September 22, 2015

A Housing Recovery in China and Hong Kong?

Peter sits down with Bryan Curtis on Bloomberg Radio to discuss signs that the Chinese housing market may bounce back after steady declines this year.

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Brian: And thanks very much, 12 minutes before 9 o’clock, China property appears to be in recovery mode, but Hong Kong residential property is likely to face headwinds in the coming 12 months. Those are the views of Peter Churchouse, author of The Churchouse Letter and he joins us in our studios, Peter good morning to you.

Peter: Good morning there Brian, welcome back to the airwaves.

Brian: Yes, it’s very nice to be here and it’s great to be on Bloomberg, it’s interesting to look at these different directions that Hong Kong property and China property may be heading in, tell us why.

Peter: Absolutely, well the stars are aligning, I think, in a slightly negative way in the Hong Kong market for several reasons. Firstly, on the demand side interest rates are set to rise, not greatly, we know that, but still that’s a negative. Also the economy is gonna be weak going forward from here, we think that’s going to be important. Thirdly, we are seeing affordability in Hong Kong as stretched, as prices have risen. On the supply side we’ve got a modest uptick in supply coming on just as demand is going to start to weaken. So I think we’ll see a correction here of 10-15% in the housing market in Hong Kong. And going exactly the opposite way, in China.

Brian: And just a couple of words then on why you think China is recovering?

Peter: Oh, yes. I mean China put in all sorts of macro prudential measures to cool the property market a few years back. It did the job, it slowed the market down and of course what’s happened is those measures have been rolled back as the market collapsed, and they’re now actually operating in exactly opposite direction: five interest rate cuts, a lot of the macro prudential measures have been rolled back, supply has been reduced, demand is picking up, prices are now up in half of the 70 major cities month-on-month. 6 months ago, they were all down. So that’s been a significant turnaround in the last few months.

Brian: Give me a sense of the amount of equity that a typical owner has to put up in order to receive a loan. I mean, I’m wanting to get at the level of leverage, I guess, in the property market in China.

Peter: In Hong Kong, the minimum you can put up is 30%, but now you’re required for middle income housing, more like 50-60% put up of equity. And in China is typically been about 30% of equity, also for households. In some cases you’ve been able to get top-up mortgages which reduces that to around 15%, but typically across the country it’s more like you’ve gotta put up more like 30% of equity, 70% borrowing.

Brian: I think Bulls on China would be rather pleased to hear your view about housing recovery. Do you think it’s enough of a positive that it helps drag up the overall Chinese economy?

Peter: Well, I think it does. I mean, construction makes up, depending on how you look at it and all the various spin offs, up to as much as 18 or 19% of the total economy and housing is of course a big part of that. So I think we are going to see a pickup going forward in construction starts again, which are down 20 to 30% in most cities over the last year or so. In the last few weeks we’ve started to see land sales pick up again as well, which suggests starts may pick up coming into 2016, so I think this is going to be a little bit of a positive fillip for the broader economy in China in 2016.

Brian: So how have these developments then Peter, impacted the rental market?

Peter: China’s rental market is not actually very active. It’s really a primary sales market in the housing market. In the commercial market it’s been a mixed picture. And certainly in tier 2 and tier 3 cities, rentals in the retail market and in the office market have been soft, there’s just been an oversupply. In the primary markets, or the primary cities like Beijing and Shanghai, Shenzhen, Guangzhou, we’ve seen very, very positive upside in rentals in those markets and we’d not seen a massive amount of oversupply in the office markets. Retail markets, slightly different, there is definitely a pattern of oversupply there. But not so much in the office markets.

Brain: To our global listeners, hearing you say that people have had to put 30, 40, 50% down, they might be thinking ‘how can you have a crisis with that kind of equity in the the property yuan’, and that’s a point that you’ll hear from people like Arthur Kroeber at GaveKal, there’s no leverage problem in China in property, but when you look at the developers, how much they had to borrow, is this where the problem comes in?

Peter: That’s where the problem is. It’s not really at the household level, because households have a great deal of equity. They’re not going to slide into negative equity unless property prices fall 30, 40, 50% and it doesn’t look like that’s the case, in fact prices are picking up. But it’s at the developer end that we’ve got problems. The average debt-to-equity ratio in the major property developers that are listed in Hong Kong, there’s about 40 of them, the average debt-to-equity ratio is about 45-50%. That’s a little higher than I would like to see, but it’s certainly not at a critical level I would say, certainly with pickup and sales that we’re seeing happening right now.

Brian: Would you buy those stocks now?

Peter: I’m a buyer of, certainly of the bigger, what I would call the S.O.E.s, the State Owned Enterprise property developers. They’re not going to go under, they’re going to survive very well, thank you very much, they are positioned in all the major cities.

Brian: China Overseas Land, China Resources Land, these types?

Peter: Absolutely, those two would be my bellwether picks. And as the market recovers, I’d go down the scale a little bit into some of the private sector companies which are trading at 4-5 times earnings, trading at 60% discount to underlying asset value. They are certainly cheap, and they’re going to grow earnings at 15 or 20% next year.

Brian: So away from the developers, if we can pivot to the brokerage firms that obviously are involved in many of these transactions. How has their business been?

Peter: Well the residential brokerage business in China, has been suffering over the last 1 or 2 years, but it has been picking up a little bit over the last few months, there’s no question about that. But it’s not yet, I think, it’s not a sector that I particularly fancy as an equity investor, it tends to be very, very volatile, and you never know quite where it’s heading. I much prefer to be associated with the property investment companies, the real estate trusts and the property developers rather than the brokers.

Brian: Lemme ask you a semi-political question, okay. In the People’s Daily today, there’s a commentary that says ‘it’s okay to let Li Kashing go’. Now Li Kashing, formerly the richest man in Asia, now number two has been selling some of his assets in China and Hong Kong, that’s a very complicated story, but what about the malls in China and some of these assets that he’s disposed of?

Peter: Well he’s making a bit of a switch, I think strategically, and if you look at his two companies, Cheung Kong Properties and Hutchison, they’ve been investing more and more in Europe, and particularly in infrastructure, in waste water treatment and energy. Pretty much those long term recurrent income kinds of assets, and moving out of the real estate sector which tends to be a bit more volatile in this part of the world. So I don’t think this is anything particularly somber or noteworthy, this is just following a strategy they’ve had in place for a number of years. Bear in mind, that company is still the second or third largest port operator in the world, still has billions of dollars invested in ports in China, energy in China, infrastructure in China, so I don’t see this as an exit from China at all.

Brian: So if we view China through the lens of the real estate market, especially the residential market, I mean things aren’t as bad as we’ve been hearing, no?

Peter: Well, they’re not, they’re certainly recovering. They were pretty grim 6 or 9 months ago, out of the 70 major cities in China, every single one of those was experiencing month-on-month decreases in asset prices, property prices. In the last 6 or 8 months that has turned and now we’ve got 50% of those cities having month-on-month price increases. So that’s been a very big turnaround that we’ve seen in the last 6 or 8 months.

Brian: On Hong Kong, you’re predicting a downward push, is it going to be a modest correction or is it going to be akin to a crash?

Peter: I see no reason for it to be a major crash, we’re not seeing a huge surge in supply here, we’re not seeing a total withdrawal of liquidity, we’re not seeing interest rates soaring to 10% or anything like that and in fact, in the commercial market, I’m extremely optimistic, we’re seeing vacancy rates in the office market now at frictional levels at 3% or thereabouts, that to me signals that we’re going to see upside momentum in that sector.

Brian: Okay Peter, we gotta go. Thanks very much, Peter Churchouse, the author of The Churchouse Letter and a former Managing Director at Morgan Stanley, lets get a quick check of how the markets look here, Hang Seng Index futures up 125 to 21,806, that’s a gain of about 6/10ths of 1 percent. This is First Word Asia.

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