China: the Bull Case

A reader has sent me the below email, which comes from the President & CEO of CapitaLand, Mr LIEW Mun Leong, and was sent to all staff in July this year. CapitaLand has apparently been the major residential developer in China for the past 15 years.

The email presents a rather bullish view of China, and suggests that if there is a property correction, it would be very short lived.

Given that I have recently published a series of bearish articles on China’s economy, in the interests of balance, it’s only fair that I provide the other side of the debate. And there’s arguably no better source to convey the bull’s case than the CEO of the largest property developer in China.

Here’s the email in its entirety. I’ll leave it to readers to make up their own minds. Feel free to either post a comment or email me if you have anything that you wish to share.

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Dear colleagues

As soon as Jamie Dimon, Chairman and CEO JPMorgan Chase, sat next to me at Beijing’s Grand Hyatt Hotel after delivering his keynote address at an investment conference, he popped an abrupt question to me, “So, are you worried about the Chinese government’s recent measures to manage the property bubble?”

Somewhat to his surprise, I replied, “I would be worried if the government doesn’t do anything about it.” To clarify, I added, “We are a long term player in China. We have been here for 15 years, and have seen several cycles including the painful Asian crisis. We prefer a more orderly and stable property market instead of an excessively speculative one.”

I then asked him, “Is there a stronger property market in the world than China?” He thought for a short moment and said, “No.”

As one of the most well-known Wall Street bankers in the world today, Jamie Dimon is not alone in his concern about China’s property boom. Many alarm bells have been raised previously, the most stirring being the remark by James Chanos, a hedge fund short-selling expert who proclaimed early this year that the property boom in China looked like “Dubai times 1000 — or worse”.

Jim Rogers, a well-known international investor, rebutted that Chanos’ remarks showed “a lack of understanding about Dubai and China. Dubai’s economy is built on real estate speculation, whereas China’s is not. It is just part of the Chinese economy”.

So what is our view then? How do the recently introduced measures affect CapitaLand?

China’s Unstoppable Growth

China is a huge country with the world’s largest population. It is a continent economy with 1.3 billion people, and had not too long ago embraced a “market” economy. Over the last 30 years, it has grown “miraculously” at an average of 10% per annum. It is now the largest manufacturer and exporter in the world and enjoys huge trade surpluses. It has prudently built up the world’s largest foreign exchange reserves of US$2.4 trillion. With a GDP per capita of US$3,687 in 2009, up from about US$100 in 1965, the country has progressed exponentially. In every sense, its growth seems unstoppable.

Urbanisation & Housing Demands

With such growth, China is experiencing the largest urbanisation in human history. Currently, the urbanisation level in China is still relatively low at 46.6% which was Japan’s in 1965. Between 1990 and 2030, China’s urban population is forecast to increase by 560 million, more than 100 million larger than the combined population of the United States (309 million) and Japan (128 million). Given such rapid urbanisation, China will easily need 10 to 15 million new homes every year.

The China Economic Information Network estimates that with such urbanisation, the number of cities in China will increase from the current 660 to beyond 1,000 by 2014. This has resulted in the property sector playing catch-up to meet the housing needs required in China’s cities. It did not help that more than 20 years ago, the government halted its subsidised public housing programme to let the private sector take over the massive housing needs of the country. The physical demand for homes is growing acutely without adequate supply, particularly for the non high-end housing sector.

Is there a Housing Bubble in China?

The answer is not so straightforward.

First, it is important to understand that China is not one big homogeneous market. Home prices vary from first to third-tier cities and for different spectrum of homes. For example, a mid-end apartment in Shanghai can cost five times more than a similar one in Zhengzhou, the capital of Henan province. Even in Shanghai, where every affluent Chinese in the country aspires to own an apartment, there is a huge price discrepancy between different tiers of apartments. High-end apartments may cost up to five or seven times a mid-tier apartment. The market is very segmented.

Next, we must look at affordability for the average Chinese. A practical measure is the affordability ratio, defined as the mortgage debt payable per month over monthly household income. Banks will not lend if the buyer’s affordability ratio exceeds 50%. Surveys show that now, the average affordability ratio is around 40% for 70 major cities. This is similar to Singapore. For the key gateway cities, namely Beijing, Shanghai, Guangzhou and Shenzhen, the ratios have exceeded 50%. But only about 50% of homebuyers will take up a mortgage. Also, statistics have shown that only 20% of buyers are “bubble building” investors or speculators. My conclusion is that there is a property bubble building up but it is limited to the four gateway cities. The same cannot be said of the other cities, or when considering the mid-end market.

China’s experience of rising property prices is quite unlike those experienced in the US and other developed countries. In China, household income growth today still outpaces its house price growth. This was not so for US, UK and Japan before their property prices crashed. Between 2004 and 2009, cumulative property prices growth in China rose by 72%, while cumulative household income growth increased by 82%. Contrast this with the household income growth against house prices from 1995 to 2007 for the US and UK respectively (48% vs. 114% and 36% vs. 220%) and for Japan between 1976 to 1990 (126% vs. 190%).

As long as demand for housing remains unmet and household income continues to grow faster than home prices, property prices will continue to escalate. The Chinese government has intervened with rapid cooling measures such as restricting apartment sizes to 90 sqm, curbing speculation by raising deposits to as much as 50% for second-home buyers and restricting lending for third-home buyers, banning non-resident foreign buyers, restricting bank lending capacity, and aggressively supplying more land for ‘economical’ housing. The government further demonstrated their seriousness here by only allowing 16 out of 94 of their major state owned enterprises to continue with their non-core property business.

Will there be a Subprime Crisis in China?

Unlike other developed countries, China’s housing mortgages constitute 12.5% of the total financial institution RMB loans, whilst RMB loans to real estate developers constitute only 6.7% of their entire RMB loan portfolio. The total exposure to the property sector is therefore less than 20% of the total financial intended RMB loan. Another comforting view is that China’s outstanding mortgage constitutes 14.3% of her GDP, whilst the Eurozone figure is at 40% and US at 97%. As loans are limited to 70% of the value of the property, its capital value will have to drop substantially before negative equity hurts the buyers. On this basis, Chinese buyers with large household savings will be able to hold their properties unless prices drop drastically. Even if this happens, on the strength of the Chinese economy, the impact on China will not be as grave as what the US has experienced. I should add that because of the loan to value mortgage lending limits and the credit checks by banks in China, a sub-prime problem like the one in US is not a likelihood.

China’s Great National High Speed Rail Project & Property Market

An analysis of China’s future would not be complete without mentioning China’s ambitions to connect the country with a high speed railway (HSR) network. China already has 6500 km of these HSR lines, effectively shrinking the entire country to 80% of its original size by travel time (excluding Tibet, Xinjiang, Qinghai and the Inner Mongolia region, which account for only 5% of China’s population). By 2012, there will be 13,488 km HSR network (shrinking China to 50% of original size), and 28,538 km by 2014. Overall, it is estimated that the HSR will finally shrink China to 9% of her original size in terms of travelling time! With this increased accessibility as part of China’s overall economic development, it is believed that urbanisation and the property market will go through another enhanced phase of dramatic economic transformation. When Dr Sun Yat Sen founded New China a century ago, he envisioned a railway network to bring economic wealth to the country, just as the railway network started the transformation of America in the 19th century to the world’s largest economy. Now China is actively putting that strategy into reality.

Will Beijing and Shanghai’s Housing Prices Converge with other Asian cities?

There is still immense opportunity for CapitaLand to grow in China, especially in the mid-tier property market. As at 1Q 2010, prices in Singapore’s mid-end homes are 2.2 times that of Shanghai, and 2.5 times of Beijing. When compared with Hong Kong prices, the corresponding multiples are 3.6 times and 4 times respectively. Since Beijing and Shanghai have a much larger population and with higher growth rate, the potential for growth is much greater than Singapore or Hong Kong.

How much longer do you think it will take for them to catch up with us on housing capital values?

My guess is five to seven years! In fact, prices of some luxury apartments in Shanghai are already on par with those in Singapore.

Affordability Housing

Looking ahead, a new segment with tremendous potential is affordable housing. Building affordable housing will somewhat ease the escalating prices that delay home ownership for middle income families. With smaller, affordable properties as their first homes, they can scale up to larger, higher priced homes as household income increases. CapitaLand will be looking to build affordable housing in any city where there is demand. Acquiring land at reasonable prices is very important and we will need the support of local government and local partners to source for housing sites at the right price.

Conclusion

China’s rapid economic expansion is unstoppable. CapitaLand has been successful in China for the past 16 years. We have the experience, track record, reputation, capabilities and capacity to participate in the growth of China’s real estate market. With all the new government controls, the property market will be harder to deal with. And local Chinese developers are getting more competitive. But the market is immense there. To answer Jamie Dimon, we are more confident that CapitaLand will benefit from the Chinese government’s measure to render stability to the property market.

To us, there is no stronger market in the world than China.

Kindest

LIEW Mun Leong
President & CEO
CapitaLand Limited

Comments

  1. An interesting synopsis, but that last line sounds convincingly like "we have reached a permanently high plateau" from Irving Fisher….

  2. "Never ask a barber if you need a haircut" – What would you expect a guy who has spent his entire life in real estate to say? He is paid to be bullish! He will be doing a disfavour to his board and shareholders if he says anything against properties.

  3. I get the idea that Chinese people will need 15 million new homes a year. But, with the current prices (average price of $350 per sqm), current loan limits of 70% of the home value and affordability ratio toped at 50%, it looks to me that there are no 15 or even 5 million families able to meet all the criteria

  4. rather like all the propaganda that comes from China really … have you seen the movie "Hero"

    Same message … the sacrifice of all is for the unity and strength of China.

    BTW, I guess that you already know that the characters in Chinese for China actually means the center country. They are the center of the universe you know.

    中國

  5. "And there's arguably no better source to convey the bull's case than the CEO of the largest property developer in China."

    He is probably the worst person to convey the bull's case, because he has vested interest in the market. The best person should be someone independent.

  6. Financial Follies

    In line with your recent posts on the bear case, out the latest Michael Pettis post:

    "By the end of next year, I suspect that the consensus will be that for the rest of the decade we should expect growth rates in the 6-7% range for China… If GDP growth slows so substantially, it seems to me that consumption growth of 8-9% will be very hard to maintain, so I would argue that we should be prepared for even lower average growth numbers, perhaps in the 3-5% range… It will be very bad for commodity exporters …"

    Cheers,

    Dave

  7. Leith,

    I reproduce a response by Michael Pettis to comments from the above (FF) referred post:

    "… I don’t think China will have a real estate “collapse”. I suspect it will simply slow real estate development significantly over the next decade as it grinds away at the current excesses. This will probably have a greater economic cost in the long run but at a lower social cost"

    Michael Pettis also says he does not see any constraints to the China balance sheet….it is a nuanced article and well worth reading carefully, particularly for Australians the portion FF quotes above.

    http://mpettis.com/2010/12/chinese-growth-in-2011/

  8. Leith,

    It is not only in China& Australia that are sporting elevated real estate prices. Guess what it is also in Singapore. Its real estate development that represents the top economic activity. It is being actively supported by the Spore govt. So when China's real estate collapses, not only Australia but also in Spore will doom to fall.

  9. Most bosses of real estate developers think the same as far as I know that they "would be worried if the government are not doing something". I have heard quite enough of this, to be honest.

    Also sprach Analyst