While a gradual recovery in property sales over the last three months seemed to have bailed out China’s real estate developers, the country’s home builders may have just been dunked back into deep water by a collapse in the country’s share market.
As the Shanghai composite index has lost nearly 30 percent of its value since June 12th, real estate developers that had been counting on rising share prices to build up their balance sheets saw an index of Shanghai listed property shares slide by more than eight percent last week.
The share crash threatens to renew pressure on developer finances, and is likely to further hasten consolidation in the real estate industry as smaller developer shares take the biggest market hit.
The stock market debacle is even more alarming to many observers for the way that it has so far defied desperate attempts by the Chinese government to stop the slide and prop up share prices.
China Markets Enter Bear Territory
After a government-catalysed one year run which saw the Shanghai stock exchange rise by nearly 150 percent over the last 12 months, since the middle of last month the Shanghai composite index has fallen by nearly 30 percent.
While blue chip property shares have generally been less affected than some other equities, even China Poly Real Estate, a top five developer, saw its share price fall by more than eight percent last week. During that same period, smaller Shanghai-listed developers such as Tianjin Hi-Tech Development Co, Lushang Property, and Wolong Real Estate all saw their share prices drop by more than 30 percent.
The market reversal has come as even more of a shock to investors who apparently believed that the upward surge of share prices would never stop as long as it had the government’s backing.
As recently as March, Chinese central bank Governor Zhou Xiaochuan had said that economic growth, which was struggling to reach a target of 7.0 percent for the year, had fallen “a bit” too much. And the bank has shown its willingness to prop up the economy by lowering interest rates four times since November last year.
With government officials attempting to spur consumption and curb wasteful government-driven investment, the stock market was seen as the Xi administration’s vehicle of choice for driving future growth.
However, despite government exhortations in the official press to support the market, and what many analysts said were state-directed purchases of shares by major funds, the Shanghai composite slid another 5.77 percent on Friday.
With many investors facing cash calls over margin trading and an air of panic arising in the market, the government and corporate leaders are scrambling for a way to avert catastrophe this week.
Share Surge Had Bailed Out Indebted Developers
For the country’s real estate developers, many of whom had seen relief from a mountain of debt by a relative rise in the worth of their equity, a solution to falling share prices is doubly important.
Although prices and home sales volumes have recovered some this year, many Chinese developers are still struggling to convince the markets that their balance sheets are healthy after experiencing poor sales last year.
“The financial performance of our rated Chinese property developers weakened in 2014 as debt levels grew faster than sales and revenue,” noted Simon Wong of credit rating agency Moody’s Investor Services in a recent report.
Some quick thinking companies had taken advantage of the surge in equity values, which also benefited Chinese developers listed in Hong Kong, to raise badly needed cash through share offerings. Country Garden Holdings raised $813 million by selling shares to Ping An Insurance as its share price was hitting new highs in April, and developers China Resources Land, Greenland Hong Kong, CIFI Holdings and Yuzhou Properties issued $1.76 billion in new shares in May.
With land prices in China continuing to climb ever higher, and offshore investors leary of Chinese debt following the default of Kaisa Holdings earlier this year, the opportunity for equity fund raising was a much needed lifeboat for the firms who were able to take advantage of it.
Government Shuts Down IPOs, Cuts Rates to Contain Panic
Unfortunately for those developers who didn’t take the opportunity to raise cash while share prices were up, the current stock collapse has begun to look more dire.
After shares began sliding in mid-June the government responded last weekend by cutting interest rates again, to record low levels. Also, for the first time ever, the central bank reduced the reserve ratio requirement at the same time that it cut interest rates.
However, despite this effort at encouraging the market, investors continued to sell shares, and even new rules introduced last week that allowed margin traders to use their homes as collateral failed to stop traders from running for the exits.
When allowing margin traders to bet the house failed to stop the stock rout, on Sunday the local media revealed that China’s sovereign wealth funds had also been conscripted to bail out declining stocks, and that the central bank would provide financing to the China Securities Finance Corporation, a government-backed margin finance agency, to further prop up the market.
These steps came just one day after China’s State Council, the equivalent of the cabinet, over-ruled market regulators to suspend all new IPOs indefinitely, in an effort to prop up demand for existing equities. The share offering moratorium superseded a decision just one day earlier by the China Securities Regulatory Commission (CSRC) to reduce the number of new offerings scheduled for July from a record 28 down to just 10.
Also on Saturday, the CSRC reportedly ordered 21 major mainland brokerages to prepare RMB 120 billion ($19.3 bilion) in capital for deployment by 11:00 am Monday (today) to support China’s blue chip stocks, according to a report by China’s Caijing magazine.
Given current trading volumes, and the vulnerability of many shares to cash calls on margin-driven investors, some analysts estimated, however, that even RMB 120 billion would only be able to prop up the market for a few hours.
Developers Who Failed to Refinance Could Be Back in Trouble
While developers such as Country Garden successfully rode the wave of China’s equity surge to replenish their capital, many other Chinese real estate companies may find the next 12 months to be a challenging time.
Land prices have continued to climb this year, even as overall property investment has slowed, forcing developers to either gamble on buying overpriced new sites or taking the risk of seeing their pipelines of new projects dry up.
To be certain, China’s government seems determined to keep the stock party flowing, but rebuilding investor confidence after a 30 percent loss of share values in just three weeks is likely to be a challenging task.
Developers such as Wanda Commercial, who had just last week announced plans for a RMB 12 billion ($1.9 billion) mainland share sale, may see those plans delayed and could face difficulties achieving desired valuations.
For smaller listed firms, financing will continue to be difficult to come by, and unlisted companies which may have been hoping to IPO in either Shanghai or Shenzhen may find the way for such market access to be long indeed. After the last market crash, the CSRC enforced a three-year moratorium on new share offerings.
So while renewed growth in home prices means that the overall real estate market is not facing the same pressures as last year, developers who failed to take advantage of the stock surge to refinance, will continue to face balance sheet pressures into 2016.