One of the greatest mysteries of China for many observers may be the country’s gravity-defying housing market.
China’s average housing prices rose in October for the seventh straight month, seeming to fly in the face of the laws of supply and demand, as the country faces of an overhang of unsold housing which could be enough to supply the market for nearly two more years at current rates of sales.
Solving the conundrum of how home prices can be rising despite the large supply of homes requires foreign investors to not only understand China’s many urban areas, but to examine micro-markets in individual cities for opportunities, says the Hong Kong-based head of real estate private equity firm Forum Partners.
Home Inventories Grew After Government Clampdown
While not garnering as much international attention as the country’s roller coaster-eque stock exchanges in the last year, China’s real estate industry has been under closer scrutiny by investors and analysts after a series of policy measures slowed down sales and helped create large inventories of unsold homes.
Earlier this year, Zhu Min, a deputy managing director of the IMF, estimated that the mainland is facing one billion square metres of unoccupied buildings. However, as the government released home purchase restrictions this year, home prices have gradually recovered with 27 out of 70 cities reporting rising home prices in October, according to the National Bureau of Statistics.
The biggest rebound has come in Shenzhen, where prices are now up by 40 percent compared to the same period one year ago, while in Shanghai the market has gone up by 10.2 percent in the same period.
For Greg Wells, Forum’s Managing Director and Head of Asia-Pacific, and a 12-year veteran of the China’s real estate industry, understanding the current housing recovery requires researching micro-markets, rather than trying to judge the whole country by headline numbers.
“You have to generalise when you talk about China as a whole, but you also have to look at each market,” Wells told Mingtiandi in a recent interview. “A city can have an oversupply because of a large scale development in an outlying location, and the rest of the city may be doing just fine.”
Micro-Markets the Key to China Opportunities
The key to resolving the apparent contradiction of unsold homes and rising prices, may be to look at China’s housing market on a micro-level, according to Forum, which manages more than $5 billion in real estate assets globally, and has more than $560 million invested in China.
“In China, we look for proven demand in a micro-market, rather than just focusing on particular cities or regions,” Wells pointed out. “We would stay away from new towns, and stick with locations where there is a proven demand.”
In a rush to develop their cities during China’s boom years, many local governments have set up new districts or towns away from the city centres, often predicated around creating new business districts which would attract industry and boost home sales. While some of these new towns, such as Suzhou New District just west of Shanghai, have been successful, others have ended up looking more like China’s notorious ghost cities.
Forum Partners remains bullish on China’s economy overall, and the housing market in particular, believing that the removal of home purchase restrictions which triggered the 2014-2015 slowdown in China’s real estate market, has paved the way for a recovery.
“Things are moving in the residential markets – back to where you expect them to be,” Wells contends. Home sales in China have picked up in terms of volume and pricing since early last year, helped along by the lowering of down-payment levels that had been hiked as the market overheated in 2013, as well as by cuts in interest rates by the central bank.
Finding Deals in Overbuilt Cities
As for China’s oversupply of homes, Forum acknowledges that there are still areas of excess inventory, but argues that even an oversupplied city can have demand for new homes.
“A China residential project that we are involved in right now is in a city where there is a large overhang of unsold homes, but in our particular location there is a scarcity,” Wells explains.
Forum specialises in providing structured debt financing to developers, and has two active investments in China at the moment, one with a large residential project, and the other being a pre-IPO debt deal with with a developer planning to list soon.
And while it would appear attractive to invest in opportunities in China’s fast-recovering first tier cities, including Shenzhen, Shanghai, Beijing and Guangzhou, with land costs soaring, these primary urban centres are increasingly dominated by a few major developers – often state-owned, who typically enjoy strong access to traditional bank financing.
Picking Your Market Sectors
But even enthusiasts such as Forum are looking at the China market carefully before making investments, with Wells pointing out that, “it’s no longer build it and they will come like it was 15 years ago.”
In addition to looking at locations at the micro-level, the private equity firm has also focused in on market sectors that it believes are the most promising.
“We focus on mid-market developers, who generally are regionally focused,’ Wells said. Adding that the firm is not looking at high-end luxury housing, a sector that many analysts believe was overbuilt during the boom years.
Even with many analysts predicting a continued recovery for China’s housing market in 2016, however, Forum believes that for private equity investors, finding profitable deals will not be easy.
The search for yield in China’s housing market will require looking through opportunities in the mainland’s 160 cities of over one million in population on a project-by-project, developer-by-developer basis.
“That’s why we’re here on the ground,” Wells points out. “We’re supposed to see these things.”
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