Real Estate Stocks: Time To Sell The Shop?

by: Doug Young

Shares of US-listed Chinese real estate websites have been on a roller coaster ride these last few days, raising the question of what the next few years may hold for industry stalwarts SouFun (NYSE:SFUN) and E-House (NYSE:EJ), and newly listed Leju (NYSE:LEJU). For anyone who doesn’t live in China and is reading this, the issue that’s weighing on investors’ minds is the fate of a Chinese real estate market that’s showing early signs of a needed correction after years of hyper growth. Such a correction would undoubtedly put a chill on transaction volumes and other service-related activities, which form the mainstay of these New York-listed firms.

June 12 could well go down as the day that saw Chinese real estate services stocks head into a prolonged period of stagnation after some strong growth in the previous year. SouFun led the downward charge that day, with its shares tumbling as much as 20 percent. E-House and Leju both saw their shares drop sharply though by lesser amounts in the 8-10 percent range.

The sell-off was so alarming that SouFun held a conference call to calm investors’ nerves, and its shares have subsequently regained some of the ground they lost. (company announcement) E-House shares have also regained much of their losses, though Leju’s shares haven’t recovered just yet. SouFun and E-House have both been listed for years, though Leju just made an IPO in April. At its current price of $10.36, its shares are slightly ahead of their IPO price, though they’re nearly 20 percent down from their post-IPO highs.

Shares of these 3 companies may look weak, but their recent slump is relatively mild compared to what’s happened to some Chinese real estate developers’ stocks these last few months. Shares of strong players like leading developer Vanke (OTC:CVKEY) are down 35 percent over the last 12 months, while some smaller players are down even more.

Everyone is fretting over a real estate market that has posted explosive growth over the last 2 decades since China started allowing the development of privately owned, western style properties. But that growth has shown signs of ending this year, with prices stalling and transaction volumes slowing sharply as regional governments take steps to boost their local markets.

Myself and others have previously predicted a correction for the market, and in those cases were incorrect. But perhaps this time the correction is finally coming, which should pose some interesting challenges for SouFun, E-House, Leju and the many other companies that make their money from real estate services in China.

To figure out what lies ahead for these US-listed players, it’s helpful look at their current valuations. SouFun shares currently trade at a relatively modest price-to-earnings ratio of about 12 based on last year’s earnings, and investors aren’t expecting big profit growth this year. E-House trades at a richer P/E of 20, but again investors are betting the figure will come down modestly this year as profit growth slows. Leju is showing similar trends, with a P/E of 22 based on 2013 profits but the figure falling to 15 based on expectations for slowing growth this year.

So, what does all this mean? Essentially, investors aren’t expecting big growth from these companies, whose valuations already look quite reasonable compared with other Chinese tech firms. While pricing weakness in the property market is likely for the rest of the year, we could actually see a spike in transaction volumes if home buyers start to panic and sell due to concerns about further price declines. At the end of the day, there does appear to be some potential upside in these shaky real estate services stocks, though such upside could be relatively short lived if the coming downturn really materializes and ends up lasting several years.

Bottom line: Chinese real estate services stocks could see some upside in the next 6-12 months due to overselling, but could face longer term pressure if a property correction drags on for several years.

Editor's Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.