Hong Kong () - Some analysts say don’t believe the hype of a China housing bubble.
Negative outlooks on Chinese real estate have become increasingly popular recently, but they don’t match up with what’s really happening on the ground, or the story that lies behind subtleties of prices and other investment data that can sometimes be tricky to read, some analysts say.
Instead, these analysts see a market in line with fundamentals, albeit one riddled with pockets of excess, and they say prices are unlikely to see the kind of death-spiral that followed the long period of housing-price gains in many Western economies.
In fact, some analysts believe housing markets in some Chinese cities are still priced low enough to offer a good entry point for new buyers, with prices poised to move higher after trending sideways for the last few months.
Bank of America-Merrill Lynch said it found few of the tell-tale signs of a bubble in its recent look at the market.
In approaching the controversy, Merrill noted the gloomy forecasts given by famed fund manager Jim Chanos, president of New York-based Kynikos Associates LP, and also a well-know bear on China’s property market.
Chanos told Bloomberg recently that some mainland Chinese property developers have balance-sheet problems similar to U.S. real-estate developers before the housing market imploded there, and he has often cited data showing as much as 70% of China’s economy is dependent upon construction.
And Chanos is far from alone in his views. Fellow China-property bears include economist Andy Xie, who believes low savings rates led households to borrow in order to invest in property as a way of beating inflation. Marc Faber, of the “Gloom, Boom & Doom” newsletter, was also among those calling for a day of reckoning in China’s housing market last year. More recently he spoke of China succumbing to stagflation, possibly including a technical recession.
However, Merrill analyst Ting Lu said the property bears are getting “lost in translation” in their reading of China data, failing to consider nuances in the way China compiles statistics, or even perhaps even getting the meanings crossed.
“Some frequently quoted numbers about China’s fixed-asset investment are based on misunderstandings about Chinese statistics, and investors should shun these numbers when making China-related investment decisions,” wrote Lu in a report co-authored with fellow Merrill Lynch Hong Kong-based analysts.
Lu said Chanos is off-base with some of his numbers. For example, fixed-asset investment as a share of the economy was closer to 46.5% in 2010 — rather than Chanos’ rough 70% figure — according to Merrill calculations using gross fixed-capital formation against gross domestic product by expenditure.
Misleading figures
One problem, Lu said, was using China’s fixed-asset investment figure as synonymous with construction, something which leads to a “big exaggeration” of the scale of activity.
The official 27.8 trillion yuan ($4.28 trillion) of fixed-asset investment in 2010 isn’t adjusted correctly to strip out land values, and it likely includes some double-counting of equipment, Lu said.
The Statistic Bureau provides instructions on how to remove misleading values for land — which shouldn’t count if its use value hasn’t changed — but few surveyors are “trained well enough to follow this rule,” Lu said.
Merrill forecasts that China’s investment boom will gradually slow in what could be described as a soft landing, where easing rates of growth will become the norm in the decade ahead.
That likely means slower inflation in housing prices, though Merrill did not lay out any specific forecasts.
While China’s housing market is still growing, that growth does appear to be cooling recently, as prices in Beijing, Shanghai and other top cities have flattened owing to government measures such as raising down-payment requirements for second homes and penalizing developers for sitting on idle land. In an exception to the broader trend, house prices in the southern cities of Guangzhou and Shenzhen accelerated in April.
China’s Statistics Bureau scrapped its nationwide property index earlier this year amid growing public criticism that the figures underestimated the pace of price gains.
A Reuters index indicated nationwide house prices rose 4.3% in April on an annual basis, easing from a 5.2% gain in March. Meanwhile, others says the gains have been faster, with property group Knight Frank clocking price gains of 40% over a 16-month period to May 2010.
However, Citigroup said in a note earlier this week that developers in Shanghai expect prices could to weaken in mid-autumn. If Beijing doesn’t switch to an easing stance, developers may need to cut prices by as much 15% to raise needed capital before year end, they said.
Urban living revolution
Another area where Lu said analysts tend to go wrong is in assessing supply data. Reported figures for the amount of square footage in development are known to be deliberately inflated by real-estate developers seeking to avoid land-hoarding penalties Lu said.
Figures for completed floor space are more reliable, he said.
In fact, the housing boom has barely kept pace with the millions of rural residents flocking to Chinese cities in search of better lives, according to Merrill figures.
Average floor space per city resident has risen to 40 square meters from about 25 square meters in 2002. Again, these numbers likely overstate the cramped living conditions for many urban migrants.
Others see China’s housing market as part of its rapid transformation.
Shaun Rein, managing director of market analysis group China Market Research in Shanghai, says many analysts don’t have a good idea of what’s happening on the ground.
“I don’t think people understand how fast incomes are rising here,” Rein says. “They are equating fast growth in house prices with a bubble, but incomes are growing even faster.”
Looking around Beijing and Shanghai, one doesn’t encounter the kind of debt leverage that should cause worry, he said. Buyers are laying out down payments on first homes in the range of 30% to 50% of a property’s value.
Government efforts to curb speculation have been effective in routing out the weak hands that can get caught in downdraft, he said. Unlike during the heyday of the U.S. property boom, Rein said that few apart from the super-rich are buying second homes.
Rein’s company recently analyzed the urban housing market for a European home-furnishing company, which used the data in assessing whether to expand in China. Many skeptics base their arguments on poor local knowledge, or views gleaned during quick business trips, Rein says.
Rein relates one person who told him that property developers in China were delivering apartments that had no internal walls or kitchens, a sure sign that the market was in a bubble. Rein responded by pointing out it was local practice for developers to hand over the keys to apartments that are little more then bare concrete on the inside, as mainland Chinese buyers like to do their own interior finishing.
Rein is bullish on Chinese property. He reckons luxury Shanghai condos are a good long-term investment, even though prices rose 33% last year, as authorities are pressuring developers to focus more on affordable housing. Hong Kong’s upper-tier housing markets also look well supported, he says.
“I view China like Japan in the late 1970s,” he said, referring to when Japan entered a golden period in terms of its economy and asset prices.
Citibank also weighed in with an upbeat view on the residential sector earlier this month. Hong Kong-based analyst Oscar Choi said he liked the outlook for developers who have shown they can adapt to tighter credit conditions and create developments that appeal to new buyers.
China’s property sector, as measured by the share prices of the top six developers, had outpaced the MSCI China by 23% in the past year, Choi said in the note, dated May 20.
“If developers can maintain good momentum even in the current tough operating environment, the investment case gets even stronger in relative terms,” Choi wrote.
Commercial, on the other hand...
However, at least according to Rein, commercial real estate is a very different story.
Many residential developers switched to commercial projects amid heightened government regulation, which means the market will be flooded with new shopping malls and office complexes in three to five years, he said.
“I’m very worried about inefficient development on that end,” Rein said.