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China: Property market is on the brink

Developers’ bonds trading in 70s, 80s; Analysts expect more price cuts as sales fall


China’s property market is on the brink of a big downward correction, say analysts.

Despite the central bank’s consistent application of tightening measures over the past 18 months the sector has held up well. However, declining sales, price cuts and sharp falls in the value of developers’ bonds all suggest that a big re-evaluation is under way. The question now is whether the sector will plunge far and fast, or merely reprice to a more rational level gradually.

Citi analyst Oscar Choi says in a November 1 note: "The property market has become the central government’s tool to adjust economic development and balance social public opinion. Reasonable cooling and price correction in the property market are welcome by governments but a collapse is ill affordable."

The turning point for the sector came in September, as big developers began cutting prices as sales fell. Those cuts continued in the traditionally strong sales month of October. Citi’s Choi says average selling prices for the financial year 2011 are set to decline by 10% to 15% in the fourth quarter, with a further estimated drop of 10% in 2012.

Investors have responded to the sector’s woes by selling the bonds of developers, with a preference for unloading the debt of non state-owned and smaller companies on the assumption that those categories will have more difficulty raising funds and are less likely to be bailed out.

While large-cap property developers’ bonds had recovered an average of 20 points by November from their early October trough, according to Nomura, the bonds are still trading at values between the high 70s and low 80s.

"That’s no-man’s land for bonds," says an analyst covering the sector. "They will have to either tank completely or go back up in the long run."

Financing risks for the sector have been exacerbated by a policy-driven squeeze on bank lending, forcing developers to borrow at higher rates than they are used to from the informal banking sector. While investors seem to believe state-owned developers are more likely to survive, some analysts think they are not guaranteed to be safe. In a September note Credit Suisse’s team argued: "Even though SOEs may not have apparent bankruptcy risk, the whole sector downturn should affect all developers. SOEs are not immune, especially with potential book-value write-downs and margin squeeze."