Improving credit environment set to boost China's property sector

Public firms' debts ballooning almost thrice to RMB 3.3 trillion in 2015 remain a concern.

Supported by improved access to credit, enhanced onshore bond markets, robust housing sales in upper tier cities and improving destocking process in lower tier cities, developers are in a better position to repay existing debt, according to CBRE’s latest report, China Real Estate Debt: An Assessment of Credit Risk in the Chinese Property Market. However, smaller developers remain challenged by debt repayment, creating newer opportunities for investors.

The more favorable conditions for developers and investors have resulted from the commitment of China’s policymakers to increase oversight and enhance transparency of financing channels and products. Since 2014, new regulations aimed at developing a more transparent credit environment have been introduced, including the launch of functional onshore bond and asset-backed securities markets and limitations on investment in non-standard credit assets and other shadow banking products.

“Developers are positive on the longer-term prospects of China’s real estate sector in upper tier cities despite the cloud of rising debt levels. Supported by the introduction of more transparent financing channels, improving bank lending underwriting critieria and a revival of the national housing market in upper tier cities, much of the systematic risk in the real estate sector has been mitgated,” said Dr Henry Chin, Head of Research, CBRE Asia Pacific.

Beneficial refinancing opportunities also exist for larger developers due to the low interest rate environment in China. Developers are increasingly accessing capital from the domestic bond market at a lower interest rate compared to the offshore market to refinance high yield offshore bonds.

“Despite the availability of alternative domestic financing channels in China, developers should be prepared for the possibility of future policy changes as well as an interest rate reversion that may subsequently impact their cost of capital and debt maturity exposure,“ said Canon Yau, Senior Director, Capital Advisors, CBRE Asia Pacific.

“For small and medium-sized developers, we advise a longer-term view on refinancing plans by exploring strategic partnerships or forming joint ventures with investors to reduce concentration risk. As the government seeks to create more transparent financing channels, the introduction of asset backed securitization markets will provide opportunities for property companies to expedite the repatriation of funds,” added Mr Yau.

The report also suggests lenders and real estate funds should adjust pricing to reflect the escalating repayment risk among smaller developers. Other steps can include restructuring investment deals to include guaranteed returns, or the option of converting debt to equity.

CBRE’s report reveals that, despite favorable funding conditions, potential risk factors still remain in China’s real estate debt market:

· Developers’ ability to repay debt - While liquidity risk has decreased, the ability to repay debt remains challenging for small developers, due to narrowing profit margins. China-listed developers’ total debts have expanded significantly from RMB 1.34 trillion in 2011 to RMB 3.3 trillion in 2015. Small developers may also find it challenging to generate proceeds from pre-sales to support their operations, therefore relying on debt.

· Sustainability of residential sales - Following recent changes to government policy, doubts exist around the sustainability of residential sales. Factors including declining affordability and the re-implementation of home purchasing restrictions and stricter lending regulations have influenced market sentiment in certain cities. The recent cooling measures implemented by the government show that the focus will be on controlling prices in upper tier markets and selected second-tier cities.

· Postponing rather than resolving debt - Numerous developers have delayed the maturity date of their bond repayments instead of alleviating debt obligations. The next wave of corporate bond repayment by developers will mature between 2018 and 2021, valued at US$72.8 billion. Investors are advised to be aware of the subsequent impact on developers’ refinancing rates if the interest rate cycle reverts.

· Over-leveraging among regional developers - Housing demand is increasingly bifurcated to tier-one and tier-two cities. Regional developers looking to expand their portfolio nationwide to diversify their operational risk will likely place aggressive bids on land parcels outside their traditional areas of business focus, resulting in over-leveraging.