that a sharp property downturn could lead to GDP growth dropping to five plus per cent in 2015. Nomura is even more pessimistic than UBS. Its chief China economist Zhang Zhiwei says the question is no longer “if” or ‘when” but rather “how much” China’s property market will correct.
He believes the country’s GDP growth will slow down to 6.7 per cent this year without additional policy stimulus.