China’s Goldilocks Property Market

Every few years, investors become concerned about the Chinese property market. During these episodes, we often hear commentators talking about the volatility of the Chinese property market and we sometimes encounter the view that after many boom years, a bust is inevitable.

However, this perspective is entirely contrary to the long-term evolution of house prices in China. Prices have been rising at a stable rate for more than a decade. Any discernible cycles have been short and shallow.

This has been a consequence of the Chinese government’s frequent interventions into the property market. Their preference is to see house prices rising at a rate that is not too fast, not too slow, but just right.

Chinese policymakers have plenty of tools at their disposal to both cool down and support the property market. When prices are rising too quickly, they can raise mortgage down payment requirements and the interest rate on mortgages. In recent years, cooling measures have become increasingly surgical, with restrictions on investor loans for larger homes in particular cities where prices are rising above the national average. When the market turns and price growth falls, the government can push growth back to trend by rolling back the restrictions they imposed in better times.

The cooling measures are effective, as the government has a high degree of control on lending eligibility and interest rates. The supporting measures work as there is significant real demand for accommodation arising from continual internal migration from rural areas to cities, as well as demand from families to upgrade from poor quality communist-era housing.

The question remains, could the government lose control of the property market at some point in the future? It can’t be discounted as a possibility, but we note the government has enormous incentives to maintain stability. More than a third of local government fiscal revenues are generated from land sales. Moreover, more than half of Chinese household assets are stored in property. A crash would risk civil unrest. Therefore we would expect the government to do everything within its power to stabilise prices and keep them rising at a moderate, though not excessive rate.

In this context we struggle to understand the low multiples that some Chinese property developers trade on. Even after the recent rally in the markets, Yuzhou Properties trades on under 4x price-to-earnings. The market seems to be pricing in a steep earnings decline, an eventuality which appears unlikely given the government backing for the overall property market.