The real estate sector in China and its consequences on asset classes

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The Chinese real estate sector is huge, with a total market value that exceeded $ 52 trillion in 2019 and is double the US residential housing market according to Goldman Sachs data. According to some statistics, the sector represented 18% of China’s GDP against 10% representing the sector in the United States (source JP Morgan). In this sense, Jaime Raga, head of customer relations at UBS AM Iberia, comments “The real estate market represents too high a share of GDP for Chinese leaders to allow great damage to occur and run the risk of triggering a slow-down Worse. In addition, the country has a long history of dealing with high level business problems without allowing them to become systemic risks ”.

The growth of the middle class, which should represent 72% of the total population in 2030 and which is now 41% (with a population of 1.45 billion people), means that Chinese cities are growing rapidly, with an urbanization rate of around 60%, and with a forecast to reach 75% in 2030. It compares very favorably to its big rival, India, even whether there is still a long way to go in South Korea or the United States

Over the past two or three decades, the price of real estate in China has risen, sparking a popular belief that “investing in real estate is always safe. But history has shown that bubbles do burst eventually and even when a real estate investment is attractive, it is worth looking at the situation on a case-by-case basis and at every moment. In this sense, the relationship between average apartment prices and average disposable family income is one of the highest among the largest Chinese cities and those in the world. According to the JP Morgan study in mid-2021, the ratio of average price to average disposable income reached 46 times in the case of Hong Kong, 43 times in Shenzhen and 42 times in Beijing, while in Paris it is 20v. or 13v in London, as can be seen in the image below. But given the state of development China finds itself in, this suggests that housing demand may continue to support high prices in this sector as well as the sector. Based on comments from Christy lee, Senior Fixed Income Manager at Axa IM, “I think any restructuring process would be orderly, but US dollar bondholders would likely be at a relatively disadvantage, as offshore bondholders are structurally subordinate. “

For all of the above, it is no wonder that a significant part of the wealth of Chinese families comes from the possession of real estate followed, but far away from deposits and cash, while in Taiwan or the states -United it represents less than 30%.

The interaction between the real estate sector as the main engine of growth and employment, the dependence of local communities on the sale of land and the financial sector links between banks, developers and local communities could have created pillars of vulnerability that if they collapse they could introduce a feedback loop, which would amplify a recession, he commented a few days ago Robert gilhooly, Senior Emerging Markets Economist at Aprdn. In addition, he stressed that some indicators of housing vulnerability are potentially worrying, even if not all are in the red. Although household debt has increased significantly over the past decade, nearly 35 percentage points of GDP since 2010, this ratio is not as high compared to other countries.

The headlines of Evergrande is the Chinese Lehman therefore seem somewhat exaggerated, even if it is a “good reminder that too much leverage does not allow corporate defaults to diminish everywhere”, underline Thomas Hempell , responsible for macro and market analysis, and Elisa Belgacem, credit strategist. for Generali Investissements. Specialists add that in China Developer over-indebtedness is currently both a micro and macro issue, with Evergrande being the example of the exuberant Chinese real estate market. Bondholders will likely be forced to contribute, both offshore and onshore, as currently reflected in the prices of Evergrande bonds, which are trading around 25% of their notional value. And despite this, no contagion effect is perceived in the banking or real estate sector in Europe for the moment.

Pimco He was already anticipating at the start of the year, when they published their opinion on the Chinese real estate sector, that they expected the state’s credit crunch to partially offset the very resilient market demand, even so given the news, they have updated their outlook and impact on the banking sector. For this reason, “he considers that the Chinese government maintains strict real estate policies which impose greater control over the growth of total developers’ debt, over the exposure of banks to the real estate sector and, through the centralized system of land auctions, based on the price of the land. And as other managers have already done, they stress the fact that they do not anticipate systemic risk in the real estate sector in China because of the importance it has for its weight in the economy. But the fund managers of this manager were not limited only to the real estate sector, but also to the indirect effects, such as Chinese banks. They conducted stress tests to assess the direct and indirect implications for the Chinese banking sector, noting that global banks typically hold intangible holdings in Chinese mortgage loans and are therefore likely only indirectly affected by further macroeconomic developments. China, rather than directly from real estate.

UBS AM Iberia believes that the two topics that may be useful identify medium-term stock market winners in China are the transition to more service-oriented growth and the premiumization of goods and services (the consumer tends towards high-end products as his level of income increases). The key is to find companies that can create and maintain their own advantage, not those whose operational benefits are tied to government policy, because we’ve seen how quickly that can change. Typically, if a firm takes excessive advantage of the lack of competition or abuses its pricing power, the government can step in and reduce its market share. Raga adds that long / short equity strategies have performed quite well in China due to the high degree of market dispersion in recent months. In the long term, we expect Chinese equities to be a great source of structural alpha. Many opportunities are created due to the high degree of involvement of retail investors, lack of comprehensive coverage by analysts and regulatory reforms that allow better access to short selling in the Chinese market.

“China will continue to be a very strong growth engine for the global economy, also in the future, and we believe that investors want to gain exposure to this market despite the regulations that have recently arisen, as it is ‘this is the last phase of what it’s been a cycle for us,’ he says Deniel Hurley, Emerging funds specialist at T. Rowe Price.

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