China Real Estate: Don't Go Chasing Waterfalls

Stick to the consumptions that you're used to

We sold all Chinese real estate stocks in April 2020 and haven’t bought back any since. Wouldn’t touch the private developers with a ten-foot pole right now.

There are however some beaten-down consumer names that we like, as “innocent bystanders” of the real estate crash. Their core businesses have little to do the property market. In some cases, they may benefit from a structural change in household spending as people buy less real estate.

Jump to the end for our consumption stock picks.

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A dollar a day, keep the China surprises away.

“For the offshore debt of Chinese property developers, don’t get your hopes up because of the latest policy change. I suspect the Chinese government will get involved at some point but not right now… Without a clear policy direction from China, the future of USD bond defaults will remain company specific. Namely, company management largely determines the outcome.”
Qi Wang, November 2022

If you’ve been following my China real estate views, there shouldn’t be surprise from the Country Garden default and Evergrande’s bankruptcy lately.

Here is a recap of what happened (and my trades):

• We sold all real estate stocks in April 2020, more than three years ago.

• Back then, I thought the financing cost of private developers was too high to be sustainable, even though the equity valuation appeared cheap.

• In August 2020, Chinese authorities launched the Three Red Lines policy, the toughest real estate crackdown to date.

• Less than a year later, Evergrande (3333.HK) began to show signs of stress… The rest is history.

• In late 2021, I saw that slowing home sales coupled with the real estate crackdown could spell trouble. The tightening policy would have to be reversed to avoid a disaster.

• Shortly after, China started easing its real estate policy in early 2022. Not only the Three Red Lines was removed eventually, China had an almost 180 degree turn in real estate policy by the end of 2022. The change might be too late.

• In July 2022, my research showed the mortgage defaults were not a big deal to China’s financial system. Actually, the big headache for Chinese banks is the prepayment of mortgages, not the mortgage delinquency.

• In August 2022, I also highlighted one of the long-term structural issues of the Chinese economy, “Too Much Banking and Real Estate”.

• In November 2022, I mentioned consumption as the best play on the real estate recovery, if any. It’s a euphemism for saying “don’t buy any real estate stocks!” The following article explains why investors should “avoid real estate at all costs”.

• In “Re-assessing China Risks” (March 2023), I ranked real estate as one of the top risks for China this year.

“I think it’s too early to call a sustained recovery in real estate, mainly because of the stagnant second-home sales. The second-home market is improving but the transaction volume is still well-below the historical average. The real estate recovery cannot continue without a real recovery in second-hand home sales. The risk is that the strong February [new home] sales is just a ‘relief rally’. We need to wait and see.”
Qi Wang, March 2023

Private Developers: A Russian Rolette?

Let me reiterate my outlook for Chinese real estate stocks: