Chinese Real Estate Growth Expands Into Smaller Cities Even As Housing Fears Linger

by: Kevin Quon

For the past few years, as the world emerged from one of the greatest recessions it has ever encountered, one of the few notable countries that has experienced ongoing substantial growth has been China. With hundreds of millions of rural Chinese projected to move into cities in the coming decades, new housing demand has been skyrocketing. Yet recent concerns of an economic slowdown in the country have turned eyes once again to the fears of a possible Chinese real estate crash.

For its part, the central government has taken drastic measures to cool down the market. With speculation rampant, housing markets, particularly in the larger cities, have seen overwhelming increases in value. And thus far, the government's efforts appear to be succeeding quite well. Year-over-year property prices have declined in 46 of 70 cities, according to last month's survey as per the Globe and Mail. Yet such a decline in property prices has likewise been more difficult to swallow for public real estate developers and services companies.

For the companies listed on the American exchanges, well known real estate service companies, such as E-House Holdings Limited (NYSE:EJ), Syswin Inc. (NYSE:SYSW), and IFM Investments Limited (NYSE:CTC), have all taken significant blows over the last month, and significantly more so over the past few years. In the last month alone, E-House saw its shares fall from a high of $7.60 to the most recent price of $5.01, a decline of 34%. Syswin fell from $1.85 to the most recent $1.05, a decline of 43%. And IFM Investments fell from a recent $2.03 to $1.25, a decline of 38% in a relatively short time span.

For property developers, the outlook continues to remain cautious, but robust. Smaller developers such as Xinyuan Real Estate (NYSE:XIN), China HGS Real Estate (NASDAQ:HGSH), and China Housing and Land Development (NASDAQ:CHLN) all continue to express confidence in their business models. Most notably, each appears to be concentrating on Tier II, Tier III, and Tier IV cities, when contrasted against the larger markets found in the Tier 1 cities.

In its most recent earnings conference call, Xinyuan expressed the following:

"We are pleased to raise our full year financial forecast. This reflects higher levels of contract sales in the current operating environment [inaudible] expected easing of purchase restrictions from the Chinese government this year. Our balance sheet remains very strong, and our quality development project in Tier-II and Tier-III cities will allow us to record continued growth in 2012."

In its latest Form 10-Q, China HGS Real Estate reported the following:

"Since the initiation of our business, we have been focused on expanding our business in certain Tier 3 and Tier 4 cities and counties in China. The restrictive policies started to have significant impact on the real estate market in Tier 3 and Tier 4 cities in late 2011. These policies also negatively affected buyers' confidence and consumption psychology. Some buyers are taking a wait-and-see attitude and may delay their purchasing decision...

Despite the declining transaction volume and cooling real estate market, housing prices in Tier 3 and Tier 4 cities and counties have not shown a substantial correction. For the three months ended December 31, 2011, our average selling price for real estate projects located in YangCounty was approximately $444 per square meters, an increase of 16% from the average selling price of $383 per square meter in fiscal 2011."

As a developer of Tier II and Tier III cities in western China, the majority of China Housing and Land Development's customers are first-time home buyers and first-time upgraders. This is a trend that the company believes will benefit from China's rapid GDP growth. In its latest Form 10-Q filing, the company stated one of its goals concerning its ongoing strategy:

"Expand into Other Tier II and Tier III Cities. We believe our proven business model and expertise can be replicated in other Tier II and Tier III cities, especially in western China. We stepped into Ankang city in July 2011 for a residential project. Furthermore, we have identified certain cities that possess attractive replication dynamics."

Overall, these Chinese property developers have experienced a cautious, and yet optimistic approach to the ongoing market. Expansion appears to be moving further out west to the smaller cities, with more prominent growth and lucrative options available for these companies. Even as the housing market cools down in China, the growth trend continues as one of the largest migrations of people moving from rural towns and into cities continues to unfold in modern times.

Disclosure: I am long XIN.