Too much stock, too little confidence. Addressing this imbalance is key to an improvement in China's beleaguered property market. We anticipate property sales could stabilize, but only if the conditions are right.

Boosting sentiment among both developers and homebuyers is paramount. The government will have to address a supply glut and developers must have assurances on funding. Otherwise, the current squeeze on margins and deteriorating sales could take a further toll on the creditworthiness of the developers we rate.

The market has swung in favor of homebuyers, but before they jump in, they will need signs that developers are healthy.

Funding And Confidence: The Keys To Stability

The first key condition will be easier access to funding. When developers witness more favorable funding opportunities, they might regain their confidence in land acquisitions and new starts.

Secondly, the government will have to increase measures to reduce inventories. The People's Bank of China (PBOC) recently introduced a Chinese renminbi (RMB) 300 billion relending facility to purchase existing inventories for social housing. Although helpful, it only accounted for a small percentage (4%-6%) of the overall completed housing stock, by our estimate.

Further policies to help destocking are key. When inventories gradually reduce, we believe developers will no longer need to resort to drastic price cuts to destock.

We estimate the government's new policy on urban village redevelopment and dilapidated housing, announced on Oct. 17, 2024, has the potential to reduce the overall completed housing stock by an estimated 9%-11% if implemented effectively.

Third, a rebound in developers' confidence will concurrently boost homebuyers' sentiment, in our view. Indicative of this would be a rebound in land acquisitions and new starts, as well as stabilization in primary home prices. When prospective homebuyers regain confidence in the market, they will be more inclined to make purchasing decisions.

By plugging these holes, the property market could see a positive shift, leading to stability in prices and sales.

Time For Structural Change: Quality Over Quantity

Structural changes continue to reshape the outlook for China's real estate market. It has moved away from a high-churn model and is increasingly focused on profitable projects with good quality and desirable locations.

Among the changes to the market structure is an increasing share of secondary-market sales, which we estimate will rise to more than 40% in 2024 from about 30% in previous years. Homebuyers are more willing to explore the secondary market because they know that what they see there is what they get.

The other change is the decline of the presale model. The fear of non-delivery has led some provinces and lower-tier cities to discourage presales and tighten requirements for presales permits. The tightening has also spread to higher-tier cities. In early September 2024, a land auction in Shenzhen required developers to only sell properties after completion. In the first eight months of 2024, about 70% of sales by gross floor area (GFA) came from presales, versus close to 90% before the sector downturn.

Investment demand in lower-tier cities is diminishing, as continuous relaxing of purchase restrictions in tier-one and higher tier-two cities diverts demand away from lower-tier cities.

Homebuyers are also now more selective, and developers are increasingly targeting higher-tier cities rather than lower-tier ones. This has led to a rising share of sales from high-tier cities and those with better locations within those cities. In the first half of 2024, 61% of the contracted sales of China Overseas Land & Investment Ltd. came from first-tier cities, a big jump from 38% in 2023. Greentown China Holdings Ltd. has also continued to increase its land bank in higher-tier cities. As of the first half of 2024, it stood at 79%, up from 74% by the end of 2021.

Chart 1

The prime driver of demand in the real estate market is upgraders seeking good quality homes. Developers focusing on premium-quality residential products in higher-tier cities will be more resilient during a downcycle. An increase in the supply of social housing provided by the government could affect the market for entry-level homes market.

Negative Wealth Effect: Falling Home Prices Are Eroding Sentiment

The ongoing decline in home prices has eroded not only the wealth of homebuyers but also their confidence. In August, primary housing prices in tier-one cities fell 4.2% year on year. Of the four tier-one cities, only Shanghai saw an increase in price (4.9%). For second- and third-tier cities, newly built housing prices fell by 5.3% and 6.2% year on year, respectively.

Furthermore, in August, secondary housing prices in tier-one cities fell 9.4% year on year. Prices were falling across the board for the four tier-one cities. Secondary housing prices in second-tier cities declined 8.6% year on year and in third-tier cities 8.5%.

Chart 2

The National Consumer Confidence Index reflects a slump in consumer confidence since 2022. This decline aligns with the fall in secondary home prices, which began in early 2022 for tier-two and tier-three cities, and later in 2023 for tier-one cities.

Chart 3

Data from China Real Estate Information Corp. (CRIC) reveals that sales remained weak in September, which is a historically strong month for property sales. Property sales of China's top 100 developers shrank 37.7% year on year during the month. Year to date until September, property sales of top 100 developers have fallen 36.6%.

However, after the government released a policy package to stimulate the economy in late September, property sales in selected cities soared during the national holiday week in the first week of October. According to CRIC, primary property sales area in 22 major cities, which are mainly higher-tier cities, saw a 26% year-on-year increase when compared with the national holiday week in 2023.

New Policies Offer No Quick Fix For Developer Confidence

In our view, it will take time for the government's policies to filter into supporting the overall property market. If the government continues to prioritize support for developer financing and destocking, we believe property sales and prices could stabilize toward the second half of 2025.

In the meantime, the cautious approach among developers toward acquiring land and initiating new projects suggests a lack of confidence in the market. We anticipate the percentage of newly added salable resources in relation to contracted sales will significantly decrease in 2024 for all the developers we rate. Their 2025 sales performance will in turn suffer.

Chart 4

The number of new construction projects has also been plummeting. In 2023, the national new home starts, measured by GFA, fell by 58% compared with their peak level in 2019. During the first eight months of 2024, there was a further decline of 23% year on year. This decline in new construction reflects the need among developers to preserve their liquidity. As sales and operating cash continue to decline, it becomes crucial for developers to maintain a steady cash flow through financing.

Funding Conditions Remain Choppy

Government policy efforts to shore up developer liquidity have yet to cause a thaw in funding conditions. From 2020 to 2023, the sources of funds for real estate development fell by 36%. These sources include domestic loans from banks and other financial institutions, self-raised funds such as onshore bonds and other borrowings, and foreign capital such as offshore syndicated loans and offshore bonds.

From January to August 2024, the accumulated sources of funds from domestic loans, self-raised funds, and foreign capital fell 6.6% compared with the same period in 2023.

To further support developers' funding conditions, the government announced that the approval of property development projects that are eligible for the white-list scheme would be fast-tracked. By end of 2024, the government expects that the approval of bank loans for white-list projects will reach RMB4 trillion, up from about RMB2.2 trillion currently.

Furthermore, based on negotiations with commercial banks, developers may obtain the entire property development loan in one go at their escrow bank accounts, instead of receiving such loans based on the development progress previously. This might help developers to better manage their cash uses for construction-related activities. These policies related to the white-list scheme, in our view, might help strengthen homebuyers' confidence in the primary housing market as it could further reduce uncertainty on deliveries (see "Will China's 'White List' Boost Housing Sentiment," published on RatingsDirect on March 25, 2024).

Chart 5a

Chart 5b

Prices Cuts Loom To Clear Unsold Inventory

We anticipate that primary home prices will decline by 6%-8% in 2024 and further by 4%-6% in 2025, primarily due to the increasing inventory levels and market-driven pricing. As inventories continue to rise, developers may resort to price-cutting to attract buyers and reduce stock. The price cut will still be more severe in lower-tier cities given the large amount of inventory, lack of investment demand and lower confidence of housing delivery. On the other hand, higher-tier cities may see gradual price stabilization, with less supply and stronger demand.

Local governments are also taking action by gradually removing price restrictions. Several cities such as Chengdu, Hefei, and Zhengzhou have canceled or relaxed price restrictions since 2023, allowing housing prices to be increasingly determined by market forces.

In 2024, we expect China's property sales to decline to RMB8.5 trillion-RMB9 trillion from RMB11.7 trillion in 2023. We forecast sales will further drop to RMB8 trillion-RMB8.5 trillion in 2025, mainly due to further price declines.

Table 1

Chart 6

There has been a jump in the amount of national completed unsold inventories. The GFA of these inventories has risen to 738 million square meters (sqm) as of the end of August 2024, compared with under 600 million sqm between 2018 and 2022.

The rise in inventories reflects worsening project sell-through. Data from CRIC shows that inventory levels, including completed and uncompleted units, in 100 cities for primary homes were 26.6 months as of the end of July 2024. This is a big jump compared with about 10 months during the period of 2019-2021. Inventory levels were relatively healthier in tier-one cities at 20 months, tier-two cities at 23 months, and much higher in lower-tier cities at 34 months.

We estimate PBOC's RMB300 billion relending facility will only account for a small portion of the existing completed inventories in the commercial housing market. However, we do not rule out the possibility that the government might roll out further similar programs, which would help further destocking. In fact, on Oct. 12, 2024, the Ministry of Finance expanded the usage scope of local government special bonds for purchasing existing housing inventory for social housing.

Developers' Liquidity Buffers Are Shrinking

We expect Chinese developers to face shrinking liquidity buffers and rising leverage as sales and margins continue to decline. China Vanke, one of China's largest property developers, is a case in point. We recently downgraded the liquidity assessment of the company to less than adequate (see "China Vanke Co. Ltd. Downgraded To 'BB-' On Weakening Sales And Margins; Outlook Negative," Sept. 6, 2024).

As revenue decreases due to both lower sales volume and ASPs, there will be a significant squeeze on profit margins. Consequently, the debt-to-EBITDA ratio, which measures leverage, is likely to increase. We estimate that the average leverage for our rated developers will rise from 6.3x in 2023 to 7x in 2024. If margins continue to be squeezed, leverage could increase even further. For instance, we project that China Vanke's leverage could rise to 9x in 2024 from 4.2x in 2023, as its adjusted EBITDA margin drops to 9.6% in 2024 from 15% in 2023.

For developers to replenish their liquidity, they will need to ensure they have access to smooth financing channels. For the time being, developers that have better access to financing are those who have a state-owned background or have sufficient investment property assets that could be pledged to obtain bank borrowings (see "Credit FAQ: China Rules Easing Gives Developers A Shot Of Liquidity," Jan. 31, 2024)

Chart 7

Table 2

Table 3

For developers to stay competitive and sustain their sales performance, it will be crucial for them to:

• Ensure strong brand reputation by offering high-quality products.
• Operate in the core areas of selected higher-tier markets.
• Acquire and replenish a high-quality land bank to maintain satisfactory sell-through rates and earn reasonable profit margins.

The linchpin in the China's property market will remain confidence, be it among homebuyers or developers. Recent stimulus has helped boost the local stock markets. Stabilizing the property market, on the other hand, may take more effort and more time. But we believe policymakers have the tools to do it.

Writer: Lex Hall

Related Research

• China Vanke Co. Ltd. Downgraded To 'BB-' On Weakening Sales And Margins; Outlook Negative, Sept. 6, 2024
• Will China's 'White List' Boost Housing Sentiment?, March 25, 2024
• Credit FAQ: China Rules Easing Gives Developers A Shot Of Liquidity, Jan. 31, 2024
• China's RMB350 Billion Policy Push May Help Developer Destocking, Jan. 23, 2024