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Property/Real Estate 
China 
Chinese Residential Real Estate:
Special Report  Q&A 
Analysts  Overview 
Ying Wang This report addresses some key market questions and concerns over China’s
+86 10 8567 9898 ext. 107
ying.wang@fitchratings.com
residential property sector, as a follow‐up to Fitch Ratings’ report “Rating Chinese
Property Developers: Sector Credit Factors” published on 16 February 2011.
Kalai Pillay
+65 6796 7221 This report highlights factors which differentiate the Chinese housing market from
kalai.pillay@fitchratings.com 
developed housing markets in the Western world. The report does not attempt to
predict the direction of China’s property prices — such speculation has already been
Related Research  widely circulated by different research houses in many different ways. Instead,
Applicable Criteria Fitch explores what any “downturn” would look like, and the implications of a
· Rating Chinese Property Development downturn for the agency’s rated Chinese property developers.
Companies: Sector Credit Factors
(February 2011)
The report addresses the key risk factors facing property developers, and, more
importantly, the actions which property developers have taken — or are expected
to take — as they attempt to navigate through a downturn. 

How is the Chinese Housing Market Different? 
It is relatively easy to become concerned over the threat of over‐inflation in China’s
housing market, judging from the combination of residential property valuations
comparable with — or, in some regions, above — Western developed levels, and
average income levels significantly below those of developed countries.
Fitch agrees that China’s residential property prices are at a stretched level by
Western standards, and that the inherent sector risks are more consistent with the
current speculative‐grade ratings of Chinese homebuilders in the ‘BB’ and ‘B’ rating
categories.

Figure 1
Fitch’s Published Ratings on Chinese Property Issuers
Franshion Shimao Evergrande Road King
Properties Property Real Estate Sunac China Infrastructure Shanghai Zendai
(China) Ltd Holdings Ltd Group Ltd Holdings Ltd Ltd Property Ltd
IDR BBB‐ BB+ BB BB‐ BB‐ B+
Outlook Stable Stable Stable Stable Stable Stable
Source: Fitch

However, the agency believes that the fuller picture is more complex, and the
following are the key factors differentiating the Chinese housing market from
Western developed markets.

Rapid Urbanisation: Continues to Drive Housing Demand


Urbanisation in China is taking place at an unprecedented pace, and will continue
to drive demand for infrastructure construction and real estate over the next few
decades. China expects its urbanisation rate to rise from 47.5% in 2010 to 51.5% by
the end of 2015, with an average annual increase of 4%, according to the
government’s 12th five‐year plan. Furthermore, Fitch notes from a poll of estimates
by sell‐side research analysts that the country’s urbanisation rate is likely to grow
at an average annual increase of 1% beyond 2015 — and to approach 70% by 2030.
Many of the people moving from rural areas will become first‐time home buyers,
while the rest (including the existing urban population) will have a greater desire
and more disposable income to upgrade their housing. 

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Affordability: Income Multiples May be Inflated


China’s average income levels — which are commonly used to estimate the
country’s housing affordability — relate generally to the entire spectrum of the
local population.
It must be noted, however, that the vast majority of the Chinese urban population
lives in homes built by the government, ownership of which was transferred to their
tenants in the 1990s. This accounts for the high levels of homeownership in China,
where rentals generally only apply to temporary residents. Many owners of
government‐built homes do not have the income capacity to afford even the
cheapest of the homes being sold by private property developers. These individuals
and households are not their target buyers; simply put, these homes are not being
sold to the “average” Chinese.
In addition, income data collected by Chinese government agencies are not
inclusive of grey income, or non‐taxable income such as allowances and stipends
rewarded by Chinese companies as supplemental employee benefits. There are also
a variety of ways adopted by private enterprise owners to understate their taxable
income. Therefore, the official income statistics are not reflective of actual income
levels in China.

Low‐Leveraged Buyers
A further support to the argument that affordability, while appearing stretched, is
not at explosive levels, comes from the leverage being employed in home purchases
in China. In stark contrast to the recent sub‐prime debacle in the US, a substantial
proportion of new home purchases in China are made in cash (i.e. no mortgage is
taken out). Fitch estimates — from discussions with major property developers,
bankers and investors — that this proportion of cash payment is in the region of
30%‐50% of new‐build purchasers.
This figure is supported by the lack of a vibrant private rental market — there is a
very limited supply from real estate investors willing to accept yields of 2%‐3% on
leasing otherwise‐vacant properties. While this may seem odd for many investors
globally, it is consistent with practices elsewhere in Asia, notably Singapore, where
high rates of unoccupied investment properties co‐exist with low rental supply. It
also supports the conclusion that few, if any, of the home purchases are funded by
leverage through a different channel (i.e. other than bank mortgages) not visible to
property developers.

Lack of Alternative Investments


China is grappling with rising inflation. Despite the central bank’s multiple interest
rate hikes over late‐2010 and early‐2011, real interest rates remained negative in
China at end‐Q111. A lack of sound alternative investment opportunities make real
estate the most attractive asset class in China from the perspective of both capital
appreciation and inflation hedging.
The Chinese people’s preference with regard to real estate investments is also
supported by the country’s lack of a well‐established social security and medical
system. China faces the challenges of a CNY10trn social security fund deficit which
will continue to widen over the next few decades. The Chinese people regard
property ownership as a sense of security, in addition to a storage of value.

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A Different Stage in Time 
The reader must keep in mind, though, that some of the factors “differentiating”
the Chinese market also existed in other developed markets in their earlier
stages of development. Urbanisation, inflation and income growth contributed to
the fairly steady and rapid rise of median home prices in the US from USD11,900
in 1960 to USD17,000 in 1970. The period of high inflation in the 1970s resulted
in their median prices hitting USD47,200 in 1980 and rising further to USD79,100
in 1990, despite the onset of the Savings & Loans crisis1 . 

What are the Likely Scenarios for a Downturn? 
Fitch believes that property sales volumes are more meaningful than pure valuation
declines in assessing the magnitude of a housing downturn.

Lower Price, Lower Volume


In one scenario, both property prices and sales volumes may fall from their peaks,
and be sustained at low levels for at least two years. Fitch believes this is the most
negative scenario for property developers. A sustained period of low transaction
volumes coupled with declining prices would indicate severe damage to buyers’
sentiment, which could arise from a significant and unexpected slump in China’s
economy — and requiring years to recover.
A shrinkage in contracted sales will retard the cash inflows of property developers,
and liquidity crunches could be exacerbated further if the economic slowdown is
preceded by — or coincides with — a major failure in China’s banking system,
making government macro‐loosening ineffective.
In addition, any prolonged period of high real interest rates may also result in low
property sales. While mortgage rates may not directly influence demand, due to
low household leverage, as acknowledged above, high real interest rates could
dampen demand by raising the opportunity costs of locking up cash in low‐yielding
property investments.

Lower Price, Higher Volume


A more plausible scenario is for property prices to decline with a simultaneous drop
in sales volumes. However, sales volumes would start to rise again to approach or
even exceed pre‐downturn levels within 12 to 24 months. This scenario assumes
that the macroeconomy and the banking system remain fundamentally intact such
that the Chinese government maintains the flexibility to implement macro policies
to stimulate housing demand.
As was observed in some other Asian markets like Hong Kong and Singapore
between end‐2008 and end‐2009, once prices fall sufficiently, demand returns —
driven by low real interest rates, low household leverage, and the existence of a
large number of potential buyers who felt that they had “missed the boat” in the
previous rapid price rise. Indeed, this phenomenon was observed on a somewhat
lower scale during the same period in China.
An additional factor that may boost demand in China would be the potential for the
government to encourage banks to grow by focusing on mortgage and consumer
lending to improve profitability and capital ratios after large losses in the wholesale
loan book. A rapid shift to consumer lending and personal financial services was
observed in South Korea following the corporate loan‐driven banking crisis in the
late‐1990s.

1
Source: US Census Bureau

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Under this scenario, property developers will face short‐term liquidity pressures.
Those developers who have accumulated cash prior to the downturn from pre‐sale
deposits and fund‐raising exercises to refinance some debt maturities, while
maintaining discipline over land replenishment needs, will be more financially
resilient than those challenged with imminent bond maturities and, to a lesser
extent, unpaid land premiums.
Although unloading inventories at low prices will result in reduced or even negative
profit margins, Fitch would expect property developers to prioritise liquidity, rather
than profit, during the initial 12 to 18 months (“Phase I”) following the onset of a
housing downturn. Rising sales volumes, despite price drops, can still allow
developers to conserve cash by unloading inventories at a faster rate.
In addition, land costs generally contribute no more than 20% of turnover for most
rated developers, unlike more developed markets where this figure may be 30% or
higher. There is potential for other costs — including construction and building
materials — to fall in a period of downturn. Fitch notes that metal spreads in the
Chinese steel industry and gross margins in the cement industry remain healthy
despite chronic overcapacity in these industries, indicating potential for lower
prices if demand tapers off.
As a result, the “lower price, higher volume” scenario contains a manageable
downside for developers. Industry consolidation activities are likely to be
concentrated during Phase II of the housing downturn, after a number of small and
weak developers have failed within the first 12 to 18 months and the stronger ones
have survived the worst period. In Phase II, large, geographically diversified, mid‐
end and mid‐ to high‐end‐focused developers such as Evergrande Real Estate Group
Limited (Evergrande, ‘BB’/Stable) may take the opportunity to acquire good quality
land banks and/or projects at a low cost from weaker competitors in distress.
Another Fitch‐rated issuer, Road King Infrastructure Limited (Road King,
‘BB−’/Stable), which is known for its toll road operations in China, established its
presence in the mainland property market in 2007 by acquiring the assets of a then‐
high‐profile property company (i.e. Sunco) which was in distress at a significant
discount to its pre‐crisis market value.
Fitch believes the ability of those developers to survive a downturn and lead
industry consolidation is not only driven by their geographic and project profiles
and existing liquidity positions, but also by the equity cushion in their financial
leverage. Figure 2 shows that Fitch’s publicly rated Chinese property developers
maintained moderate financial leverage (measured by net debt‐to‐inventory ratios)
in the range of 20% to 50% at end‐2010, providing modest headroom for additional
debt‐funded acquisitions.

Figure 2
Financial Leveragea
Franshion Shimao Evergrande Road King Shanghai
Properties Sunac China Property Real Estate Infrastructure Zendai
(China) Ltd Holdings Ltd Holdings Ltd Group Ltd Ltd Property Ltd
IDR/outlook ‘BBB‐’/stable ‘BB‐’/stable ‘BB+’/stable ‘BB’/stable ‘BB‐’/stable ‘B+’/stable
Net debt/ 20 18 46 38 20 53
inventory (%)
a
As of 31 December 2010 for Franshion, Sunac, Road King, Shimao, and Zendai; as of 30 June 2010 for Evergrande
Source: Fitch 

How Effective are Government Policies? 


In Figure 3, Fitch outlines a number of policy measures the Chinese government has
implemented since April 2010 to tighten the property market. Although many of the
measures have taken a toll on transaction volumes over the past six months,

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May 2011  4 
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nationwide property prices have remained relatively resilient. The agency notes a
number of “loopholes” which have made these measures “less effective” from a
price‐adjustment perspective.

Figure 3
China’s Property Tightening Measures
Government measures Effect upon market
Bank mortgage lending limits are being Many buyers are cash, or largely cash.
centrally reduced.
Consumers are being prohibited from Families may arrange their purchases to evade this restriction,
taking out a mortgage for second or through extended family members or artificial divorce.
third properties. Corporates will continue to invest (though most are just buying
raw land).
Residency limits are being enforced (eg Extremely effective in the near‐term driving sales volumes
in Beijing it is necessary to show five down significantly. Questionable as to how sustainable China’s
years of tax returns) traditional focus on residency in regulating its citizens will
remain at a time when labour mobility is still encouraged.
A 5% tax is levied on any house sale Tax rates in this bracket are not a major deterrent for those
within five years. looking to long‐term appreciation, or if short‐term
appreciation expectations are above 15%.
Banks are prevented from lending to Developers can still raise equity, domestic bonds or offshore
developers to buy land, only to funds. Discipline on the lender side may be more patchy for
construct. smaller, rural banks where local governments may be more
influential.
Policy is encouraging people towards High demand may just be exported, as inflation pressures are
the interior. rising in the interior as well.
Source: Fitch

In addition, while the scope and range of China’s policy response is formidable
relative to the types of policy tools available to the authorities in developed
markets, China’s central authorities face similar, significant challenges to all other
market factors from the low level of data transparency and verification within the
property system (see the Limitations section below). This will inevitably act to
dilute the efficacy of policy measures in practice. 

Which Type of Developers are Most Vulnerable? 
The factors which would lead to increased vulnerability to a potential liquidity
shortfall include developers with:

· high reliance on a limited number of projects;


· strong regional concentration;
· high concentration in high‐end luxury and/or vacation properties;
· strong concentration of planned project launches in cities with high pre‐sale
requirements on construction completion; and
· significant bond maturities which have yet to be refinanced over two years.
Fitch believes that bond maturities over the immediate two years present the
biggest risk to a Chinese property developer’s liquidity position in the wake of a
downturn. Developers are vulnerable, to a lesser extent, to unpaid land premiums
and project loan maturities. Land premium payments generally span six to 24
months.
Although a significant amount of unpaid land premiums raises a red flag, developers
may have some degree of flexibility in negotiating with local governments on the
deadlines — or, in the worst case, they could give up the land and forfeit their
bidding deposits already paid. Banks may also be willing to extend some flexibility
on project loan maturities, including loan rollovers over a certain time period.

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Figure 4
Debt Mixa
Franshion
Properties Sunac China Shimao Evergrande Road King Shanghai
(China) Holdings Property Real Estate Infrastructure Zendai
Limited Limited Holdings Ltd Group Ltd Ltd Property Ltd
IDR/Outlook ‘BBB‐’/stable ‘BB‐’/stable ‘BB+’/stable ‘BB’/stable ‘BB‐’/stable ‘B+’/stable
Total debtb 2.8 0.9 6.4 5.3 1.3 9.6
(USDbn)
Of which onshore: 2.0 0.9 4.2 2.5 0.3 9.5
Of which offshore: 0.8 ‐‐ 2.2 2.8 1.0 0.1

Summary of 0.5 Apr 21 ‐‐ 0.3 Dec 11 0.8 Jan 14 0.2 Jul 11 0.1 Jun 12
offshore bond 0.4 Dec 16 1.4 Jan 15 0.2 May 12
maturities (USDbn) 0.5 Aug 17 0.6 Jan 16 0.2 Feb 14
0.4 Mar 18 0.2 May 14
0.4 Sep 15

a
Pro forma for all financing transactions since 31 December 2010 for Franshion, Sunac, Shimao, Road King, and Zendai,
and since 30 June 2010 for Evergrande
b
Assume 1USD = 7.8HKD; 1USD = 6.5CNY
Source: Fitch 

How are Developers Preparing for a Potential Downturn? 
Short‐Term Strategy: Focus on Liquidity
Fitch notes that many Chinese property developers have taken steps to extend their
bond maturity profiles over the last six to 12 months — or are in the process of
doing so. Since the offshore high‐yield market re‐opened in H209, major Hong Kong‐
listed Chinese property developers have raised equity and/or debt financing at least
once, using some cash to refinance their 2011 to 2013 bond maturities.
The next bond maturity peak will come between 2014 and 2017. Fitch expects
Chinese property developers to start chipping away at these maturities within the
next 12 to 18 months, assuming the offshore capital markets remain open to them.
Although developers could have some flexibility managing their land premium due
to Chinese municipalities and project loan maturities due to state‐owned Chinese
banks, those who fail to maintain discipline over their land replenishment needs —
and have therefore acquired, or have committed to acquire, land banks at a much
faster rate than their pre‐sale cash inflows — are in greater danger of being caught
in a liquidity shortfall, challenged by mounting unpaid land premiums and project
loan maturities.
Fitch treats land premiums as cash outflow items upon their due dates, while
allowing project loan rollovers in its rating case scenario analysis. The agency’s
stress case liquidity analysis assumes that neither land premiums nor project loan
repayments can be delayed.
Other ways to conserve cash amid a housing downturn would include a cessation of
additional land purchases and a slowdown or temporary halt in project construction.
It must be noted that contractual norms in China have not matured to a point
where it is clear what the liabilities of a developer to the pre‐sold deposit customer
may be in the event of a delay in project delivery. In addition, it must be noted
that in most cases, Chinese developers are not obliged to maintain a ringfenced
“project account”, i.e. there is much flexibility in cash movements from one
uncompleted project to finance another, with limited restrictions.

Long‐Term Strategy: More Stable Cash Flows from Investment Properties


Aside from building strong liquidity buffers and as part of a long‐term business
strategy shift, many Chinese property developers are attempting to increase their

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exposure to commercial real estate — where rental‐derived income is more stable


than valuation‐driven commercial property or residential development income.
Some Fitch‐rated developers currently maintain some level of rental income,
ranging from 3% to 10% of total EBITDA. A few large players such as Franshion
Properties (China) Limited (Franshion, ‘BBB−’/Stable) and Shimao Property Holdings
Limited (Shimao, ‘BB+’/Stable) plan to expand their rental revenue substantially
over the next three to five years, targeting 30% and above of total EBITDA.
Office leases on commercial real estate tend to be shorter in China — up to five
years. To the extent a property company generates rental income from a diversified
base of tenants with good covenants in prime locations, matched by similarly long‐
dated funding, this more stable activity may be supportive of higher ratings. At the
same time, it is important to note that the commercial real estate business is much
more capital‐intensive, and requires stronger execution capabilities and savvier
management. Most of Fitch’s ratings on Chinese property developers have not yet
factored in meaningful benefits from rental‐income producing commercial real
estate — which are likely to take at least three to five years to materialise — at the
speculative‐grade rating categories.
Indeed, due to the capital‐intensiveness of commercial real estate investment, any
property developer that aggressively enters this business without having procured
long‐term capital and good execution capabilities, will likely face a liquidity crunch
in the event of a property down‐cycle during the investment property development
period.

Limitations
The Chinese market is generally known for the limited availability of data for
many purposes, both demographic and market‐related. Fitch has supplemented
the available public data with soundings taken from contacts with major property
developers, domestic banks, investors, major industrial companies and regulatory
authorities. In its rating analyses, where data is absent or incomplete, the
agency makes conservative assumptions in creating issuer‐level forecasts.

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