Stuart Rae and John Lin
New measures to cool China’s housing market have triggered fresh volatility and stock declines across Asia. But we think the latest government moves won’t derail the long-term drivers of Chinese real estate growth.
How quickly things change in China. After house prices rose at close to 1% a month in 2011, investors worried that the market was overheating. Then, last year, fears that the government would clamp down on the market prompted a slump in real estate stocks, which later bounced back when the market didn’t collapse. Now, as new fears of a bubble prompted more mortgage restrictions, stocks across Asia dropped and Chinese property developers tumbled sharply again.
So what should equity investors do? In our view, the key to navigating the turbulence is to understand the underlying dynamics of the capricious housing market in the world’s most populous nation.
It’s widely believed that rapid urbanization is the fuel for Chinese real estate growth. Just over 50% of China’s population lives in urban areas, compared with about 75% in industrialized countries. Li Keqiang, the next premier who is driving the urbanization move, has stated his commitment to promoting more movement from rural areas to cities.
While urbanization is important, it’s only part of the story. In fact, we think housing upgrades account for a much bigger component of real estate demand, based on our view of various market trends. China’s housing stock is dominated by poor quality communist-built blocks. Large-scale residential housing projects only began to take off in the late 1990s, and modern units were only introduced in 2004. With more wealth, people naturally want housing that meets developed-market standards.
This distinction is important. Since upgrades and replacements are the engine of the market’s growth, changes in government policies can’t really impede the long-term trends. Tighter mortgage restrictions might cause some Chinese buyers to temporarily defer a housing upgrade, but people with more money will still want better houses next year—and developers are eager to build them.
Having a clearly defined long-term outlook can allow investors to take advantage of market turmoil. Indeed, as home purchase restrictions (HPR) were tightened in 2011, shares of Chinese real estate companies tumbled (Display). Investors who bought these shares on the decline were rewarded in 2012, as restrictions eased and shares surged. Similarly, the latest blow may prove to be a buying opportunity for select Chinese real estate stocks that are best positioned to benefit from the next wave of replacement and upgrade construction.
In a blog post last October, we said that Chinese house prices and home sales were more resilient than widely perceived and that the real estate sector was attractively valued. It’s no different today. Even before the abrupt declines of the last few days, Chinese real estate stocks traded at a valuation of about 8.6 times earnings for the next 12 months—a discount of about 12% to the MSCI China Index. Now, we think property stocks are likely to become even more attractive, especially given the likelihood that the fundamentals of demand in the property market should eventually reassert themselves.
There’s a broader lesson here for investors. China’s government loves to micromanage everything from power tariffs to oil prices to infrastructure investment. With this in mind, it’s much easier to separate the noise that often moves stocks from the sound of China’s incredible economic growth rumbling ahead.
The views expressed herein do not constitute research, investment advice or trade recommendations and do not necessarily represent the views of all AllianceBernstein portfolio-management teams.
Stuart Rae is Chief Investment Officer—Pacific Basin Value Equities and John Lin is Senior Research Analyst and Portfolio Manager—China Value Equities, both at AllianceBernstein.