Restrictive regulations in Chinese homebuilding sector challenge smaller local, regional builders, even in high-end residential market where there is significant pent-up demand for housing: Fitch

Audrey Dixon

NEW YORK , April 17, 2012 (press release) – The recent bankruptcy filing by Hangzhou Glory Real Estate Co, a comparatively small homebuilder focused on the high-end residential market in Hangzhou, illustrates how restrictive regulations continue to polarise the Chinese property market between large and small players.

Lower property prices and sales volumes – the consequence of restrictive regulatory policies – are hurting profit margins and cash flow generating ability. This means that the homebuilding sector remains highly challenging for the smaller local and regional operators such as Hangzhou Glory, which have neither the scale nor liquidity to ride out the slow-down.

Yet the larger players, including Franshion Properties (China) Limited (‘BBB-’/Stable) and Evergrande Real Estate Group Limited (‘BB’/Stable), are maintaining their strong credit profiles – thanks to substantial scale and diversity of both location and type of real estate, as well as healthy liquidity and multiple funding sources.

The sector continues to face slower growth – again, driven primarily by the restrictive government policies introduced in 2010 and 2011. These include a limit on the number of homes per individual; restricting new residential unit purchases to an individual’s town of residence; and requiring a 3-year tax return to be submitted.

The rationale behind the government’s ongoing intervention remains more to do with the accessibility of property ownership to the average Chinese (in terms of price), rather than any concern over a deterioration in the credit quality of homeowners. Legal requirements for at least a 20% down-payment for first-home buyers, and significantly more for second and subsequent homes, underlines quite a different scenario than with many other real estate markets beset by mortgage repayment issues.

Fitch views the government’s objective of restraining property prices as a very difficult task, given the agency’s forecast for Chinese GDP to continue growing by a relatively high 8% in 2012 and 2013, and for substantial inflationary pressures on wages and consumer prices. The low probability of a large number of mortgaged houses being auctioned off to pay down bank loans also indicates that prices are unlikely to fall significantly despite the continuing restrictions. However, transaction volumes have fallen significantly, and the outlook for the smaller operators is likely to remain fraught with difficulties so long as the regulations remain in place.

Fitch believes there is significant pent-up demand for housing among the more affluent classes, particularly for high-end properties where demand is compounded by the lack of viable alternative investment instruments and restrictions on offshore investment. Nevertheless, the potential introduction of a wider range of investment products for high-net-worth individuals remains a risk for high-end property demand.

The government has launched an ambitious plan to build 36 million new “affordable” homes, in response to public concerns and as part of the 12th Five-Year Plan (2011-2015). The impact on both the mass and high-end housing markets remains unclear, as details have yet to be provided, together with how low the “low-income” household band will be set. Fitch would take a negative view of any implementation that could place a significant burden on the larger private homebuilders to help achieve the government’s goals, including a requirement for them to assist with funding the programme.

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