Is The Worst Over For China’s Real Estate Developers?

In short, Standard & Poor’s Ratings Services thinks the answer is no. Indeed, we believe the industry is bracing for slower sales and lower property prices, thanks largely to the ongoing rollout of government regulations and credit-tightening measures. Making matters worse, we expect credit conditions to become increasingly severe for property developers. That would increase the impetus for some companies to cut prices and look for alternative funding channels, many of which would be costly. The upshot is that smaller and niche developers with large refinancing risks could struggle in 2012, potentially leading to an acceleration of industry consolidation.

A recently completed liquidity sensitivity analysis on 30 rated property developers across China confirms our view that the sector is facing a difficult near-term outlook. A key finding of the analysis is that weakening property sales and tightening credit conditions at home and globally are likely to increase liquidity pressures over the next six-to-12 months. The analysis suggests that most rated developers could absorb a 10% decline in property sales in 2012. But a 30% fall in sales, which we don’t view as likely, would put even some large developers under severe strain to meet their short-term obligations.

In our view, developers will probably have to cut prices if their liquidity positions deteriorate. It’s unclear if these cuts would stimulate sales if credit lines and policy remain tight. But we believe that niche players that develop high-end properties in top-tier cities–including Beijing and Shanghai–may feel the most heat. That’s because these properties are generally affordable to just a highly concentrated group of investors, whom purchase restriction policies target.

It would take ever-increasing sales to support developers’ ever-increasing leverage and aggressive growth appetites. Although we expect developer’s contract sales to grow in 2011, they could fall over the next six-to-12 months if market conditions become as severe as in 2008. A 30% drop in 2012 would bring sales back to the level in 2010, but the industry would have substantially higher leverage this time around. We note that rising refinancing requirements and financing costs have lifted the break-even point for many developers.

To see a detailed analysis of our sensitivity test and commentary on the sector, see the report titled “Stress Tests Show A Big Sales Slump Could Severely Strain The Liquidity Of Many Rated Chinese Developers” (published to Ratings Direct on Sept. 26, 2011).