Change in PRC developer business model. We see short term rise in mainland home prices

Change in PRC developer business model. We see short term rise in mainland home prices

As the housing market in China develops, and with ever rising home prices, property development has also become a more competitive business as more developers jump on the band wagon fighting for market shares. This article looks into how developers coped with the high speed of growth while juggling very tight working capital, and how their business models changed to survive in this fast changing market.

Earlier presales, more efficient capital utilization

Looking at the lead time between flat presale and date of completion before 2008, it is apparent that presales typically happened ten months before completion [Chart 1]. This suggests that developers’ operating methods were still maturing, and that by and large, the size of their projects may have been small, resulting in project launches barely one year before completion. At this stage of market evolution, developers were unable to advance presales to improve cashflows and returns on projects.

Chart 1: Presale started 10 months before completion prior to 2009

From 2009 onwards, presales appeared to take place some 18 months before completion [chart 2]. This change suggests that the government presale approvals may have been speeded up, but a more likely explanation may be that in order to cope with limited cash resources in a high growth environment, developers increasingly focused on cashflows to increase the efficiency of capital utilization.

Chart 2: Presale starting 18 months before completion in recent years

The shift in presale timing coincided also with ever more developers seeking or becoming listed companies, and were now answerable to the discipline of capital markets, leading to faster asset turnover; further larger sized projects also became more common, further allowing developers to obtain presale approvals of later phases in the same project.

                 

Pursue Efficiency, Speed up Construction

Apart from earlier presales, construction durations are also shortened, for example, before 2011, residential buildings normally required two years to complete [chart 3], but since then, construction was compressed into one year [chart 4].

Chart 3: Construction requires 24 months before 2010

 Chart 4: the construction time shortens to 12 months in recent years

In fact, vastly improved construction techniques has become a norm in China, as can be observed in a recent case where a 57-floor building was built in 19 days in Chang Sha. It is reported that the construction industry is now able to add one floor in three days when building skyscrapers, suggesting the construction industry has been successful in achieving higher efficiency in the same vein as developers.

From the above analysis, it is possible to project the trend housing completions over the next 12 months: completions will likely rebound in the second half of 2015, and start to fall again in the first half of next year.

By analysing presales, construction starts and completions, this article is hopes to chart the change in business model in the Chinese property development industry, from one where construction leads presale which in turn precedes completion, to one now where presales happen before construction starts [Figure 1]. This fundamental change turns a net cash outflow to an inflow during the development period, freeing up more capital for developers to grow their business and also better control market and policy risks.

Figure 1: Cashflows of the new and traditional business models

Falling Inventory suggesting rebound in developer stock prices

The above analysis has demonstrated the maturing of the Chinese property development sector. As long as home prices continue rebounding, one can expect decent returns for investors in developer stocks from the current depressed levels.

As inventory build-up falls in relation to completions, it is likely that home prices will rise, and vice versa [Chart 5] - when the relative measure (represented by blue line) drops below 5%, home prices typically increases, while a rises above -4% points to price declines instead. From the position of the blue line as it stands now, mainland home prices could increase till the end of the year by about 15%. Of course, eventual magnitude of increase is largely dependent on how forcefully the government loosens credit conditions to achieve its GDP growth target of 7%.

Chart 5: Drop in inventory-to-completion ratio presages a rise in home prices

With developer stocks on inexpensive valuation metrics, the recent drops in share prices back to levels seen before the launch of Shanghai-Hong Kong Stock Connect, one could perhaps be relatively optimistic on the short term outlook of developer stock prices.

This article was researched and written with significant input from Mr Tom NG Chun Wai, whose contribution is greatly appreciated.