Too big to succeed - Are China’s real estate giants heading for a fall?

With restrictions on home sales and a more risk-averse capital market, real estate developers are winding back investment to conserve cash.

Photo from CFP

Photo from CFP



For years, Chinese home buyers and authorities have locked horns with real estate developers in a struggle to rein in speculation and bring some order to the tempestuous housing market. Suddenly, the authorities seem to have the upper hand. Once toweringly invincible, these titans that bestrode the land may soon be distant figments of mythology.

‘Sell 20 billion and see how it goes’

Shenzhen’s real estate index has fallen 12 percent in the year to date. Sales have slowed, so has land buying and borrowing. There is no more talk of trillion-yuan sales. Developers are still surveying the new landscape.

Sales nationwide have slipped for six straight months in terms of both square footage and value. In August square footage sold was down 16 percent from the year before. Sales by the top hundred developers were 20 percent lower than last year.

The slowdown is partly a result of the government's efforts to control home prices. More than 300 new restrictions on sales were issued in the first seven months of this year, 50 directly by the central government. Although prices are still increasing in the most expensive cities, the pace is slow, 0.3 percent per month, less than 4 percent per year. Guangzhong even saw a drop in August prices. But the hardest times are still to come.

SUN Hongbing, founder and chairman of real estate giant Sunac, said in a recent earnings call that sales would fall considerably in H2. The government has sent a clear message, he said, and expectations are adjusting. Some developers might be forced to offer discounts.

Developers, including state-owned ones, are holding off acquisitions to conserve cash. Although this is partly due to seasonality — developers usually buy land in the first half of the year so that the inventory can go on presale the same year — the mood is far from enthusiastic. As much as 35 percent of available plots were passed in recent auctions in some second-tier cities. Most of the rest were sold at the asking price. Some non-state-backed developers simply did not participate, even in hot markets like Suzhou and Hangzhou.

“We opted out of a few big auctions,” LI Peng, who works at a top 30 developer, told Jiemian News. “The management decided that it’s not the best time to buy land. We probably won’t start looking again until next year. We have about 50 billion yuan of inventory. The goal is to sell 20 billion and see how it goes.”

China Resources Land, part of the Hang Seng Index, has set maintaining a healthy balance sheet as its top priority but has not ruled out acquiring some land given current low prices.

Sunac plans to spend a maximum of 20 percent of sales on land acquisition in the second half of the year. “We expect financing and sales to be harder in the future, so we will be sure we operate with a sufficient safety margin,” Sun said. “We can’t afford to spend like before.”

It’s payback time

The focus on sales and cash flow will put pressure on prices. The reluctance of smaller, non-state-backed developers to buy land will make land cheaper in the medium to long run for those with money to spend.

“We are now extremely prudent in land purchases,” said Li. “We won’t buy unless we are sure of quick sales.”

For years, developers have prioritized expansion over profitability. Large developers have better access to land and funding, while smaller ones get gobbled up. The strategy may not work as well in a cooling market with tightening credit, especially given that margins are already shrinking. Vanke, China’s largest developer, saw its profits fall for the first time in 12 years. China Overseas Property’s net profit margin also fell below 20 percent for the first time.

It is almost industry consensus that profits will continue to drop as a result of home buying restrictions and increasing labor and material costs. Another big concern is the rising cost of finance. Bond issuance from January to August was down 21 percent from that of last year. In particular, August issuance dropped 40 percent from the previous month and 54 percent year over year.

An employee at a medium-sized developer said investor sentiment has drastically changed this year. “The market is extremely risk-averse at the current moment. Previously the question was how a company makes money. Now, the only thing people care about is how it saves money and pays back its debt.” The situation is less grim for developers with less debt and stronger ratings. Even among the 20 largest developers, before the Evergrande crisis, the overall cost of capital was as different as 3.6 percent versus 9.02 percent.

Stop the expansion 

With potentially more cooling in the offing, the industry needs a stable cash flow. Instead of expansion at all costs, some will stay small and local, but it might already be too late. Although most developers are not on the brink of default yet, many are tens of billions in debt. The Evergrande incident will likely make the market less tolerant and repayments more costly.

The fortune of almost all giants in myth and literature is to fall. Dinosaurs are synonymous with both extinction and great size. Small empires rarely crumble. Times are changing for the titans, having to some degree incurred the wrath of everyone from home buyers to senior ministers.

Once deemed too big to fail, it may be their very size that ultimately brings these colossuses to their knees.