Peter's Perspective
19th May 2014 by Peter Churchouse

A Pullback on Asian Real Estate Cooling Measures?

Could there be a potential rollback of cooling measures in some of Asia’s largest property markets in the near future?

Why Did the Media Call Me Non-Stop Last Week?

Events on the policy front last week have us taking a fresh look at investments in one Asia’s most important and largest stock market sectors, Real Estate.

I think there is good money to be made in the coming months. Let me explain.

Asian economies are way ahead of the west in experiencing the effects of the flood of money printing that hit the world in the wake of the GFC. They were first to experience big surges in property prices as liquidity flooded into regional asset markets creating risks of property bubbles. Governments and central banks throughout the region responded with rafts ever tougher monetary and fiscal measures aimed at cooling red hot property markets. This was a problem that western governments would have liked to have as it would have signified an end to a sorry chapter in their recent past.

Well, as the saying goes, be careful what you wish for.

While investors in Asia were first to heat up the real estate pot, this heat is now warming many western markets. Talk is turning from deflation to asset bubbles. Just look at property prices in London, San Francisco, New York, and Vancouver.

But this week there has seen a very early sign that perhaps the tightening in Asia has done its job. Stock markets are starting to focus possibly on a relaxation of policy in real estate. Hong Kong is the first point of reference in this potential swing in the policy pendulum. Property stocks have responded positively to this possible eventuality.

So what is getting people so excited?

Basically the Hong Kong Government this week is proposing a small measure that signals a tiny retreat from its tough policies aimed at cooling an overheating property market.

Is this the beginning of a more widespread roll-back of policies that have crunched the local property market?

Some background is needed here.

In February of 2013 the government promulgated its most recent piece of legislation taking a swing at the property market. This was the latest in a series of measure imposing punitive stamp duties that started in 2010. Singapore and Chinese governments were also at the vanguard of imposing a string of tough measures to curb enthusiasm in regional property markets.

In Hong Kong’s case it has taken from February last year until this week for this legislation (which has in fact been enforced since February 2013) to actually come to the Legislative Council for formal approval by the lawmakers. The debate has been in the legislative chambers this week.

In the intervening 14 months, Hong Kong property market volumes have collapsed. The measures have worked. Volumes are below levels we saw in SARS back in 2003. At that time, the economy almost ground to a halt. For months people exited the city, refused to hold meetings, hotels were empty, as were planes, restaurants, bars, pubs and clubs. The city virtually shut down for several months. Look at the chart below. Volumes have simply been CRUSHED by these measures.

Hong Kong Sale & Purchase Agreements Per Month from Jan 1996 - Jan 2014

Property markets today are worse than at that time in terms of numbers of transactions being completed. Prices though have fallen in the residential market this time by a modest 4% or so since the early part of 2013.

Is This A Signal for Relaxation of Property Cooling Polices?

The Government of Hong Kong, in response to pressure from the public and legislators has floated the idea of a very minor relaxation on the conditions of the punitive stamp duty that it launched in February 2013. And it seems prepared to include these amendments in the legislation being voted on right now.

There are 3 questions I’ve been peppered with:

Firstly, will this very minor relaxation lead to an improvement in sentiment and transactions in the local property market?

Answer: Not really!

Second, is it the thin end of a wedge that is set to begin rolling back the tightening measures put in place over the previous three years?

Answer: Yes. But it will take time.

Third, does it signal that other markets that imposed tough cooling measures (Singapore and China in particular) will also start slowly relaxing these measures in the coming year or so?

Answer: Yes I believe so.

Is it Time to buy Asian Real Estate stocks?

I feel this could be the start of some upside in property stocks, especially for residential developers. The implications for the very large listed property stock universe in these markets could be significant. Stock markets, as we know, are discounting mechanisms. They often discount what investors think is going to happen in the future, sometimes well before it happens. Sometimes they get it right, and sometimes they get it wrong.

In the case of Asian property stocks, the market has long signaled its concern over property cooling policy measures. For some years now, since the cooling measures were first introduced, performance of property stocks in most of the region have been muted. In most of these cases property stocks have underperformed the broader index. They are now cheap by most normally used measures.

Take a look at the chart below showing the Hang Seng Property Index (HSP) and Hong Kong’s residential property price index. Typically over time property stocks track the underlying real estate index pretty closely. However, since late 2009 stocks have moved sideways while actual real estate prices have gone up over 50%.

Hang Seng Property Index v Centaline Property Index

In Hong Kong and China, property stocks are trading at deep discounts to underlying net asset values (NAV), about as low as periods of dire conditions in property markets over the past 20 years of so. Conditions are far from dire for property companies in Hong Kong and Singapore for sure. In Hong Kong average discount to NAV for the main companies in the property sector is around 40%.

Hong Kong property developers historical Net Asset Values (NAV) discount from 1990 - 2014.

They are also cheap in terms of price/earnings ratios, again, trading at the very low end of their historical ranges. This is clearly demonstrated in the chart below showing the Hang Seng Property Index P/E ratio.

Hang Seng Property Index & P/E Ratios (Jan 1995 - 2014).

China property stocks listed in Hong Kong are especially cheap. Many trade at mid-single digits against estimated 2014 earnings. Discounts to NAV of 50% and more are common.

It is time to start dipping the toes back into this sector in core Asian markets of Hong Kong and Singapore, and even in China, which is hardly high on the lists of many emerging market investors right now.

It is early days in any “normalisation” process on the policy front.

But the future holds out much more promise of rolling back previous cooling measures than introduction of new ones.

In all markets, in the early stages of this normalisation process we should stick with the larger “bellwether” names. In Hong Kong that means stocks such as Cheung Kong Holdings Ltd (1 HK). Regular readers will know we recommended Cheung Kong back in August of last year. The stock has given us returns of 30% since then. It remains a buy.

In the case of China, the property market is set to cool quite sharply in the coming months, so the prospect of various cities and provinces rolling back previous property cooling mechanisms is quite high in my view.

This will benefit the bigger players listed in Hong Kong. In addition, these companies are all part of, or are State Owned Enterprises (SOE’s). They are highly unlikely to be sunk by a financial torpedo. They will be survivors. The government will ensure that. And given their scale and spread of activities, they are likely to be beneficiaries of policy changes that might occur in just about any major city. They are active in most.

China Overseas Land & Investment Ltd (688 HK) is the stand-out for me. Along with China Resources Land Ltd also (1109 HK).

I know this will raise a few eyebrows, but I believe there is a distinct possibility of a 30% to 50% bounce in these larger China property stocks – I also advocate a relatively tight 20% trailing stop-loss on these China stocks to limit our downside.


P.S. If you are keen on more specific recommendations on how to build your wealth, try our 50 day risk-free trial of The Churchouse Letter.

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