Long-Term Boom rooted in Robust Fundamentals, or Looming Bubble and Fragile Lynchpin in a Doomed Economy?

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China’s Real Estate Sector –
Long-Term Boom rooted in Robust Fundamentals, or
Looming Bubble and Fragile Lynchpin in a Doomed Economy?
France Houdard
Managing Director
france.houdard@exolus.com
M (86) 135.8591.0838 (China)
W (86 21) 5100.1833 x 1100 (Shanghai)
W (1) 305.677.3923 (United States)

2. China’s Real Estate Sector –
Long-Term Boom rooted in Robust Fundamentals, or
Looming Bubble and Fragile Lynchpin in a Doomed Economy?
In the course of the global financial crisis, China edged further forward on the global stage in its
strategic, operational and financial significance for executives spanning the sectors, whether
corporate multinationals or institutional investors. The health of China’s economy is central to the
success of those investors and a global economic crisis rooted in a dysfunctional global real estate
sector begs a host of questions around the health of China’s own property sector.
In April 2010 China’s leaders began to put in place a series of very strong policies designed to cool
down its property sector. Naturally, this has given rise to concerns about the stability of the sector
and the degree to which China’s economy hinges on a healthy real estate sector. In short, those
executives with elaborate strategies rooted in the health of China’s economy are drawn to wonder:
Is China’s real estate sector a looming bubble – and the fragile lynchpin in China’s “economic
miracle”? Or, is China’s real estate set for long-term secular growth, solidly rooted in robust
fundamentals?
Section 1
Significance of China’s Real Estate Sector in the Broader Economic Context
Today, China’s real estate investment accounts for roughly 11% of its GDP. It thus has a critical
bearing on the country’s sustained high levels of economic growth and, accordingly, the health of
the real estate sector is of considerable significance to any investor. And, indeed, it is of primordial
importance to China’s leadership.
2 China’s Real Estate Sector: Looming Bubble or Long-Term Boom? | Exolus International Advisory

3. A close look at how the structure of China’s economy differs from that of the United States and
Germany sheds light on the critical role that real estate plays in the country’s economy.
Whereas the health of the US economy, and to a lesser extent the German economy, is heavily
dependent on Private Consumption, the health of China’s economy has been considerably more
dependent on Investment. In the United States, Private Consumption accounts for 71% of its
GDP, compared to 59% for Germany and just 35% for China. Conversely, China’s economy is
proportionately much more dependent on Investment, accounting for 44% of its GDP, as
compared to both the United States and Germany, where it accounts for 11% and 16% of their
economies respectively.
In the past five years, China’s strong exports have helped bolster its economy, its Net Trade
accounting for 4% of GDP in 2009, down from a high of 8% in 2008. However, in a shaky global
economy, where exports are threatened by softness in external demand, China’s need for
sustained levels of robust investment has become all the more important. And, with real estate
investment accounting for 11% of the country’s GDP, it is clear that China’s leadership would seek
to support healthy real estate investment, so as to continue driving GDP – as well as sustain
personal wealth.
China’s Real Estate Fundamentals are Very Strong and on a Long-Term Secular Growth
Trajectory.
China’s real estate fundamentals are strong and they combine to point to a long-term secular
growth trajectory. This would include:
 Strong GDP Growth. China’s GDP has been growing at 9.9 % over the past ten years.
Starting in the early 80s, China’s economy began to double in size every seven years.
Most recently, China’s economy tripled in size over the seven years spanning 2002 to
2009.
3 China’s Real Estate Sector: Looming Bubble or Long-Term Boom? | Exolus International Advisory

4.  Disposable Income, Middle Class Growth and Strong Upgrade Demand. China’s per
capita urban disposable incomes have been growing at a CAGR of 11.4 % between 1999
and 2009. Its middle class currently has a population of 400 million people and is
projected to grow by another 100 million within the next five years. This growth in
wealth has translated to a growth in expenditures and China’s population is actively
seeking to own and upgrade homes. Moreover, the desire to own property is
reinforced culturally by social norms and traditions, such as marriage, that emphasize
property ownership as a rite of passage.
 Rural Migration to Cities. China’s urbanization level has been increasing by
approximately 10% every 10 years for the past three decades. At this rate, some 85
million more people will move from China’s countryside into its cities in the next five
years, increasing its current 2010 urban population of 600 million people to 685 million
by 2015. Within the next 15 years, the urban population is projected to grow to 822
million.
4 China’s Real Estate Sector: Looming Bubble or Long-Term Boom? | Exolus International Advisory

5.  300 New Households in Past Two Decades. Some two years ago, it was quite common
to have multi-generational family members living under one roof, frequently referred to
as the “2+2+1 Phenomenon”: 2 Grandparents + 2 Parents + 1 Child (under China’s
one-child policy). During the past two decades, this has shifted considerably, whereas
in 1992 the average household had 4.5 members, in 2010 this has shifted down to
approximately 2.5 members. This has translated to a household formation trend,
where in 1992 there were approximately 200 million households and today this number
has increased by an additional 300 million households in just the last two decades,
resulting in approximately 500 million today.
 Limited Land Supply. While China’s large-scale migration into cities is translating to
immense demand for land, its actual supply of land is quite limited. Roughly two-thirds
of China’s landmass is covered by mountains and deserts and is thus uninhabitable.
Within the context of this large scale migration, China is witnessing a clustering of urban
dwellings into the formation of a pattern of mega-cities and mega-corridors – roughly 10,
each with populations roughly the size of European countries.
5 China’s Real Estate Sector: Looming Bubble or Long-Term Boom? | Exolus International Advisory

6.  Very Low Household Leverage, High Savings Rates. According to BofA Merrill Lynch
Global Research, household leverage in China is very significantly lower than in most
Western countries – the ratio for China is 45% versus 136% in the United States and 125%
in the UK. Furthermore, savings rates are relatively high in China. China’s household
savings rates stood at 17 percent in 2009 and 20 percent in 2008.
 Healthy Banking Sector. China’s banks have relatively little exposure to the real estate
sector. Their total exposure to the real estate sector is approximately 18% (year end
2009), compared to 56% with US banks. Furthermore, its NPLs have been cleaned up,
once at around 40 to 50%, now only account for roughly 6%. Furthermore, the Central
Bank has accumulated over USD 2 trillion in foreign reserves. The accumulation of
large external surpluses means its financial system enjoys abundant liquidity.
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7. 7 China’s Real Estate Sector: Looming Bubble or Long-Term Boom? | Exolus International Advisory

8. Section 2
Long-Term Fundamentals and Strong Secular Growth Trend, Yes. But, what about the
Short-Term: Is China’s Real Estate Sector Currently Overheating – Today?
The general discourse in China around an overheating real estate sector revolves around the pace
of growth of incomes relative to that of housing prices. Specifically, it is suggested that
overheating occurs when a protracted growth rate in housing prices exceeds the growth rate in
incomes.
In view of the above, China’s national average trends would suggest that the real estate sector is
not overheating. When examining China’s economic growth over the past decade, we find that
growth in home sales prices (ASPs) has remained lower than growth in disposable income, as well
as below GDP growth. Disposable income growth has grown at a 10-year CAGR of 11.4%, while
home prices have grown at a 10-year CAGR of 9.7%.
Further, the application of standard measures of real estate affordability show relative health in
the real estate sector across China. There are several accepted conventions for measuring real
estate affordability: Mortgage Affordability and Housing Affordability. The Mortgage
Affordability Ratios is a housing debt to income ratio, assessed by determining the percentage of
monthly income that is required to service monthly mortgage payments. The Housing
Affordability ratio, usually expressed as years of income, is a housing price to income ratio,, which
in effect measures the numbers of years of household income it would take to pay off a house (at
0% interest).
At 34% in 2009, China’s national Mortgage Affordability ratio was at a healthy level. Further
China’s average property prices, at approximately 8x annual income (Housing Affordability ratio)
also reflect a very healthy level. As such, both of the Mortgage Affordability and Housing
Affordability ratios reflect a healthy real estate economy for China – when they are applied at the
national level.
8 China’s Real Estate Sector: Looming Bubble or Long-Term Boom? | Exolus International Advisory

9. However, given the size and complexity of China, the use of blended statistics based on national
averages may tend to smooth over any trends that might be occurring within social, geographic
and economic sub-segments of the county. Trying to make a broad-sweeping generalizations
about a continental-size country as highly diverse as China, whose population of 1.3 billion
exceeds 20 percent of the world population, is in effect tantamount to making a broad
generalization about all the 50 countries that span the UK to Russia and make up Western,
Central and Eastern Europe. After all, China is an immense and highly diverse country that has
over 600 cities, 160 of which have populations in excess of 1 million residents. The total
population of the combined 50 countries in Western, Central and Eastern Europe is 731 million
residents, making it roughly half the size of China.
In employing standard measures of affordability on a local and city-by-city level, we see that in
fact the prices of real estate in a few of China’s largest metropolitan cities has grown at a pace
that has made property increasingly unaffordable and this situation has continued to deteriorate
over the past several years. In fact, a few select Tier 1 cities, such as Beijing and Shenzhen
(whose combined populations account for only two percent of China’s total population), have
seen a doubling of average residential prices since the end of 2008.
Housing and Mortgage Affordability -- Trending to Unhealthy Levels in a few Major Cities
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10. City Population/ Mortgage Payment/ Property Price/
China Population Disposable Income Annual Income
Cities (Overheated) with Unhealthy Affordability Ratios
Beijing 1% 98% 19x
Shenzhen 0.7% 101% 20x
Shanghai 1.3% 68% 13x
Hangzhou 0.5% 94% 18x
Wenzhou 0.6% 84% 25x
Dalian 0.3% 88% 17x
Shantou 0.4% 73% 14x
Fuzhou 0.2% 68% 13x
Xiamen 0.1% 67% 13x
% of Population The Above Cities Account for 5 percent of China’s Total Population
Cities with Relatively Healthy Affordability (Ratios Slightly Above China Average of 46% and 9x)
Guangzhou 0.9% 63% 12x
Chengdu 0.4% 62% 12x
Nanchang 0.3% 62% 12x
Kunming 0.4% 66% 9x
Yangzhou 0.3% 57% 13x
Tianjin 0.6% 57% 11x
Xi’an 0.3% 54% 11x
Guiyang 0.2% 52% 13x
Wuhan 0.5% 50% 10x
Zhengzhou 0.3% 48% 9x
Cities with Very Healthy Affordability (Ratios Lower than China Average of 46% and 9x)
Lianyungang 0.4% 43% 11x
Shenyang 0.4% 43% 8x
Huizhou 0.3% 41% 9x
Xuzhou 0.7% 41% 8x
Chongqing 0.6% 39% 8x
Changsha 0.2% 31% 6x
10 China’s Real Estate Sector: Looming Bubble or Long-Term Boom? | Exolus International Advisory

11. Section 3
Government Steps in with Tough Real Estate Policies
A look at the real estate sector in a few of China’s largest cities shows a trend where housing is
less affordable to the average family. As such, this trend fits into the general discourse in China
around overheating in the real estate sector and this, in turn, has served as a call to action for
China’s leadership. The challenge, of course, resides in finding a way to temper the property
prices in just a few major metropolitan cities, while still supporting real estate investment across
the entire country which is contributing 11% to the country’s GDP – and sustaining personal
wealth.
Since its ascension to power in 1949, China’s political leadership has advanced policy within an
overarching framework of axiomatic principles that highlight the need for a balanced course for
development, in which economic growth is sustained and the dividends of that economic growth
is spread across the span of China’s massive population. In particular, a central focus in the
leadership’s tenets resides in insuring that the lives of China’s middle- to poorest segments of the
society are enhanced and that they are not left behind as the rest of the country advances.
With real estate prices racing ahead of incomes in its few Tier 1 cities, China’s leadership put into
place on April 15, 2010 some of its toughest real estate policies to date. The policies are
multipronged and span the following initiatives:
1. Significant Increase in Land Supply and Focus on Economic Housing
 Major Increase in New Land Supply. In 2009 Chinese authorities made 75,000
hectares of new land available for housing development. By comparison, the
authorities made 185,000 hectares available nationwide in 2010 for housing
development, representing nearly a two-and-a-half fold increase in new land made
available.
 Majority of New Land Designated for Development of Small to Medium
Commodity Housing. Of the total stock of new housing made available in 2010, a
total of 77% has been specifically allocated for the development of small to medium
housing (defined as housing with GFA less than 90 sq m), as well as economic
housing (below).
 Major Increase in New Land Supply for Economic Housing. Of all the new land
made available in 2010, a total of 13% (24,000 hectares) has been reserved for social
welfare housing (accounting for 3 million units). This reflects a significant increase
from the previous year, when only 4% of the new land was made available for social
welfare housing. This said, it is up to local governments to implement this policy,
where such well-intended policies designed to have government act as a
counter-balance to the private sector have traditionally faced a wide range of
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12. implementation challenges – lack of funding, lack of political will to act against the
interests of local developers, and poor public acceptance.
2. Tough Mortgage Policies – Downpayment Ratios and Mortgage Rates
 First Home Purchase. Downpayment for homes less than 90 sqm can be 20%,
otherwise 30% downpayment.
 Second Home Purchase. Downpayments cannot be less than 50% and mortgage
rates cannot be less than 1.1 % of the best lending rate.
 Third Home Purchase. On April 17, 2010, the State Council announced that
commercial banks have the right to restrict mortgages for persons buying a third or
fourth home in an area with overheating property prices. As well, commercial
banks were forbidden from issuing mortgages to non-residents who cannot provide
one year of tax or insurance records.
Before April 2010 After April 2010
First Home
 30% if GFA is more than 90 sqm
Downpayment 20% or 30%
 20% if GFA is less than 90 sqm
Mortgage Rate 30% off to standard lending rate 30% off to standard lending rate
Second Home
Downpayment 30% or 40% At least 50%
Up to 30% discount to best lending rate (most
Mortgage Rate 1.1 times of standard lending rate
are 15-20% discount)
Third or Above Home
Downpayment 30% or 40% Banks have stopped lending to third home buyers, in
Up to 30% discount to best lending rate (most some major cities, such as Beijing, Shanghai, and
Mortgage Rate
are 15-20% discount) Shenzhen.
Other Possible Future Measures …
3. Clamp Down on Land Hoarding
 Land Hoarding Crackdown. There are increasing cases of governments clamping
down on developers holding land idle by reclaiming the land from developers, but
this is not applied nationwide. This takes place primarily in first tier cities such as
Beijing, Guangzhou and Shanghai. The Ministry of Land and Natural Resources
reports some 2,815 such cases, involving a total land reclamation of 11,300
hectares, during the months spanning March to July 2010.
12 China’s Real Estate Sector: Looming Bubble or Long-Term Boom? | Exolus International Advisory

13. 4. Taxes
 Property Tax. The current holding cost of land is very low and, as such, a property
tax would discourage excessive land hoarding and speculation. While there are
on-going discussions on introducing such a tax in specific cities, the actual
implementation of such a tax is very complex and would require time to legislate
and implement.
 Real Estate Tax. There are tentative regulations for a Real Estate Tax for which
there are currently inconsistent applications as relates to both RET rate and taxable
base calculations. In general, however, for self-owned properties a tax rate of 1.2
percent will be applied to a taxable base – derived by taking 70% to 90% of the
original cost of the property. A rate of 12 percent of the annual rental income will
be applied to properties held for lease.
 LAT Enforcement. The State Administration of Taxation (SAT) has discussed the
application of the existing LAT regulations, in collecting LAT liabilities from
developers across the country. Though such discussions have been underway, the
SAT has not moved forward on this, in part due to the complexity around actually
calculating LAT liabilities.
5. Other
 Loan Restrictions to Developers. It is possible that the government would
implement loan policies making it difficult for landhoarding developers to obtain
financing, while making it easier for those who develop economic housing.
However, most of the financing does not derive from banks. It should be noted
that most of the funding for real estate investment comes from the developers’
own retained earnings and the advanced payments they receive from homebuyers;
bank lending only accounts for roughly 20% of all real estate investments.
13 China’s Real Estate Sector: Looming Bubble or Long-Term Boom? | Exolus International Advisory

14. Section 4
What Impact are the New Policies having on Reining in Overheating in its Tier 1 Cities –
and, more broadly, across the Span of China?
4.1 Property Sales Volumes and Pricing
There is a direct parallel to draw from in very recent history, where China employed a similar
strategy of tightening mortgages -- in September of 2007 -- to cool down the property market
that can be used as an effective touchstone for assessing the potential impact trends on property
prices of these types of policies. In the wake of the September 2007 measures, property selling
prices actually continued to increase for another 6 months. The drop-off in prices only
happened later in 2H08 – contemporaneously with the onset of the global financial crisis. Prior
to the September 2007 measures, the national average monthly transaction volume was 56.2
million sqm GFA. For the first 6 months, property prices remained unaffected by the 2007
policies. Prices did eventually drop and in 2008, the national average transaction volume
dropped 25% to 42.3 million sqm GFA. Tier 1 cities were most impacted and suffered a drop in
transaction volumes of 43%, compared to the national average of 25%.
In 2008 China ended the year with a gross primary transaction volume of 559 million square
meters of GFA for residential properties. The following year, in 2009 the market saw a 53
percent increase in transaction volumes, the year ending up with 853 million sqm of GFA for
residential properties. So far in 2010, the YTD (January to August) gross transaction volume
reached 527 million sqm of GFA. In focusing on the months prior to April – when the State
Council initiated its Policies – monthly transaction volumes in January and February were 72
million sqm and 78 million sqm respectively. Later in the year, after the State Council had
initiated its Policies, transaction volumes for July and August had come down to 65 million sqm
and 69 million sqm respectively, representing an average decrease of 11 percent.
Though transaction volumes are still high on a national average basis, Tier 1 cities have
experienced a considerable drop in transaction volumes, with 3Q10 YTD transactions down
between 50 and 60 percent as compared to 2009 Q3 YTD. The high gross national average level
of transaction volume is driven by excessive liquidity in the market and strong demand from
urbanization and housing upgrades.
As concerns pricing, national average sales prices have continued to increase, though the rate of
increase has diminished in some cities, as compared to 2009. Even in the select group of cities,
where transactions volumes have dropped considerably, ASPs in these cities with “overheating”
have continued to rise. Beijing and Shenzhen ASPs have risen 50 percent in 2010 YTD Q3 as
compared to YTD 3Q09, and Hangzhou nearly 60 percent. To date, developers have been cash
rich, in much better financial positions than in 2008, and thus have had the luxury of employing a
wait-and-see attitude, with no need to quickly drop ASPs. Tier 3 and Tier 4 cities have had
relatively healthy property markets, with moderate growth in pricing. These cities are the most
resilient and are likely to be the least impacted by recent policies.
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15. Public Housing.
Increasing the stock of public housing units is an important part of providing for the
lower-income segments of society and thereby delivering on the leadership’s mandate to provide
for a balanced course for development, in which economic growth is sustained and the dividends
of that economic growth is spread across the span of China’s massive population -- in particular,
to China’s middle-to-poorest segments of the society. The long-term implications of China’s
public housing policy are that developers will be crowded out of the lower end of the housing
market. However, this will not be effective immediately.
In the short-term, however, local governments are reluctant to promote these policies for a host
of reasons – a lack of funding and a lack of political will to act against the interests of local
developers -- and because land auctions generate significant revenues for the local governments.
Fees generated through land transactions are split 30:70, with 30 percent going to the central
government and 70 percent going to local budgets. Samsung Securities analysts estimate that
local governments only delivered between 10 and 20% of the promised housing in 2009 and, if
this is to serve as a basis for predicting the future, the implementation of the new public housing
policy is likely to be equally small – and thus not represent an immediate threat to developers.
15 China’s Real Estate Sector: Looming Bubble or Long-Term Boom? | Exolus International Advisory

16. 4.2 Inventory
Based on trends in the average number of months to digest inventory (GFA available for sale
divided by GFA sold), it would appear that housing supply remains tight. The national average
was 12 months in February 2010 and down to 7.3 months in June 2010. We can see that supply is
particularly tight in the cities of Shanghai, Shenzhen, Hangzhou and Chongqing. This low level of
inventory should be a factor in acting to prop up ASP’s in the near term, particularly in Tier 1 cities.
Furthermore, the construction activity is expected to remain low during the 6-month-long Shanghai
Expo and the Guanzhou games, keeping the supply tight in these Tier 1 cities.
Residential Digestion Cycle
(Average Months)
Feb '10 June '10
24
22
20
18
16
No. of Months
14
12 Jan/Feb '10 National avg = 12 months
10
8 June avg = 7.3 months
6
4
2
0
Beijing Shanghai Chongqing Shenzhen Hangzhou Chengdu
Source: CREIS
4.3 New Construction
The year 2009 was somewhat unique, in that countries across the world were coming out with
large stimulus packages designed to stimulate and hedge their economies against unforeseen
challenges in navigating the unchartered waters of the global financial crisis. To weather the
storm, China had come out with its own very significant stimulus package, which included strong
incentives to stimulate construction, along with very loose credit policy. Starting in 2H09,
developers were cash rich and responded by acquiring a lot of land, while accelerating
commencement of construction and the speed of on-going projects.
The pattern of accelerated land acquisition and new construction continued through the first
quarter 2010. In March of 2010, the commencement of new construction had soared 60% YoY,
up from roughly 40% YoY in February. To date, the commencement of new construction has
continued to accelerate, with new construction up 56% YoY in August. This is a pattern that is in
line with the government’s attempts to increase supply.
16 China’s Real Estate Sector: Looming Bubble or Long-Term Boom? | Exolus International Advisory

17. With an average of 8 to 12 months from the commencement of new construction to presale, this
sustained pace of new construction should drive supply in 2H10 and 1H11. The projected spike
in future additional supply could place additional pressure on a weak physical market. In the
absence of strong pre-sales proceeds in Tier 1 cities to take up the additional supply, developers
will face hard decisions, to either drop prices, and/or slow down the rate of land acquisition and
new construction. With local governments working against land hoarding, developers will also
have to contend with the possibility of having land taken back.
4.4 Demand
The migration of some 100+ million people in China’s urban cities every decade, coupled with a
growth in the middle class on roughly the same order, undergirds the current and long-term
demand for the residential property sector. The drive in demand for the residential property
sector is not driven by excessive leveraging. China’s banking sector is heavily regulated and the
current policies that require mandatory downpayments of 20% to 30% for first time home buyers
and 50% for second homes. Of important note, China’s banks have relatively little exposure to
the real estate sector. Their total exposure to the real estate sector is approximately 18% (year
end 2009), compared to 56% with US banks. Housing bubbles require excess amounts of credit,
and this is not the case currently in the PRC.
Further, China’s relatively high level of savings represents good potential for future spending.
During the recent financial crisis, China’s savings rate moved up to 20% in 2008, though this rate
declined in 2009 to 17%. In a healthy economy, some of this savings could be spent in the
residential property market, further sustaining demand.
As to the actual trends in the composition of demand, the premier developer Vanke has data that
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18. shows first time buyers in 2009 accounted for 30%, as compared to 8% in 2005. Improvements
accounted for 51% in 2009, as compared to 77% in 2005. Also, speculation was up to 19% in
2009, compared to 14% in 2005, but still a bit lower than 2007 when it accounted for 20%.
China’s new mortgage policies are expected to have some impact on consumer behavior. The
Policies favor first-time home buyers of smaller units (less than 90 sqm), which enjoy 20%
down-payment and favorable mortgage terms, 10% lower than that for units larger than 90 sqm.
As to speculation, the new mortgage policies will tend to drive away some of the speculation,
given the higher downpayments, and thus lower leverage.
18 China’s Real Estate Sector: Looming Bubble or Long-Term Boom? | Exolus International Advisory

19. Summary
China’s real estate fundamentals are strong and they combine to point to a long-term secular
growth trajectory. Long-term trends notwithstanding, a public debate has emerged both inside
and outside China around the health of the country’s real estate sector and the extent to which it
might be currently overheating in the short-term.
A national-level general review of China’s real estate sector based on affordability ratios shows a
healthy sector and would lead us to believe that concerns of an overheated economy are
overstated. However, given the size and complexity of China, the use of blended statistics based
on national averages may tend to smooth over any trends that might be occurring within social,
geographic and economic sub-segments of the county. Trying to make a broad-sweeping
generalizations about a continental-size country as highly diverse as China, whose population of
1.3 billion exceeds 20 percent of the world population, is in effect tantamount to making a broad
sweeping generalizations about all the 50 countries that span the UK to Russia and make up
Western, Central and Eastern Europe. After all, China is an immense and highly diverse country
that has over 600 cities, 160 of which have populations in excess of 1 million residents. The
total population of the combined 50 countries included in Western, Central and Eastern Europe is
731 million residents, making it roughly half the size of China.
In applying a finer analytical comb to China’s 600 cities in extracting micro-geographic trends on a
city-by-city basis, one can indeed find some select cases of affordability at unhealthy levels. In
particular, it is a handful of China’s cities – perhaps five or six out of the country’s 600 cities
(accounting for approximately 5% of the total population) – whose affordability has grown to
unhealthy levels. As these include Beijing and Shenzhen (China’s northern political capital and
the country’s southern “commercial capital”), China’s leadership began in April 2010 to introduce
a series of policy initiatives designed to rein in prices in these important and prominent cities.
As to near-term consequences of the Policies, the physical market will continue to experience
moderate transaction volume increase on a nationwide basis throughout the end of the year, but
will experience volume decreases in the select targeted “overheating” cities. With local
governments actively working against land hoarding in China those cities, developers will focus
on asset turn and one could expect increasing numbers of developers to begin price cuts by year
end.
In the mid- to long-term, the new Policies have broader and more substantive implications.
They are expected to reshape the real estate sector on a national-basis over the next several
years and will on the whole have a positive long-term impact on the industry. The introduction
of economic housing will result in some level of bifurcation in the property sector. The
government will increasingly take on the lead on housing for mid-to-low income earners, while
the private sector will take the lead on mid-to-high end commodity housing, as well as the
top-end.
As to more specific projections on the near-term impact of the policies, the following …
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20.  Top Tier cities will be impacted the most – e.g., Beijing, Shenzhen – and stand to
experience the greatest drop in current sales prices.
 Investment-driven cities that are much more sensitive to credit tightening are also likely
to see significant declines – e.g., Hainan, Hangzhou.
 Cities with serious oversupply could also suffer –e.g., Shenyang , Changsha, and Hainan
 Cities that have maintained healthy levels of affordability and balanced supply demand
are to suffer the least – e.g., Suzhou, Wuhan, Xi’an
The policies will also have varying impact on the revenues and profits of its developers:
 Impact developers if the majority of their landbanks are in Tier 1 cities.
 Impact companies with low margins
 Little to no impact on developers with properties in the retail sector.
 Little to no impact on mass residential developers focused on mass-market.
To date the China Property sector has performed quite poorly, underperforming MSCI China
Index by 37% since July 2009. Within the context of the above trends, one would expect the
market to grow increasingly discerning in favoring developers with the following attributes:
 Residential developers with a large percentage of landbank located in 2/3 Tier cities, as
they will benefit from urbanization and wealth trends.
 Commercial developers who focus on high-growth Tier2/Tier 3 cities and middle income
consumers (benefit from strong domestic consumption).
 Developers with creative investment structuring – e.g., sell a portion of their commercial
projects for near term earnings, but also retain a portion for investment purposes for
future capital appreciation.
 Developers with good brands, professional management, and with track record and
execution capabilities.
20 China’s Real Estate Sector: Looming Bubble or Long-Term Boom? | Exolus International Advisory

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21 China’s Real Estate Sector: Looming Bubble or Long-Term Boom? | Exolus International Advisory

22. 22 China’s Real Estate Sector: Looming Bubble or Long-Term Boom? | Exolus International Advisory