Chinese Investors Shrug Off Property Downturn, Cheer SouFun

Jul.11.14 | About: SouFun Holdings (SFUN)

Investors in China real estate service stocks have a short memory these days, reflecting the broader uncertainty in the country's real estate market that could be on the edge of a major downturn. After a sharp sell-off earlier this week on concerns about a property bubble, shares of SouFun (NYSE:SFUN) have come bouncing back on news about equity tie-ups with two leading home agency companies. Shares of its two major listed peers, E-House (NYSE:EJ) and Leju (NYSE:LEJU), have also quickly bounced back from the brief sell-off as investors decided it might be premature to worry about a downturn.

I was a bit surprised by this sudden change of heart among investors who are clearly a fickle group when it comes to Chinese real estate. The earlier sell-off was sparked by reports that a growing number of home builders, facing financial difficulties, were delaying payments to their real estate service providers. Such reports are appearing with growing frequency, though it's hard to say whether the problem is getting worse or perhaps is just affecting the smallest, least profitable companies that feasted on China's property bubble over the last decade.

SouFun's shares were the worst hit when the reports surfaced earlier this week, sparking a sell-off that saw its shares tumble 12 percent. Shares of E-House and Leju also fell by smaller amounts, losing 4 percent and 8 percent of their value, respectively.

In a bid to ease those fears, SouFun just announced new tie-ups with two of China's top home agents (company announcement). Such agents are one of the primary revenue sources for SouFun and its peers, buying advertising and other services on their sites. The separate strategic tie-ups will see SouFun team with Shenzhen World Union Properties Consultancy and Hopefluent Group, two of China's three largest new home agency companies.

The deals will see SouFun invest $120 million for 10 percent of World Union's shares, and another $91 million for 17 percent of Hopefluent. Money for the two purchases probably came in part from SouFun's issue last year of $350 million in convertible bonds.

Shareholders certainly seemed to like the two new tie-ups, bidding up SouFun shares by 6 percent in the latest trading session, bringing them close to where they were before the earlier sell-off. Shares of E-House and Leju have also bounced back strongly since the sell-off, and are now back to their previous levels.

Investors probably believe that SouFun is spreading its risk by taking the stakes in these two home agencies. But the reality is that SouFun could be exposing itself even more broadly to a property downturn through these two new investments. Real estate agencies help property developers to sell new homes, and then collect a fee after the sale closes.

Thus through this latest new pair of tie-ups, SouFun is taking on the added risk faced by these two major home agencies if they fail to get paid by property developers. It's clear that some developers are already delaying payments to some of these service companies, and many weaker developers will ultimately never make those payments.

The bigger and more important question is whether this kind of payment delay or default will start to spread up the food chain to medium-sized and larger property developers. Such a development could easily happen if China's property market shows continued weakness, which looks increasingly likely. The recent rebound for SouFun, E-House and Leju shares indicates investors aren't worried about such defaults. But that could be a big mistake if the market downturn starts to accelerate, which looks increasingly likely due to inflated prices and oversupply.

Bottom line: Real estate services firms like SouFun could suffer from falling revenue and payment delays in the current market downturn, even though investors are currently brushing off such concerns.

Disclosure: None.