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Trends of Chinese Real Estate : Consolidation
The Chinese real estate industry has enjoyed a golden era in the last twenty years. Leading developers have benefited from both the fast-growing market size as well as increasing market share. We have seen the top 20 developers’ market share increase from 17.0% in 2010 to 46.4%1 in 2019 in terms of gross contracted sales. Quite naturally we may ask the following questions: What was the catalyst behind their gain in market share? Will the trend continue into the future? These are the topics we will address in this article.
How did the top 20 developers’ gain Chinese market share in the past decade?
As shown in Exhibit 1 below, the top 10 developers’ market share in China had continually increased from 12.1% in 2010 to 32.5% in 2019 (gross contracted sales). Meanwhile, the top 20 developers’ went from 17% to 46.4% during the same period. The inflection points occurred in 2014 and 2017 when national sales were decelerating mainly due to the tightening of polices that occurred earlier on. A few of the leading developers completed rapid strategic positioning in top tier cities and were aggressively land banking. They were able to increase the contracted sales shortly after policy turned favourable, while small names were casted out. We saw high growth over 25% year-over-year for Greenland, Evergrande and Sunac in 2014; over 40% for Vanke, Evergrande, Poly, Longfor and Sunac in 2017 (Exhibit 2). Credit restriction on developers’ end discouraged nationwide financing activities as well as land banking. It prolonged the subsequent constructions and sales. Yet leading names with strong financing capabilities were relatively less affected. On the contrary, they could benefit from cheap land during down cycles and gain market share with adequate offerings when spring came.
Although the market concentration has sharply increased, constituents of the top 20 has remained unchanged in the last decade. We have seen that only 11 out of top 20 developers remained in the sales league. The number is 6 for top 10. If we look at those who fell behind, refinancing difficulties in tightening credit environments is usually the direct catalyst to failure. Stretched debt pushed new starts and construction delay, asset on-sale and even bankruptcy.
What drives consolidation?
A typical construction cycle spans across three to four years2 from land acquisition to the delivery of first phase units. In generally, takes six to nine months for developers to receive the first round of pre-sell proceeds, which means developers are running at a negative cash flow in the early stages of a project. Thus, raising additional funding plays an important role in the business model. Developers’ funding source mainly consists of four parts: domestic bank-borrowing takes a portion of 14.5% in 2018, off-shore debt financing of 0.1%, self-raised funds of 33.6%, homebuyers’ down payment and mortgage loan of 47.7% and others of 4.2%3. Developers generally devote only one-third of total investment. The business scale highly relies on credit and pre-sale policies across cities.
China’s housing market experienced three phases since the housing market reform in 1998. The first phase was the land dividend stage prior to 2002 when land allocations were done by the state, with no market mechanisms involved. Anyone who could attain land definitely came out as a winner. Land market auction mechanisms were introduced in 2002. After that, China’s real estate industry took off, coupled with a fast-growing capital market. Publicly-listed developers fully utilized capital dividend to scale up their business till 2016; this was when China’s central government first emphasized “housing for living, not for speculation”. It is the financing capabilities that drove the high-paced coarse growth and moderate market share increases in the second phase. During the period, floor area per capita increased to over 304 square meters in China, quite close to the level in most developed countries. Nationwide adequate supply and continuous tightening of policies imposed new requirements on developers in the next phase, despite demand from upgrading and further urbanization existing across regions. It could be as a result of comprehensive competition in financing, land bank quality and geographical split, as well as land costs and housing price balance, product as well as sales channels. The recent new financing rules of “three red lines” further restricted the financing scale. Some developers could not add new debt in the near future. They even have to sell assets to accelerate cash collection and lower their debt levels. It resulted in a near term industry wide deceleration and may consequently help with consolidation from a medium term perspective.
What are the implications of the consolidation trend to investors?
Real estate is essentially a financial business which requires capability of financing, investment, product development and sales. Property developers are able to increase the rate of return by leverage though gross margins of each project or when overall net margins are low. However, the other side of the coin is when leverage becomes a major source of risk. When the economy is going well and demand is strong, the requirements on product and sales are low. Leverage is helpful in revenue augment. As the industry becomes mature and more competitive, the right products and promotions, accurate rate of return calculation in land investment, solid financing capabilities, are all needed for sustainable success. We can see in Exhibit 2 that the concentration of the top 10 developers in tier 1/2 cities in China is still relatively low compared with other countries. The market expansion pace may slow down thanks to the new financing rules, but won’t stop from a longer-term perspective. We believe the rate of return considering leverage to developers should not be too much higher than other mature industries in the long term. This will ultimately prevent new entrants and end consolidation.
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