Credit: The stars align for China property bonds
- China’s property sector was a particularly bright spot in the country’s domestic recovery
- Recent policy-guided deleveraging measures will improve sectoral credit risk in the long run
- Credit offers an unusual opportunity to move up the capital structure
- It can capture higher yields than equity dividends in China property
- Investors should gain exposure in good quality High Yield credits while spreads are still wide
Growth roaring back with a vengeance. China’s economy marches undeterred along its path of recovery with a 3Q20 gross domestic product (GDP) print of +4.9% y/y, a remarkable feat considering that the country was initially hit the hardest, being the epicentre of the viral outbreak at the start of the year. Although the figure missed consensus expectations (+5.5% y/y), one could argue that the (1) stronger-than-expected pickup in imports in September (+13.2% y/y) and (2) RMB appreciation played a part in narrowing net export growth; two factors that are not always symptomatic of broader economic malaise.
Home is where the growth is. Nonetheless, the drivers of growth have evidently been domestic activity, as China appears to have been immunised against the viral second waves that have afflicted much of the world outside its borders. One particularly bright spot is the property sector, which saw both residential gross floor area (GFA) and average selling prices (ASP) growing 7.7% y/y and 9.5% y/y, respectively, in September.
Factors that may have contributed to the sector’s strong recovery include:
- Hukou (户口) reform. Lifting of restrictions in further household registration (hukou) reform as part of a continuous drive for population urbanisation to raise wealth and consumption – creating expanding demand for residential property.
- Work-from-home trends. Despite the belief-defying success in China’s reopening, expectations of more permanent shifts towards home-based activity in certain aspects of work/leisure may have elevated demand for residential real estate. Such trends are not unique to China alone.
Policy intervention to curb exuberance. The sector’s performance was strong enough to warrant policymakers stepping in with tighter financing rules for property developers via the proposed “Three Red Lines” policy, which limits debt growth based on three balance sheet metrics. While this is likely to inflict some short-term pain, we believe that this is ultimately beneficial for the sector through tampering bubble formation and systemic risk.
Moreover, such forced deleveraging makes an interesting proposition for China property credits; a higher yielding asset class now guided by a government directive to improve issuer credit quality – and hence investor’s risk exposure – over the longer term.
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