Uncertainty clouds China Housing

2010-06-22: Sales are slow at China Housing’s (CHLN.NASDAQ) main development in Xi’an, the Puhua project. The prospects of it meeting shareholders' expectations are minimal We have passed judgment on China Housing & Land Development (CHLN.NASDAQ) before: a risk not worth taking at its current valuation. Our skepticism was largely directed at the company’s Puhua project, which we doubted could live up to expectations.

SinoSage recently visited Xi’an to see Puhua first hand and to get a sense of the local property market as a whole. Our earlier concerns appear to be well founded.

First, a bit of background: Construction on the Puhua project, a 79-acre site in Baqiao, a district on the outskirts of Xi’an, began in the second quarter of 2009. China Housing expects the 5,500-unit residential development to generate US$700 million over a period of five years. However, by the end of March – at least three months after pre-selling began – only 393 units had been sold for a total income of US$31.7 million.

Baqiao has been designated a major resettlement zone and Puhua project brochure is effusive in its praise: “After 2010, Baqiao will have a large lake area, large forest coverage and many new industry complexes. The government is investing US$7.2 billion in the Chanba ecological area and 900,000 mid-high income inhabitants will be living there … a series of top international capital will be invested here.”

SinoSage can confirm that Baqiao is indeed a hive of construction activity, most of it associated with an “Ecological Park” to be completed in 2011.

Beyond this, accounts vary. Local officials said the government will spend US$2.2 billion – US$5 billion less than Puhua’s projection – on infrastructure and associated elements including the Xi’an Northeast Financial Center, a large residential complex and an expo site. They expect the population to be 550,000 by 2020, 350,000 less than Puhua’s figure.

These are not the only potential problems with the project. The Chanba ecological area where Puhua is based is not an independent jurisdiction with full execution power over its development plan – it has to rely on the cooperation of three other local authorities to execute projects.

The local government’s ability to attract private investment is also limited. Existing businesses in the area are generally low level and poor quality. Whatever it may become in the future, Baqiao today is still basically a rural area with little in the way of urban facilities.

Moreover, apart from the government-funded Ecological Park and Horticultural Expo, we saw no other major construction projects. Puhua is by far the largest residential complex in Baqiao and there are very few others underway.

China Housing’s brochure vigorously promotes the “riverside views” and strong transport links of the Puhua project. These, too, appear to be overhyped.

The project may have “Joy of Water Life” as its theme, but it remains desperately short of water and greenery. The river is dry, and local residents said it has been that way for years.

As for location, Puhua is connected to central Xi’an via three highways, while Metro Line 1 is due for completion in 2013. The project is, at present, a 40-minute taxi ride from central Xi’an and there are few buses. Traveling between the project site and the city center is not an easy commute, and it’s difficult to say when this might change.

Xi’an’s most popular residential areas remain the northern and southern suburbs and Gaoxin district. Developments are underway in all three, and the planning and organization is clearly better than in Baqiao, with schools, hospitals and malls already in place. It takes 10-15 minutes to reach the city center.

In each of the three areas, quoted prices are RMB4,500-6,500 (US$660-950) per square meter to Puhua’s RMB6,500. The average monthly income in Xi’an is around RMB2,000, which means purchasing power is limited.

Our conclusion is that Baqiao is weaker than competing districts of the city. The minimal activity at Puhua’s sales office would seem to confirm this.

Huang Cangsang, CFO of China Housing, admitted that the domestic property market is likely to encounter difficulties in the short term due to government tightening policies. “But small-to-medium sized cities in northwest China are less influenced by these factors,” he added. “Therefore, we are very confident of the property market in Xi’an in the long run.”

Based on discussions with people from a variety of backgrounds, SinoSage generally found a higher level of confidence in the property market compared to other big cities in China. Local people feel that the real estate market in Xian is not so bubbly and so the impact of cooling measures should be limited.

But affordability remains a pertinent issue as far as Puhua is concerned.

According to the manager of the project sales office, nearly 60% of the total 838 units available in phase one were sold between October 2009 and May 2010. The average purchase price was about US$924 per square meter (based on a range of US$733 to US$1,320) and the average unit size was 120 square meters. However, the sales figures provided by the manager show that only the lower priced and smaller size units are popular. The larger units remain mostly unsold.

Our estimate is that the total sales revenue by May 2010 came to around US$55 million. This is well short of the average US$175 million required per phase if the project is to reach its US$700 million target.

SinoSage believes sales are falling short of projections because China Housing has been overoptimistic in the face of limited market demand. The bottom line is that Puhua doesn’t have a product that fits well with the middle-class buyers being targeted.

Last time we said the company wasn’t worth the US$2.00 at which it was then trading; the stock was only worth a punt if the price slipped below US$1.00. Now investors might want to consider closing the door on China Housing.