TS Lombard with the note
After leading the recovery last year, real estate investment is set to decelerate under macro and sector-specific deleveraging campaigns as well as higher input costs. We expect property investment to reach 5% yoy in H2/21 from13% you in April. The slowdown will hit local government financing and investment. The combined impact on property and local government funding is negative for growth and commodity prices. Nevertheless, authorities will be pleased real estate FAI is finally slowing after nine months of concerted policy pressure. The slowdown will help Beijing rebalance the post-Covid economy and take some of the heat out of PPI.
Land sales and developer access to funding typically lead real estate FAI by six to nine months(Chart 1below). Financing and land purchases have both slowed since the “three red lines” on property developer leverage were unveiled in October. The impact is most evident in land purchases, which are highly leveraged. In April, new purchases by real estate firms declined to-9.5% yoy vs 2019.
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Developer credit has proved more resilient. Although the PBoC has tapered monetary policy (cutting total social financing growth from 13.7% October to 11.7% in April), mortgage rates remain low and household savings are at a pandemic-induced high. Property firms have benefited by increasing their funding from the household sector (pre-sales, deposits and mortgages). Institutional direct and indirect financing was also supportive over Q1/21 as banks’ annual lending quotas are reset in January.
Credit contraction underway. Pressure on direct and indirect financing is building. Aftertheblowoutinproperty lending in January and February, regulators stepped in to provide strong“window guidance” to banks. This week the CBIRC added pressure by announcing a new inspection campaign targeting banks with a high share of mortgage lending and/or lenders suspected of channelling business and consumer loans into the property market.
Household’s the key source of funds. Deposits, advanced sales and mortgages (DAM) have accounted for just under half of developer funding since 2017. With loans and bonds under pressure,the share of DAM in total financing is at an all-time high of 53%. Pre-sales have moved ahead to become the largest fund-raising method(chart 4 below).
Advanced sales are exempt from the“three red lines” debt metric and will remain the key source of capital for developers. However, pressure on household funding is increasing as authorities tighten mortgage-lending quotas, raise rates and price gains start to slow, lowering the incentive to pay up front. Prices in Tier 3 cities and below, which account for approximately 70% of PRC property sales by area are under particular pressure(chart 3 above). Smaller urban areas have a larger inventory backlog and greater exposure to the most indebted property developers. Companies like Evergrande, which fail all three-red line metrics, expanded heavily in tier 3 and 4 cities, and are offering discounts to clear inventory. Moreover, the post-Covid recovery has undoubtedly been weaker in non-core economic regions, reducing purchasing power. Tier 3 prices are increasing at their slowest rate since 2015. Valuations are unlikely to pick-up given property sector financing headwinds.
Taken together, tighter bank, bond and household financing will begin to show in slower investment over H2/21. We expect the rate of real estate investment to drop to5% yoy in H2/21. A slowdown in property investment, which accounts for around a quarter of total FAI in China, will weigh on growth and industrial prices. Real estate accounts for 20-25% of GDP, including suppliers, employees and related subsectors. Chart 2above shows the close link between property construction and PPI.
Land purchases will continue to fall. Policy pressure means developers are largely in inventory contraction mode. Acquisitions of new development plots–the most debt intensive part of the production process–are a low priority. Weaker land sales will hit local government revenue and investment.
Provinces rely on land receipts for the bulk of their funds, and weakness here will compound the impact of real-estate investment deceleration on PPI. Beijing will be relieved property investment is finally slowing after nine months of concerted government pressure. The timing is optimal as policy efforts focus on rebalancing the economy and curbing the impact of higher commodity prices. Real estate investment is growing at 17% you vs 2019, well ahead of the recovery in services and household consumption–retail sales slowed from 11.8% vs 2019 in March to 8.4% in April. Meanwhile, rising prices of upstream materials and powerarethreatening the recovery of private-sector manufacturing profits, output and capex. Industrial profit data for Aprilclearlyindicate pressure on the gross margins of goods manufacturersas sales prices failed to keep pace with material costs. Official and private manufacturing PMIs showed input costs at10-year highs. In the south of China, power supply issues are already forcing production delays and raising costs.
Tapering demand for commodity inputs will help take some of the heat out of China PPI. Property construction typically accounts for 35% of China’s steel consumption and approximately30% of total cement usage. Its share of commodity demand over the past 12 months is likely to have been even greater as real estate FAI grew 4.9% yoy in 2020, outpacing infrastructure 0.9%yoy and manufacturing-2.2%.
A property investment slowdown will improvedomestic supply/demand dynamics, but China is a price taker in this commodity cycle. While global supply remains tight and as US and European growth accelerates, imported inflation will drive China PPI. Although the property crackdown continues, soaring input costs mean the PBoCis likely hold off on further macro tightening. At the same time,fiscal authorities are rollingout selective support measures (tax and fee reductions)f or SMEs and policy-favoured sectors (advanced manufacturing) hurt by higher commodity prices.
What a Shakespearean note. Both so right and so tragically wrong!
What this note describes is the end of the Chinese habit of building ghost cities. With developer leverage reined in and local government funding constrained, only actual sales can trigger new development. That’s the end of “built it and they will come”.
The corollary of this stark. This is not a “marginal” change to global commodity demand. It is the beginning of the end of China’s great urbanisation project. This is very sensible policy given China is 64% urbanised with a huge number of empty apartments already built to accommodate the rest:
As such, it is the end not the beginning of some new commodity super cycle.
Moreover, China is always a “price taker” at the commodity cycle peak. It will shortly become a “price maker” as its own demand falls. There is a question over the timing given the global inventory supercycle but that’s all. There is no western demand in the pipeline to offset the end of Chinese ghost cities.
When the Biden stimulus arrives later in 2022, it will lift steel consumption 6-10mt per annum. This is so small versus the Chinese construction behemoth that it might as well not exist.
I personally think that the same calculus applies to copper and other base metals but I am not so well-versed in the specific market dynamics of those so it is only an opinion.