Friday, March 26, 2010

Is the next bubble in Chinese real estate?

The global stock market has largely shrugged off troubles with Greek debt (its too disconnected from most economies, too small and insignificant, and members of the EU will have to bail out Greece before another financial crisis develops), US policy uncertainty (on healthcare and the banking sector), as well as early signs of tightening activity in China. The US recently hit new 18-month highs, with the Dow Jones Industrial rising for 8 consecutive sessions. Despite the moderate levels of optimism displayed by investors in general, we consider it prudent to focus on potential issues which could derail the stock market in the near future.

Unsettling reports out of China
Of particular interest at this juncture is the potential bubble in Chinese real estate, an issue which could have profound backlash on various risk asset classes, Chinese property developers notwithstanding. China's real estate prices rose 10.7% year-on-year in February 2010 (according to the National Bureau of Stastics), following a 9.5% gain in January, fueling worries that Chinese property prices have risen too fast and too furiously. Various "on-the-ground" experiences reflect the increasing bubbly nature of the property frenzy (Real estate: China’s god of fortune, CHINA PROPERTY: Aspiring tycoon makes killing in virtual home sales).

Official statistics of home prices in China are generally not a good reflection of actual on-the-ground conditions, making it difficult to assess the situation. These less-than-accurate growth figures are also difficult to relate to the entire property market, with varying nuances affecting different segments of the market. Generally, various reports suggest that first-tier cities (Shanghai, Beijing, Shenzhen and Guangzhou) are experiencing some semblance of substantial overvaluation, while the problem is less prominent in second-tier cities. Low levels of borrowings (generally, most Chinese buyers pay cash for a majority of their home purchase) are a positive indication, differentiating the Chinese property market from other property bubble crashes in the past (US, Japan) where large levels of mortgage debt were employed. However, "this time is different" is usually inconsequential at the end of the day, whether in the heights of an asset bubble, or in the depths of deep recession.

No one really knows if the property market will collapse, but we want exposure
We admit that we are not in a good position to judge the extent of disconnect between property fundamentals and prices being paid. On the other hand, we continue to believe in the long-term potential of the Chinese economy, which entails some of the best growth potential over the next decade or two, on the back of unparalleled potential consumption and spending power (driven by the continued trend in urbanisation and growing affluence), and Chinese property represents one of the best ways to benefit from this immense long-term trend. Yet, talk of speculative-like property prices in first-tier Chinese cities (and some second-tier ones) is rather unsettling.

Indirect plays
Given the uncertainty over Chinese property, we have incorporated exposure to the Chinese property sector via indirect plays, rather than investing in companies who are wholly-leveraged to the Chinese property market like Yanlord Land. Capitaland is a leading real estate developer in South East Asia with a view on increasing its assets in China over the long term, but retails large amounts of property assets in the region. WBL Corp holds extensive landbank acquired at much lower prices, but has a diversified mix of businesses which include automobile distribution as well as technology manufacturing. F&N is increasing operations in China, but retains its stronghold on the South East Asian drinks market with a dominant market share. None of these companies are expected to collapse in the event of a prolonged downturn in the Chinese property market, but are all well-positioned to benefit from the longer-term growth in this space.

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