Following a recent trip to China, Investec Asset Management analyst, Tammy Lloyd, discusses the Chinese property market and the impact of stricter lending standards imposed by regulators.
Lindsay Williams:Time now to talk about China real estate and when I think of China real estate, in my own mind as a layman, I think of the word “bubble”, first of all; I think of speculative frenzy as characterised by certain media outlets; and I also think about Chinese retail investors with glossy brochures under their arms going out at weekends, having a look at brand new, shiny residential tower blocks and buying one, two or three-bedroomed apartments either as part of their normal investment portfolio or to flip later on, in other words sell on, or to actually live in.
Let’s talk now to Tammy Lloyd, Analyst, Emerging Market Fixed Income at Investec Asset Management in Cape Town. That was sort of a colourful image I have presented there, Tammy, but is there an element of truth to that?
Tammy Loyd: I think there is some speculation in the Chinese real estate market because there are over 4,000 developers and also in China real estate is one of the outlets for Chinese people to actually invest their money. They can invest in real estate or in equities because of capital controls.
So there is a lot of money pouring into the sector but I would say that China has done a really good job of growing the population to fill what – like empty cities and access development and also government restrictions recently have been working on reducing overheating in the market and then the final part to this is that we, as investors, are looking for big developers who have a track record of being discriminating, doing a lot of analysis on where they invest and also are capable of taking market share. So, as investors, you can manage your exposure to any potential [excessive line].
Lindsay Williams:And talking about government restrictions, there has been stricter lending standards imposed over the last couple of years by the Chinese authorities. What effect has that had on the market and also on the developers?
Tammy Loyd:So I would say there’s definitely a benefit of being a big company now, in particular, because these big companies have a proven ability to deliver and have access to multiple sources of financing and, because the banks have been asked by the government, to reduce their exposure to real estate, both in terms of construction loans and also mortgage financing, in order to lend to other sectors, that means that they are looking for the better companies and putting them at the front of the queue when it comes to finance.
That means that the negative impact has been that the cost of financing has gone up overall but the positive impact has been that big companies are actually getting relatively preferential treatment and this creates a positive cycle for them whereby they can take market share and grow their sales but also finance themselves at potentially lower rates and offer their customers potentially favourable access to mortgages and that means that the stronger companies keep getting stronger.
Lindsay Williams:Yes and it also means that size matters, that bigger is better in this case and it also weeds out some of the 4,000 that you spoke about that may have been slightly less than favourable for the retail investor because of their stability, because of their balance sheets, etc. So a good move from the authorities you would say.
Tammy Loyd:Yeah and also it has been interesting because a lot of the bigger companies are actually taking over the projects operated by smaller companies, provided they are good projects and good areas, as a source of getting land because now in China it is tough to get land. You normally have to compete in a pretty competitive local authority land auction or you can find a smaller company which needs to sell its assets to raise cash and get land that way.
Lindsay Williams: You go to China regularly and you have been on the ground and you have had a look at the property market there and you have assessed the investment opportunities. What about places like Shenzhen, for example, an incredible investment success story, whether it be industrial or residential? Has the success of nodes like Shenzhen sort of fanned out, if you like, to the peripheries? Give us an analysis of the residential market or the investment market when it comes to property.
Tammy Loyd: It was really interesting to be in Shenzhen. It’s an amazing city, great energy to it. It’s got a feeling a lot like Singapore, very big tower blocks and skyscrapers but also very green. It’s the home of big technology companies like Huawei and Tencent. As a result, because of the general job creation and growth in the city, it is a very favourable place for people to buy property. As a result, the government has actually put in pretty stiff restrictions. In 2016, after prices went up [40%], they put in price caps and they also restricted how many properties people can buy in order to control the market. So residents of Shenzhen can only buy two properties. They have to put down, if they get a mortgage, 50% cash for the first house and 75% cash for the second, so there’s a limited amount of leverage but, because prices are high, affordability has been affected. So the good news for people who want to live in that area is that the government is working hard to develop the Greater Bay Area by developing a lot of transport links, by putting in favourable tax benefits to attract investment and companies. So surrounding districts like Dongguan (which is where I went as well), that’s about an hour-and-a-half or so away from Shenzhen and it has been a pretty industrial area but you can see it is changing pretty rapidly. Locals are saying that about 120 companies are registering per day. There is quite a lot of development and also a lot of real estate development and here land is much cheaper and there are no price caps right now. So the developers can actually make a decent profit and good margins on these developments.
Lindsay Williams: I can almost hear ears pricking up when you speak about places like Shenzhen and the Chinese market in general and this leads us, of course, now to the obvious question: what is the investment opportunity for emerging market corporate investors? It’s not going out and buying the flats. It’s obviously to do with the fixed income market. It’s obviously to do with bonds. What are the opportunities?
Tammy Loyd: Well, even if you wanted to buy the flats, you would not be able to 95 or 99% of the time but there is a good opportunity for investors in dollar-denominated real estate bonds because, like I was saying, the big companies have continued to perform well. They are delivering sales growth of 20%, 30% year-on-year at least and at the same time that means that they have good cash flows but yields in the dollar market have gone up significantly because the authorities have restricted bond issuance. There’s a bit of concern, as we talked about earlier, about defaults in smaller companies so investors have hung back. That has increased the yields across the board. So it means that investors potentially have access to say, for example, BB-rated companies’ 5-year bonds at a 6.5% yield and this is for companies which are really growing sales and taking market share. So it’s a pretty positive balance between risk and return.
Lindsay Williams: A tantalising and compelling prospect. Tammy, thank you very much for your time. That is Tammy Lloyd, Analyst, Emerging Market Fixed Income at Investec Asset Management in London.
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