Reconsidering risk and demand

The word on the street in China is that the central government’s deleveraging campaign has led to a tighter financing environment, squeezing en-bloc deals into the picture. After a relatively quiet period over the past several months, we foresee more properties coming onto the market, partly because owners are feeling liquidity pressure after enduring nine months of tight financing conditions. Additionally, there are expectations that some listed companies may release significant volumes of properties for sale as they try to meet revenue forecasts.

However, the tight financing environment is providing opportunities to cash-rich investors. Over the past two years, mainland insurance companies have been priced out of the market as other aggressive domestic investors have used high leverage to achieve required returns on investments. Meanwhile, deep-pocketed foreign investors like pension funds and sovereign wealth funds have stepped up to capture these investment opportunities and increased their capital allocations with a long-term view.

Dynamics from here to there

Yield compression in the past two years indicate that domestic investors were willing to bear higher risks associated with heavy leverage than their foreign competitors. This pushed property prices up to a significant level even though rental growth remained flat during the same period.

Against the backdrop of the central government’s risk control efforts, over the past nine months the market has progressively shifted from a seller’s market to one favoring buyers. Domestic investors have generally quietened down as their financing capacity has been squeezed by tighter lending channels and higher financing costs. As a result, and based on several ongoing deals, asset prices had a mild correction with cap rates decompressing. Value-add strategies are becoming a wider trend – in particular, asset conversion and redevelopment plays are more common. Increasingly, active foreign investors are seeking to improve their existing stock and upgrade outdated projects in downtown locations

Bull or bear?

With the return of cash-rich domestic and foreign investors, we expect to see more transactions in the coming quarters. Buyers should not expect the “red tag” of sales prices to last for much longer. Provided they have sufficient account balances, it might be a good idea to start preparing an end-of-year shopping list.

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