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Chinese real estate sector in trouble

Chinese real estate sector in trouble
by Brad Cartier, posted in Newsletter

Reporting last week shows that although still elevated, inflation has decelerated compared to previous months. Martha C. White of CNN Business reports that consumer prices increased by 8.5% in July, dropping from the year-over-year increase of 9.1% in June. Further, on a month-over-month basis, inflation sat at 0% compared to the 1.3% jump in June.

CPI for July drops - US

Source: U.S. Bureau of Labor and Statistics (Accessed August 16, 2002)

Dan Burrows of Kiplinger quotes several experts commenting on the inflation data, with Aditya Bhave, U.S. and global economist at BofA Securities, stating:

“The July CPI report is a welcome relief for the economy. Markets seem to agree, based on the initial positive response of risk assets to the report. The Fed’s forecast of a soft landing would be greatly improved if we see continued declines in core goods – particularly durables such as new and used cars and household furnishings –and a further slowdown in shelter inflation. We think this report is consistent with our forecast of a 50-basis-point [a basis point is one-one hundredth of a percentage point] hike in September. This morning’s data confirms that we have seen a peak in inflation and endorses our view that peak Fed hawkishness is likely behind us.”

Specifically related to real estate, Lawrence Yun, chief economist for the National Association of Realtors (NAR), notes that despite lower inflation, rents continue to rise which is a testament to the supply shortage of market-rate rentals. Further, Yun reports that “If there is a sustained decline in gasoline prices and more production of apartments and single-family homes, consumer prices will pull back, encouraging the Federal Reserve policy to be less aggressive…Mortgage rates will fall.”

Rents continue to put upward pressure on inflation numbers according to Claire Ballentine of Bloomberg. Rent increased 0.7% month-over-month in July and 6.3% year-over-year. Reportedly, by one measure, rents have increased by as much as 25% year-over-year. This component of inflation is decelerating, but more on that later.

Finally, Bloomberg’s Joe Weisenthalexplains why the inflation numbers may show peak inflation: “I think there’s a pretty good chance that on a year-over-year basis, we’ve seen the worst of the inflation. We have seen the significant cooling of commodities. We have seen a slowdown in the housing market. We have seen sustained improvement on supply chains. If you look at various surveys of companies, when they talk about lag times for their own suppliers, they’re improving. So I think there’s reason to think that we’ve seen the worst of it.”

China real estate

Dorothy Ma and John Cheng of Bloomberg report on China’s worsening real estate sector, in which builders have lost $90 billion in stock and bond market capitalization. As Beijing cracks down on loose lending, many builders have gone bankrupt, leaving a trail of angry buyers and investors. Further, in the bond market, the median dollar-bond price of real estate firms was 16 cents, down from 40 cents in March 2022.

To prop up the struggling real estate sector, Reuters reported last month that an unnamed source indicated the central government was prepping a $44 billion fund to bail out the sector and turn distressed properties into affordable housing.

Similarly, Rebecca Feng and Cao Li of The Wall Street Journal (subscription required) report that millions of pre-sold homes and condos are currently unfinished, with some buyers withholding mortgage payments. This accounts for about $370 billion in home loans. Further, 9% (2.4 million households) of pre-sold homes in 2020 and 2021 are at risk of never being finished due to developer financial troubles.

“China’s real-estate downturn harks back to its government’s effort in recent years to cool a housing frenzy and deflate what it saw as a bubble that was threatening to make homes unaffordable for many. Regulators in 2020 placed curbs on developers’ borrowing, causing banks and other lenders to pull back and resulting in a credit crunch for many developers…More than 30 developers, including the property giant China Evergrande Group, have since defaulted on their international debt.”

Bank loans in China's real estate sector - WSJ

Source: WSJ (August 2022)

Suranjana Tewari of BBC highlights why this is worrisome, as the real estate sector makes up a third of the entire Chinese economy. Further, “[t]hirty real estate companies have already missed foreign debt payments. Evergrande, which defaulted last year on its $300bn debt, is the most high-profile casualty…if sales do not pick up, more companies could follow suit.”

Consumer and rent trends

Two important renter and homeowner trend reports were released this month, beginning first with Zillow’s Consumer Housing Trends Report 2022. Here are the highlights for real estate investors:

  • The median age of U.S. sellers is 46.
  • The largest share of sellers live in the South (39%), followed by the Midwest (23%) and West (22%).
  • The annual median household income among sellers is approximately $80,000 to $84,999.
  • The typical (median) seller sold a 3-bed, 2.5-bath, single-family detached house between 2,000 and 2,999 square feet.
  • Almost a quarter (26%) of sellers reported getting at least four offers, continuing the upward trend from 14% in 2020.
  • Most sellers (62%) said that at least one of the offers they received was all cash or did not include a financing contingency.
  • Sellers are more likely to use a real estate agent (88%) than other resources to sell their homes.
  • Most sellers (71%) said they completed at least one improvement project as part of selling their home.

Similarly, earlier this month published its July 2022 Rent Growth Report. Here are some of the takeaways from this report:

  • Sunbelt cities dominated the top 10 rent growth markets in July with eight out of 10 located within the region.
  • San Francisco’s average asking rents are now just $18 below their all-time peak of $3,116 in Q2 2019 as rents rose 40 basis points over the past 30 days to 5.0%.
  • 12 markets saw absolute asking rents decline over the past month, the first occurrence since 2020.
  • Markets that saw negative or flat rent growth in July are dominated by Sunbelt locations, including Fort Lauderdale, Austin, Orlando, Charlotte, and Tampa, amongst others.

YoY Rent Growth - CoStar

Source: CoStar (August 2022)

In summary, Jay Lybik, National Director of Multifamily Analytics, CoStar Group, had this to say about the data:

“Throughout the month of July, while multifamily yearly rents continued to perform well above historical averages, the deceleration of rent growth quickened at a time when markets typically post their best results…The deteriorating rent situation highlights a significant collapse of demand in the sector when new unit deliveries are projected to hit 230,000 in the second half of 2022.”

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