Tama Churchouse: Okay, so this is a slightly different version of Peter’s Perspective. I’m Tama Churchouse, publisher at Churchouse Publishing, and I am joined, of course, with the author of The Churchouse Letter, Peter Churchouse. Good afternoon Peter.
Peter Churchouse: Hi Tama, good to be back on.
Tama: Right, so this is a slightly, as I said a slightly different version of the Peter’s Perspective and we thought it was a little bit more useful and instructive, simply because Peter was up in, as some of you will know, Peter is on the board of a couple of property developers. One mainland property developer called Longfor, another property developer in Hong Kong called Hysan, but he also serves on the advisory board of a company which we can’t name at the moment, but it is a 20 billion dollar listed company in the construction industry, and Peter spends quite a lot of time up in Beijing as part of their advisory board and typically talking about the real estate side of things.
So he was up there last week, in Beijing, and put together a few slides on China’s real estate market, we thought this would be interesting to share with Peter’s Perspective and our readers in general, simply because I think Peter feels that there are a lot of misconceptions with regard to the Chinese real estate market, would you say that’s accurate?
Peter: I think that’s absolutely accurate and if you were sitting in Europe or in the States or anywhere around the world watching TV and reading the media headlines, you’d be pretty scared I think of the headlines that you see, suggesting that we’re seeing Armageddon perhaps in China, particularly on the real estate sector, and if you look at those headlines, they’re pretty scary.
Jim Chanos here on the left hand side: “It’s worse than you think. Whatever you might think, it’s worse”, and there’s a lot of people who think like that and you can go through a lot of these kind of comments from the media that you’ll see pretty much anywhere, and in actual fact, quite honestly I think a lot of these misconceptions are based on old data or sometimes even flawed data. I think it’s fair to say that there have been problems in the real estate industry, the statistics can look a bit scary and it’s very easy to paint a disaster scenario, but quite frankly if you look at the data that’s coming out and has been coming out over the last 8 or 10 months, you wouldn’t be writing these kinds of headlines if you actually could see the numbers.
Tama: Yeah I mean, just to interject here, we did a presentation in Los Angeles about a year ago I think it was, and it was just after we had recommended buying the mainland China market, the A share market, and we had also recently recommended at the time, buying a couple of Chinese developers, and we gave this presentation, Peter did most of the presenting, and we had so many come up afterwards and, you know, contact us and approach us and say ‘Hey, we thought it was the end of the world over there, and we thought that it was a gigantic bubble waiting to burst’ and it really just showed some of the misconceptions as you say, that exists.
Peter: If you look at a lot of the people that are writing about China, they’re sitting 5,000 miles away in armchairs or at desks somewhere. In actual fact, when you actually read the work that’s been presented by a lot of the people on the ground who are up to their eyeballs in the markets in China, they have a slightly different perspective on it, and I think their observations are I think, more relevant and more on the mark than we see from a lot of the people in the media outside.
Tama: Okay so, let’s dig into this Peter.
Peter: In the real estate industry as we all know, the mantra is it’s all about ‘location, location, location’, well in China it’s about 3 things also, but it’s ‘control, control control’ and I think, just stepping back a bit, the Chinese economy is probably the archetypal Stop – Go economy, it’s the textbook case of a Stop – Go economy. Every part of this economy is controlled by the Chinese government they keep turning the taps on, they keep turning them off, they turn them on again, they turn them off, and never more so than in the real estate sector. Over recent years, there have been all sorts of episodes where they’ve tightened the market to slow it down, then they suddenly take their foot of the brake pedal and put it on the accelerator pedal, and we see this happening in fairly frequent events.
But if you look right now, look at the property market in terms of pricing. This left hand chart here, this chart tells us that for the top 70 cities in China, how many of the cities are seeing month-on-month price declines or price increases, and as you can see at the end of 2014 most of the cities were seeing month-on-month price declines. Well, look what’s happened in the intervening period. We’re now very clearly in recovery mode, over half the cities in China are now seeing price increases on a month-on-month basis.
So that’s a big turnaround, it’s very cyclical as you can see, but we’re definitely well into a turnaround here. The chart on the right shows the same picture, the green line is year-on-year price increases of the 70 cities and the blue line is month-on-month for the top 70 cities, and so you can see for year-on-year we’re still in negative territory, but month-on-month we’re definitely in positive territory. Both data cycles seem to be showing we’re in positive territory, we’re on the uptick and that’s not what you see in the headlines.
And again, if we just look at a very simplistic way, the green line is the movements in the top 10 cities year-on-year changes, very clearly bouncing resounding off the bottom and even also in the 100 major cities, but perhaps a little slower than the top cities. And again here, this chart’s a little more complex. The top two data lines are really changes in sales value and changes in sales volume in the residential market.
Tama: So the blue boxes there are for tier 1 cities, in terms of the percentage change in year-on-year sales value and sales volume, so Tier 1 cities…
Peter: The Tier 1 cities are Beijing, Shanghai, Shenzhen and Guangzhou.
Tama: And then Tier 2 obviously is..
Peter: There’s about 8 or 10 different cities, including cities like Chengdu, Chongqing, Tianjin and a whole bunch of others, so I think that the message here from those top two data lines is that we were all in negative territory in 2014, in terms of sales value and sales volume. We’re now back into positive territory, growing at an average across the market of 19%, year-on-year, so that’s a pretty resounding recovery. The bottom side of the chart, the two bottom lines there are supply side, and that’s actually quite interesting because that shows us that building starts and land sales are still in negative territory.
So we’re still seeing a pinch in the supply side, supply side is trending down, but the demand side is trending up, so that’s good news, so what that’s going to mean is that inventories will start coming down, or we’re starting to see evidence of that, so that’s good news, those charts there. As you can see the long term charts for the left hand side here, land area purchased and new starts, all still in negative territory at this stage, but look at the right hand chart, the inventory. Those inventory levels are definitely trending down and particularly in the Tier 1 cities, which is the blue line, we’re down to about 9 or 10 months of inventory at the moment, down from 16-17 months of inventory about a year or so ago.
So, again very positive signs and certainly the signs that we want to see. The big issue that I think a lot of people will focus on in China is the lending to the real estate market and the lending in China generally has jumped very dramatically in the last 4 or 5 years, but you can see here the loans to developers is really fairly flat, it’s not that big a jump over the last 6 or 8 years and is around about 7 percent, just a little under 8 percent of the total loans to real estate are to the developers sector.
But as you can see, as urbanization has happened, more and more families are buying their own homes in the big cities, and they’re taking out mortgages. In actual fact, most of these mortgages, I wouldn’t worry too much about the mortgage market, because most people are putting down 40, 50, 60 percent of the price of the house as a deposit, unlike the Western market, where you’re often having down payments of only 5 or 10 percent. In China those down payments are much, much higher.
Tama: And what you do kind of tend to see here is that on the occasions where there are developers that do offer, say very small down payment options, you’ll typically see the media really pick up on that in terms of the Western media, that really picks up on that, what they don’t pick up so much about is, as Peter said, the vast majority of personal mortgage financing is done with relatively low gearing. This is not the same kind of situation that we saw in subprime for example, or in the run up to subprime. The consumer in China is not leveraged at all to the same extent as you see in more Western markets.
Peter: Yeah, I think that’s a very good point to make is that consumer lending is not a systemic problem in the Chinese economy as it has been in the West, but again, looking on that right hand chart, you can see that developer loan growth, loan growth to developer sector, across the board has been increasing over recent years, so there is some cause for concern here but most of this is to a lot of the smaller developers that you will never see on your radar screen. There are 85,000 property developers in China, the top 30 or 40 that are listed in Hong Kong, their gearing levels are very modest and are in fact probably much lower than the average that you’ll see in places like the US and even in the UK. So the gearing levels at the big listed companies are not generally a concern for us, but yes there is a concern at the smaller end of the market in China, where the gearing levels do tend to be a bit higher.
Tama: So just to kind of wrap it up, we originally recommended a couple of developers back in 2014, we stopped out of those in the recent China correction and we did some pretty good gains, 30-40 percent on both of them, and I think you wrote a piece recently to Peter’s Perspective subscribers and those stocks are coming back onto our radar again, and we won’t necessarily identify them here at this stage, but what are the kind of key characteristics of those China developers that we want, because as you say, there’s 85,000 of them, there are a lot less listed ones, but out of the listed ones, what are we looking for in terms of the developers?
Peter: Well in terms of the first cut at the developer sector, I think that we want to look at companies that are big and have scale and have basically SOE or state owned enterprise backing, because these guys are not going to face serious problems. In addition, we want to see companies which have modest to low levels of gearing and certainly in this space a lot of the bigger companies have gearing in the range of 30 percent to 40 percent, maybe a little more than that, which we don’t find particularly threatening. It’s when I see gearing levels of 100, 120, 150 percent that I get a little nervous, but at the big companies that we cover and that we look at, that are listed in Hong Kong, those gearing levels are that much lower. So it’s gearing and scale and track record and background that are the key things that we’re looking for.
Tama: Great, thank you very much Peter and thank you very much for watching and listening.
Peter: Happy investing.