Global CIO Commentary by Scott Minerd
In the first four months of this year, housing starts in China fell by 25 percent from a year ago, the amount of homes sold fell by 8.6 percent, and home price appreciation has clearly slowed, adding to concerns of property sector weakness. While Chinese policymakers are curbing the growth of shadow banking, some highly leveraged developers have been unable to repay loans or start new projects because the availability of credit has tightened. Some fear this could lead to a crisis akin to the U.S. financial collapse of 2008. Real estate investment accounts for about 12.5 percent of China’s economic activity, making it vitally important to investors and Beijing. Still, a slowing property market can be managed.
The much-feared Chinese real estate meltdown seems highly unlikely.
Alarm bells warning of China’s coming real estate meltdown sound very similar to worries about Europe’s commercial real estate debts a few years ago. In 2010, there were huge concerns over the billions of euros of commercial real estate loans on the books of European banks. With many of those loans needing to be refinanced by 2012, some feared a terrible reckoning resulting from high loan-to-value ratios, loans being under water, and broken loan covenants. While there were some localized disturbances, these were largely contained and a full-blown European real estate crisis never materialized. Anyone who understood the European system could see that this was never likely to bring the banking system down and the same goes for China today.
Chinese real estate is problematic, but not catastrophic. Chinese loan-to-value ratios on residential real estate loans are in the 50-60 percent range -- much lower than typical leverage ratios in the United States, which are currently 78.3 percent. Prices are certainly high, but Chinese policymakers have been guiding housing price appreciation to zero over the past few years, and therefore, I do not see housing falling off a cliff.
A potential fix would be for Beijing to let inflation rise to 5-7 percent for three or four years and grow out of the problem. A Chinese slow-growth scenario where nominal GDP doubled over five years or so would eliminate the housing problem with little pain. Investors wondering if 5-7 percent inflation is acceptable should remember we have been there twice in the past decade and with China’s housing market an important pillar of its economy, we may be headed there again.
Chinese Banking Crisis Unlikely
Concerns of a Chinese housing market collapse have mounted recently, with home price appreciation moderating and new construction plunging. Any housing slowdown would weigh on consumer wealth gains and damage household balance sheets but would be unlikely to cause a full-blown banking crisis. Real estate lending is a much smaller portion of banking activity in China than in the United States, suggesting any negative impact from a housing slowdown would be manageable.
EXPOSURE TO CHINESE HOUSING MARKET DOWNTURN
Source: Haver, CEIC, BIS, Guggenheim Investments. Data as of 4Q2013 for household debt and as of 1Q2014 for real estate loans.
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