China’s Real Estate could be halfway through – KKR suggests

China’s real estate problems are far from over, and urgent action is needed to address industry issues if the country’s overall economic growth is to improve significantly. This insight comes from a recent report by the global investment firm KKR, released on Thursday.

According to Henry H. McVey, head of global and macro asset allocation at KKR, who visited China for the fourth time in just over a year, the real estate sector is fundamentally overbuilt and requires swift attention. The report, co-authored by Changchun Hua, KKR’s chief economist for Greater China, emphasizes the importance of restoring confidence to encourage savings and drive consumer and business spending on higher-quality products, as encouraged by Chinese authorities.

Real estate and related sectors once made up a significant portion of China’s economy, but have declined in recent years following Beijing’s crackdown on developers’ excessive debt reliance for growth.

Drawing comparisons to housing corrections in the U.S., Japan, and Spain, the KKR report suggests that China’s housing market correction may only be halfway through in terms of its depth.

The report underscores the need for both prices and transaction volumes to come under pressure to complete the cleansing cycle, although so far, the focus has mainly been on reducing transaction volumes.

While KKR’s report didn’t dive deep into specific real estate policies, the authors mentioned that if Beijing takes more action to improve China’s real estate sector, it could significantly change how investors view the market.

Due to geopolitical tensions and the recent downturn in China’s property market and stocks, many foreign institutional investors are hesitating to invest in China.

KKR’s report highlighted that based on their surveys, a lot of investors are thinking about reducing their exposure to China from 10-12% to 5-6%. This is happening at a time when they believe the economy’s fundamentals are likely at their lowest point.

Despite concerns, much of the official data from China at the beginning of the year has surpassed analysts’ expectations.

Chinese officials have stated that the real estate sector is still adjusting, while Beijing is focusing more on manufacturing and what it calls “high-quality development.”

Additionally, authorities have introduced policies to provide financial support to certain property developers. While many local governments (though not necessarily the largest cities) have eased restrictions on home purchases to some extent.

Insights from KKR’s Outlook on Real Estate and GDP Growth

Real estate’s impact on China’s economy is expected to lessen gradually. KKR predicts a slight slowdown in China’s GDP growth, estimating it to be 4.7% this year and 4.5% next year. They anticipate the influence of real estate and COVID-related issues to decrease from dragging down the economy by 1.4 percentage points in 2024 to just 0.7 percentage points in 2025.

Henry H. McVey, Chief Investment Officer of KKR Balance Sheet, explained that ongoing corrections in the property market, coupled with potential policy support, should ease the strain on the overall economy in the coming years. He highlighted the importance of addressing weaknesses in the economy, particularly in the housing sector, to improve capital accessibility for businesses and households.

The report suggests that while traditional sectors like catering, accommodation, and wholesale will see modest growth contributions, the main drivers of growth will be digitalization and the transition towards environmentally-friendly industries.

McVey emphasized that beyond GDP growth, it’s crucial for authorities to facilitate easier access to capital markets for businesses and households. Improvements in the housing sector could lead to reduced capital costs and better opportunities for new consumer companies to access capital markets.

In response to economic challenges, Beijing has set a GDP target of around 5% for the year. Minister of Housing and Urban-Rural Development Ni Hong recently stated that if necessary, developers should face bankruptcy, and the government will focus on promoting affordable housing development.

Recent data indicates some stabilization in the property sector. New home sales in major cities showed signs of improvement, with a smaller year-on-year decline compared to previous periods. This improvement was particularly noticeable in China’s largest cities.

Consumer Trends

According to KKR, most of its investments in China focus on consumer and service companies. These businesses reflect how people with middle to higher incomes in China are spending money to upgrade their lifestyles, but not extravagantly.

KKR’s report mentioned that these companies are seeing solid growth in sales, maintaining good profit margins. People are spending money on things like smart home devices, pets, and leisure activities. Domestic travel is also popular among consumers.

In the first two months of the year, retail sales in China increased by 5.5% compared to the previous year, which was better than expected. This growth was mainly driven by increased spending during the Lunar New Year holiday.

Looking ahead, KKR believes that China might adjust its policies to be more favorable for investors, similar to what it has done in the past. While KKR doesn’t see this as a signal to invest heavily right now, they suggest that if China does make investor-friendly changes, the market could bounce back significantly from its current state.

Additionally, authorities in China have introduced measures to provide financial support to certain property developers. Many local governments, excluding some major cities, have also relaxed restrictions on home purchases.