The world’s biggest real estate market is slowing down. And it’s not because of failing subprime mortgages or an economic crisis.
China’s property market – worth seven times that of the U.S., based on total value of new homes sold – is weakening… again.
China’s new home sales hit US$1.69 trillion last year, as an estimated 22 million Chinese moved from rural areas into cities (that’s like the entire populations of the U.S. states of Kentucky, Louisiana, Alabama, South Carolina and Kansas moving to the city).
A total of 1.44 billion square meters of apartments and condominiums were sold – the equivalent of 5.76 million new homes, assuming the size of an average American suburban house (last year, 614,000 new homes were sold in the U.S.).
But a couple of years of breakneck growth has caused the average price of developed property (i.e., condominiums and residential apartments) in China to jump 18 percent since July 2015. In the biggest cities of Beijing, Shenzhen and Shanghai, prices increased more than 50 percent.
Adding fuel to soaring real estate prices are Chinese investors speculating for short-term gain, considering property prices in most cities are rising at least twice as fast as the 5.5 percent average mortgage rate.
Buyers now need to show a pile of cash upfront
To curb speculation, the government started raising the requirements to purchase property in March 2017. It increased the minimum down payment on second home purchases in second- and third-tier cities from 20 percent to 30 percent.
That compares to a typical second-home buyer in the U.S., who is required to put up between 10 percent and 20 percent as down payment.
What’s more, the Chinese government also ordered state-owned banks to raise the minimum down payment for privately-developed residential projects in first-tier cities from 70 percent to 80 percent. That essentially locked out all smaller buyers in many cities, including Shanghai, Shenzhen and Beijing.
The next stage of tightening happened in September 2017, when local governments in a number of cities, including Shenzhen, banned investors from selling newly purchased homes for up to five years. Other local governments barred investors from buying a second home for up to three years.
So after growing by 16.1 percent in the first half of 2017, home sales growth in China slowed to just 3.3 percent in the first half of 2018.
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The Chinese government’s year-long crusade to deflate the property market finally filtered through to developers’ sales. As a result, the shares of listed Chinese real estate developers have fallen.
The MSCI China Real Estate Index, which captures the performance of large and mid-cap segments of the China real estate market declined by 14 percent between May 1 and July 31. That compares with a 5.8 percent decline in the MSCI China Index and a 2.7 percent gain in the MSCI All Country World Index.
But is this a precursor to a Chinese real estate market collapse? History shows us that it’s likely not. We’ve seen this same knee-jerk reaction in Chinese real estate company stock prices in the face of Beijing’s previous efforts to deflate the hot property market.
China’s history can be a roadmap to profits
In September 2010, for instance, Beijing enacted measures to curb speculation in real estate after prices jumped 32 percent in just two years (2008 to 2010) to 4,725 yuan per square meter.
That eventually led to a 30 percent decline in the MSCI China Real Estate Index by the following year, as curbs filtered through to developers’ bottom lines.
(That also opened up a terrific buying opportunity in shares of Country Garden Holdings (Exchange: New York; ticker: CTRYF; Exchange: Hong Kong; ticker: 2007), one of China’s biggest and most established real estate developers, which I recommended to my readers in February 2011. It went on to nearly double their money (95 percent), as government curbs were eventually lifted and eager buyers returned to the market.)
Then, in March 2013, after average property prices rose 17 percent to 5,850 yuan per square meter in a just a couple of years, Beijing stepped in again, slapping a 20 percent tax on selling a home (vs. existing 1 percent to 3 percent capital gains taxes). Beijing also increased the required minimum down payment from 60 percent to 70 percent for second homes.
That resulted in a 20 percent correction in the MSCI China Real Estate Index over the next 12 months, and caused total property sales to fall nearly 3 percent between 2013 and 2015.
(The lull in the market presented an opportunity in our Strategic Wealth Confidential newsletter to recommend shares in one of the country’s best-run real estate investment trusts (REITs). REITs are companies that hold a portfolio of income-generating property and distribute nearly all their profits to shareholders as dividends. This one in particular was paying out an 8.5 percent yield.)
With average real estate prices in China again up 18 percent in just the last couple of years, Beijing’s recent determined moves to rein in the property market shouldn’t come as a surprise. We actually welcome it.
Will the Chinese real estate selloff continue?
For the short-term, the outlook is going to be weak. The government has not given any indication that it’s willing to ease restrictions on new home purchases, and will likely add more restrictions in the coming weeks and months.
But I’ve been covering the Chinese real estate market since 2003, and the volatility we’re seeing today is nothing new.
With 600 million Chinese (40 percent of the country’s population) still living in rural areas, and 22 million of them moving into cities each year, the property market in China is still far from reaching a point of peak demand.
Down the road, I expect there will be a slew of profitable, well-managed and under-leveraged Chinese property developers that will once again offer up enticing value.
Editor, Stansberry Churchouse Research
P.S. Even as China’s property market is letting off some steam, other sectors of its economy are expanding at a breakneck pace. One of these sectors is water treatment, which is growing non-stop thanks to the government’s efforts to clean up the country’s heavily-polluted rivers and lakes. It’s opening up a rare opportunity for 793 percent gains on a leading water treatment specialist. To find out more about this company – and two others with similar potential – go here.