Melting the Property Freeze

China's better-than-expected economic growth for the first quarter of 2009 is giving hope that a recovery is not too far around the corner. Analysts say that genuine demand, coupled with limited availability of quality homes, is driving up prices, and le

Issue: Jul 2009

summitresidence
Summit Residences, CapitaLand China’s first residential project in the second tier city of Ningbo
The housing reforms that began in the early 1990s in China had revamped the country's residential sector - from a government-controlled market to one chock-a-block with private players brimming with innovative ideas of new lifestyles. This rapidly growing sector definitely brought a number of opportunities to local and overseas developers.

However, the sector did not escape the 2008 global financial crisis and economic recession. Bad news of transaction volume sharply declining, prices free-falling, developers holding up projects and struggling for debt repayment, made the headlines of industry newsletters during the second half of 2008.

Fortunately, the Chinese government took prompt actions to combat the widespread economic recession. By implementing a US$580 billion (RMB 4 trillion) stimulus package and injecting credits into its banking system, the government posted better-than-expected economic growth. China's GDP grew by 6.1% year-on-year in the first quarter of 2009.

As the economy begins to warm up, the iceberg of the residential sector has also begun to thaw. In March and April of 2009, the low inventory levels in some cities and the surge of pent-up genuine demand, led to increasing transaction volumes and subsequent price hikes.

Although the market rebounded with improving sentiments, some experts and analysts continue to maintain a cautious outlook in the short term. Nevertheless, the fundamentals of China's residential market remain solid in view of sustainable urbanisation trend, increasing affluence and healthy affordability level.

Sustainable Urbanisation Trend

As China's economy has grown and become modernised, the role of its cities has increased. By 2008, the urbanisation rate (percentage of urban population) had gone up to around 45%, comparing to 10% during the 1950s.


Riding on the urbanisation wave in China: The Oasis Riviera development in Shanghai completed in 2008.
According to the United Nation Population Division's forecast, the degree of urbanisation in China will eventually grow to over 60% with an urban population of 875 million by 2030 (Chart 1).

The urban population boom means millions of people will need homes in the cities. The city size will continue to expand, especially for those economically developed ones. Infrastructure and public services such as transportation networks, utilities, education and healthcare facilities, as well as housing, will thus need to expand to cope with the growing population.

DTZ estimated that at least 15 million new home-residential units in cities will be required over the next five years, due to urbanisation. The medium and long term prospects for the residential sector remain favourable.

Despite the rapid growth, first tier cities such as Beijing and Shanghai have seen their population almost reaching their peak due to the limited infrastructure available. In the next stage of growth, the population of first tier cities is expected to continue to increase but it will probably be at a lower rate than second tier cities, where urbanisation continues to be encouraged.

The wave of economic restructuring and urban transformation has totally changed the lifestyle of Chinese residents, and strengthened the fundamental demand for residential units, not only for quantity but also for quality.

Chart 1: Urbanisation Ratio (%)


Source: United Nation, World Population Prospect

Increasing Affluence

The growth of China's economy has brought about rising affluence and the creation of a sizeable middle-income population (Chart 2). This group has enormous spending power and high aspirations for larger and better quality accommodation. By around 2011, the lower middle class will number some 290 million people, representing the largest segment in urban China and accounting for about 44% of the urban population, according to McKinsey.

By 2025, the upper middle class will comprise a staggering 520 million people, more than half of the expected urban population of China - with a combined total disposable income of RMB 13.3 trillion. Besides the middle class, the growth of HNWIs (high net worth individuals) is also astonishing. According to China Merchants Bank, the number of HNWIs in China is expected to be 320,000; their wealth could translate to RMB 9 trillion investable assets, about a third of China's GDP.

Real estate, like residential units, is always one of the favourite investment products for the middle class and HNWIs. As income rises, spending patterns change and the demand for high living standards increases. Those who have more than one residential unit, have good educational background and a fine-tuned lifestyle. Although increasing affluence will create huge demand for residential units, developers will also face the challenge of launching innovative and niche products to cater to the expectations of high living standards.

Chart 2: The Emergence of Middle Class in China


Source: McKinsey

Improving Affordability Level

The strong economic growth has led income and housing prices to rise together during the past 10 years. As a whole, income still grew faster than housing prices (Chart 3), making homes more affordable. Thanks to the strict regulation of the financial sector and foreign exchange policy, Chinese residents' income were less impacted by the global financial crisis than westerners. Given the recent countrywide softening of housing prices and the fall of interest rates, the actual housing affordability has further strengthened. In fact, both residential transaction volume and prices have rebounded in China recently, banking on strong affordability level and sustainable genuine demand.

Residential properties in second tier cities are generally more affordable as their home prices lag behind those in the first tier. The real estate market in these cities have just started taking off, signifying great opportunities in real estate investment. In addition, strong wealth creation brought about by sustainable economy in these cities will further boost the real estate business.

Chart 3: Income is Growing Faster than Housing Prices


Source: JLL


In summary, both near-term catalysts and long term fundamentals imply that China's residential sector is rebounding and this trend is sustainable. Investment opportunities arise with the decline of inventory level in major cities and macro recovery. The return of buyers also boosts construction and contributes to the overall economy. Both floor space under construction and floor space completed started to register positive growth at the start of 2009. This was after rapid deceleration in the first half of 2008, and negative growth in the second half of the year. It is thus expected that improving sentiments will continue throughout the rest of 2009 and the whole market should recover in 2010.

Contributed by Boaz Boon and Zhu Haihong of the CapitaLand Research Unit.

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