Goldman Kills The China Recovery Story, Says "Two Year Property Downcycle Imminent"

Tyler Durden's picture

With everyone focusing on the "Holy Grail" deal between Russia and China, and debating who got the upper hand in the 30 year price delivery arrangement, a just as notable story is that quietly overnight Goldman's China team just took China to the cleaners. In a flurry of reports covering everything from Chinese banks to property developers to the Chinese, Goldman effectively mirrored what Hugh Hendry said several years ago when he correctly concluded that China is drowning in overcapacity, and concluded that a "two year property downcycle is imminent."

From Goldman, who sees "Two-year property downcycle imminent; negative implications for banking/commodity/machinery"

With demand poised to slow given a tepid economic backdrop, weaker household affordability, rising mortgage rates and developer cash flow weakness, we believe current construction capacity of the domestic property industry may be excessive. We estimate an inventory adjustment cycle of two years for developers, driving 10%-15% price cuts in most cities with 15% volume contraction from 2013 levels in 2014E-15E. We also expect M&A activities to take place actively, favoring developers with strong balance sheet and cash flow discipline.

Can there be a prolonged downturn? Why yes, but there is hope:

Mortgage key to avoid prolonged downturn: We believe lower mortgage downpayment/rates, RRR cuts, and developers’ price cuts should help improve affordability and allow transaction volumes to hold at a level sufficient for the industry to restore supply-demand balance by end-2015E.

... but also risks:

Policy delay poses significant downside risks: We believe China has the flexibility (in terms of potential policies, e.g. RRR cut, mortgage easing, removal of L/D ratio, etc.) to prevent a severe property downturn. However, we are concerned about the timing of their implementation, if any, as possible delays could lead to further slowdown in the property sector and a fall in FAI.

Goldman's advice to clients: "Time to adopt a defensive stance"

Near-term, we prefer defensive stocks in the property/banking/commodity/machinery sectors, and would closely watch for downside/upside risks especially pertaining to policy changes.

And some excerpts from the Goldman Q&A:

Q. How long will the housing market downturn be for this time?

A: We expect a two-year downturn to restore supply-demand balance. Given developers’ weak balance sheet as discussed in Q3 of this report and “Deteriorating balance sheet to impact property prices in 2Q14E” dated May 5, 2014, we believe developers would need to cut their new starts and construction capex more aggressively in order to lower their leverage and reduce their interest expenses. In the first four months of this year, new starts have already fallen 22% yoy and we expect this trend to continue. By assuming different level of cuts of new starts in cities with different level of oversupply issues for the 200+ cities we analyzed earlier, we conclude that property new starts would need to be about 20%+ lower than 2013 levels during 2014E-15E. We therefore translate it into 17%/14% yoy decline in new starts for 2014E/15E. This would in turn translate into about 5% and 14% yoy decline in GFA under construction for these two years. With our expectation that GFA sold would decline by 15% yoy in 2014 and stay yoy flat in 2015, we estimate the inventory ratio would be restored to end-2010 level of 3X by end-2015E, which we believe should reduce price decline risks. We also expect a further decline in inventory ratio to 2.4X (average level since 1996) by end-2016E assuming GFA sold/new starts are similar to 2015E levels but a further 5% drop in GFA under development in 2016E.

* * *

Q: What is the current housing demand/supply situation in China versus its history?

A: We have noticed a significant increase in land sales during 2010-2013, almost doubling the average level during 2007-2009. As an important fiscal revenue source to support local governments’ fixed asset investment (FAI) post the 2008 global financial crisis, land sales in China have significantly increased since 2010, with average land area sold in 2010-2013 almost doubling the average level in 2007-2009 (see Exhibit 2).

By adding up the total residential land sold during 2011-2013 in each of the 200+ cities, and dividing this by the total population in each city, we estimate the potential living space per capita increase for each of these cities. Our analysis suggests about half of these 200+ cities could see potential oversupply of properties and construction activities would need to be cut (with different magnitudes) in the coming years.

In Exhibit 5 below, we summarize the key drivers for China’s housing demand and our estimated trend in the coming years vs. past years (since 2010). We expect policy drivers to mostly move in a favorable direction, but cyclical and half of the structural drivers would either be in a negative or weakening trend over the next decade.

* * *

Q: When did the government start to provide support to the housing market in previous downturns?

A: With further deterioration of the housing market in the coming months, we expect the government to provide policy support to prevent prolonged housing downturn that could trigger a vicious cycle on the economy.

The exact timing of such support is difficult to predict, but we summarize below the indicators that have triggered government support for the industry during previous cycles:

  • Decline in quarterly property sales volume yoy (10%-20% yoy decline);
  • Decrease in property prices mom in most cities (about 50 out of 70); and
  • Land transaction premium over government base land price approaching zero.

We believe poor sales volume/sell-through ratio would lead directly to slow land acquisition and possible price cuts.

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achmachat's picture

so... Goldman wants to go on a Chinese real estate buying spree?!

Vampyroteuthis infernalis's picture

The squid comes out after the fact that market has made a sharp downturn. Too late for the muppets to escape. Even captain obvious can write this article.

slackrabbit's picture

Is it just me, or is this politically motivated?

InjectTheVenom's picture

no way ... Goldman is simply looking out for the best interests of their clients .     /sarc

Antarctico's picture

Goldman is doing what Goldman always does when it purports to offer market analysis -- it's talking its book.

Luckhasit's picture

Why, what ever could you mean?

ejmoosa's picture

"With everyone focusing on the "Holy Grail" deal between Russia and China, and debating who got the upper hand in the 30 year price delivery arrangement"


In real markets, deals can be mutually beneficial.

FieldingMellish's picture

GS is so used to their own twisted markets they have forgotten what a real market looks like.

pound the vix's picture

Translation - Goldman is short and needs to cover

what's that smell's picture

"muppet with a side of onion rings, please"

williambanzai7's picture

A sudden change of fart...

Meanwhile it was reported today that it is now more expensive to locate expats in Mainland China than Hong Kong. This has to be principally driven by high real estate prices.

Mike in GA's picture

2 years is 2 short

But thanks for the optimism!

NihilistZero's picture

I think they should let unemployed Greeks and Spaniards buy the overbuilt RE with borrowed money from ECB bonds sold to the Chinese with money paid to Chinese workers from the "wealth effect" spending of those same Greeks and Spaniards.

Toolshed's picture

Mr. NihilistZero, you have a bright future ahead of you in high finance!! That ringing you hear is Blankentroll calling to offer you a directorship.

Handful of Dust's picture

Since RE runs in 12-15 year cycles, I bet it will be a longer downturn.

NoWayJose's picture

I remember the old commercial - when EF Hutton talks - people listen. Today, when Goldman talks, people either ignore, or do the opposite.

Toolshed's picture

Take Goldman Sucks advice, add two cents, and say goodbye to your two cents..........and your shirt. Fuck Goldman Sucks and their troll king.

vyeung's picture

GS is now a crook outfit, sad to say. Same for Citi as well as HSBC. People at the top are the crook master minds and they do not have anyones interest at heart. Not even their own clients. They would rather screw them over because the profit are much larger.

Quinvarius's picture

Why do I get the feeling Chinese Real Estate is going to heat up?

MFL8240's picture


orangegeek's picture

The communist country (-1) that builds cities (-1) that no one lives in (-1) is heading into a two year (-1) down turn.


Well thanks for letting us know.


Didn't China slaughter 60M of their own in the 1950s??  Just checking.


Go get 'em GS.  Let us know how it goes!!!

Drifter's picture

Pot - kettle?

Our new housing bubble (done with the same "fog a mirror" 125% LTV lending policies used last time) isn't on the verge of collapse too?


Leraconteur's picture

Chinese really don't think that an asset can drop in value.

They don't sell used anything, no one buys used anything, and if you sell your condo/house/apartment for less than the neighbour paid, they blame YOU for losing THEM money.

This blame can extend to riots, demonstrations and being beaten up - because you lowered the price of your unit to move it.

Now think what is going to happen when developers and their sales staffs lower prices to move inventory, and how current and recent buyers will react.

These people really think - really, they do - that the price of their house can not go down, ever. They really do blame the person who sold a newer unit at a price less than they paid. They really do think that person who sold or bought lower cost them money, and they really do insist that money is given to them by the developer to cover the loss.