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The rise of state-owned developers in China will transform this sector. S&P Global Ratings believes property development will become less financially innovative, and will be much less engaged with offshore bond markets, particularly given recent rate hikes.

The ranks of China's privately owned property developers are thinning out, and they are taking a large part of Asia's speculative-grade market with them. This class of firm was once a highly dynamic part of the region's new-issuance flow. Their growth was stellar, and they utilized an aggressive build-and-churn model that was built on debt. No longer. In their wake are slower-moving, state-owned developers that are taking over a much reduced market.

China developers previously generated about 40% of Asia's U.S.-dollar speculative-grade issuance, and over 70% of such issuance out of Greater China. Today, the Chinese developers' contribution would be negligible. In 2021, privately owned enterprise (POE) developers issued US$37 billion of offshore bonds, almost all of it speculative grade. In the first half of 2022, that figure had dropped to US$2 billion, excluding bond-exchange exercises.

With the decline of the POE developer, China's property market is getting much smaller. It is also stabilizing. The state-owned developers that are coming to dominate will use leverage less aggressively, and their practices will be less likely to fan price bubbles.

What Has Changed? RMB1 Trillion Of Fresh Liquidity

The government is taking bolder steps to restore confidence in the sector. Previously, the support measures were all triage, aimed at keeping developers alive long enough to complete millions of presold homes. Now the focus is on allowing these developers to become a going concern--to buy land, build, grow, and prosper in the future.

While these measures are not intended to bail out the sector, they will set a floor of the crisis and rebuild the confidence of the sector toward homebuyers and investors. Collectively the steps will help stop the downward spiral in confidence toward the sector among homebuyers and investors. The rounds of support in November should add Chinese renminbi (RMB) 1 trillion of fresh liquidity to the sector.

This includes a RMB250 billion bond fund announced in early November. The National Association of Financial Market Institutional Investors, which launched the program, has not clarified the amount of money going to each developer. Significant sums will likely be set aside for private firms.

The People's Bank of China and China Banking and Insurance Regulatory Commission (CBIRC) recently also gave banks and trust companies flexibility to extend by one year their loans to developers that fall due within the next six months. Among rated entities alone, the loan extensions will add at least RMR650 billion in capital, in our view.

Regulators have relaxed rules governing presale funds held in escrow which will give our rated developers at least RMB100 billion of fresh funds, by our estimate. Developers can now use up to 30% of this cash, provided they have letters of guarantee from banks, according to a joint statement issued on Nov. 14, 2022. The firms can use the money to repay project debt and settle construction bills.

The measures come on top of various easings at the local-government level. For example, Hangzhou relaxed the down-payment requirement on the purchase of second homes, to 40% from 60%, and Beijing has pared back its rules on home purchases.

We Still Assume Any Recovery Will Be 'L' Shaped

These policies are meaningful and may mark a turning point in China's property crisis over the next three to six months. They will also lock into place the new dominance of state-owned developers. The measures will target these firms, given they are the most financially sound, alongside a handful of viable private developers. Many less sound--largely private--will be left to fight for survival, in our view.

For these reasons we continue to assume China property will follow an "L" shaped recovery, possibly in the second half of 2023. The initiatives will boost the sales of some, but the faltering sales of distressed private developers should offset any gains. Weaker new construction starts and lower new land spendings from the sector, which dropped by 39% and 26% respectively for the first 10 months of 2022, will also stop sector sales growing next year.

China property sales will drop 26%-28% in 2022, in our view, a slight improvement over our prior forecast for a 28%-33% decline. In absolute terms, total property sales should fall to about RMB13.0 trillion-RMB13.5 trillion in 2022, from RMB18.2 trillion in 2021.

We expect sales to drop a further 5%-8% in 2023. This is mostly attributable to price declines. Price discounts should stabilize unit volumes for residential sales. Developers will likely cut prices to boost sales to preserve liquidity. Some will also discount slowing-moving inventory.

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Home-purchase restrictions will keep demand in higher-tier cities relatively stable, in our view. Developers will face less pressure to discount in these markets. Most of the price squeeze will be in lower-tier cities, where average selling prices will drop by a low-teens rate. In the past, these markets attracted buyers from higher-tier cities, who were seeking investment gains in a climate of ever-rising housing prices. This demand previously drove about one-third of the property sales in lower-tier cities.

Such buying has largely disappeared. Price weakening is deterring investment-driven purchases, as are COVID restrictions that limit people's ability to travel to different cities to view properties. Soft GDP growth will discourage all buyers, except for those with a real and immediate need for a residence in which to live.

This is all to the detriment of the private developers. These firms are much more active in lower-tier cities than their state-owned peers.

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A New Business And Funding Model Prevails

The high-churn business and funding models previously favored by private firms have also become untenable. These entities raised a lot of debt in offshore bond markets, some at double-digit coupon rates. This was expensive capital. However, the firms would take that money, buy land, presell homes, and move on.

The idea was based on the false belief that land and housing prices could only go up. Developers would build and then quickly sell (or presell), which meant they did not need to pay interest on the debt backing their projects for long. The money would either be repaid or redeployed to another project. This minimized the capital cost of each development.

Government restrictions on developers' leverage, mostly notably the "three redlines" implemented in late 2020, and declining sales have made this model unworkable.

Firms that have gone through a default and restructuring will see their balance sheet shrink. They are still highly levered. Restructuring typically focuses on debt extension, not debt reduction.

The limited cash flow from sales or asset disposals must go to repay debt and construction for project completions. This leaves little for new investment or buying land. Such entities are using whatever capital they have to finish presold homes, to stay on the right side of regulators.

High-churn firms, mostly POEs, have also been priced out of offshore markets. The U.S. Federal Reserve in November raised its short-term target rate to 3.75%-4%, the sixth rate rise in 2022. The series of developer defaults have prompted investors to price in an ever-widening spread. The steep funding costs do not make sense while developers are unable to quickly utilize capital from presales.

State-Owned Developers Are Taking Control Of A Reduced Sector

For all these reasons, the state-owned firms are eclipsing the private ones. Poly Development Holding Group Co. Ltd., an SOE, will likely have the most China property sales in 2022. Its contracted sales in the first 10 months reached above RMB363 billion. China Resources Land Ltd.'s October sales were up 36.8% year on year. It is on track to book increased revenues for all of 2022.

We estimate the rated sales of SOEs and quasi-SOEs dropped by 25% in the first 10 months of 2022. It is a large drop, but it's much better than the 58% sales decline for the rated (or previously rated) POEs in the same period.

Investors believe the government would be reluctant to let the SOE developers fail. This perception becomes self-fulfilling, prompting more bond investors and banks to lend them money, ensuring their liquidity.

So far in 2022, SOE developers have obtained a combined funding in domestic bond markets of RMB438 billion, versus bond maturities due in 2022 of RMB405 billion. POEs, by stark comparison, have only raised RMB33 billion in bond markets so far in 2022, with RMB170 billion in bonds falling due in the year.

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The funding model of SOE players is proving much more robust. As a result, they are more able to absorb the land purchases formerly made by POE developers. In the first half of 2022, private developers only accounted for about one-fifth of land purchases in the country, while SOE developers and local government financing vehicles (LGFVs) took the rest.

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Birth Of A Transformation

China property's fast-churn business model is dying, and perhaps so is the industry's reliance on presales. This is surely for the better. Preselling homes was often just another form of leverage, adding risk to already aggressive borrowing practices.

The market also won't likely miss private developers' heavy use of financial engineering. The hidden debt nested within minority interests and joint ventures contributed the recent rounds of defaults.

In its place will come a steadier, more stable market. The SOE firms that are coming to dominate will be less prone to veer into liquidity crunches. They are less aggressive than the POEs in their leveraging and financial innovation, and can typically receive extraordinary government support if they run into trouble.

And yet, as the POE developers fall back, some will miss their dynamism. The firms were the first to venture heavily into third and fourth-tier Chinese cities, bringing contemporary residences to millions. The POEs also fed a multidecade property boom that enriched many. As that boom has faltered, many will regret the entities' worst practices, while retaining a nostalgia for the bull years.

Writer: Jasper Moiseiwitsch

Digital designer: Evy Cheung

Related Research

• China's LGFV Land Grab: Things That Can't Last Won't, published Nov. 14
• Only China's Government Can Revive Property Confidence, Sept. 15, 2022