Uh-oh- Here it comes – China Property Bubble Pops

Read from the bottom on a recent China property bubble discussion and this morning???s Wall Street Journal Article on the China Property Bubble Article.

Some ETFs that could be impacted:

?????????????????? CHIX -??http://www.google.com/finance?q=NYSE%3ACHIX?? – ??Global X Financials ETF (CHIX) is a pure play on the Chinese financial sector.

?????????????????? AFXI -??http://www.google.com/finance?q=NYSE%3AFXI??-??iShares FTSE/Xinhua China 25 Index Fund (FXI) allocates nearly 47.7% of its assets to financials. Some of its top holdings include China Construction Bank (CICHF.PK), Industrial & Commercial Bank Of China, and Bank of China (BACHY.PK).

?????????????????? GXC-??http://www.google.com/finance?q=NYSE%3AGXC??:??SPDR S&P China ETF (GXC) allocates nearly 33.3% of its assets to financials and boasts??CICHF.PK??as its top holding.

?????????????????? YAO:??http://www.google.com/finance?q=yao??:??Guggenheim China All-Cap ETF (YAO) allocates nearly 33.7% of its assets to the financial sector.

?????????????????? TAO:??http://www.google.com/finance?q=NYSE%3ATAO??(Real Estate but more in HK than China)

Some of the ETFs above from Kevin Grewal at Seeking Alpha in another context.

Another Takes on the WSJ article here:??http://www.alsosprachanalyst.com/economy/china-real-estate-boom-is-finished-now-what.html??


Wall Street Journal Article


June 9, 2011

The Great Property Bubble of China May Be Popping

After years of housing prices gone wild, China's property bubble is
starting to deflate.
By Bob Davis

BEIJING???After years of housing prices gone wild, China's property
bubble is starting to deflate.
Residential prices are heading downward in some major cities, damping
some undesired real-estate speculation but raising the prospect that
the Chinese economy may slow more rapidly than anticipated with
profound consequences for global growth.

Real estate is a foundation of China's phenomenal growth record in the
past two decades, and its health is crucial to China's construction,
steel and cement sectors. Real estate is also a favored investment of
Chinese looking to get better returns than bank deposits pay. Local
municipalities and provinces depend on rising prices for land sales as
well to fund infrastructure projects.

World Bank economists warned at a Beijing press briefing on Wednesday
that a real-estate bubble was among the biggest economic risks China

Already, in nine major cities tracked by Rosealea Yao, an analyst at
market-research firm Dragonomics, real-estate prices fell 4.9% in
April from a year earlier. Last year, prices in those nine cities rose
21.5%; in 2009, the increase was about 10%, as China started to
recover from the global economic crisis, with much steeper increases
toward the end of that year.

A downturn in property and apartment prices would harm Chinese
industry and investment, and crimp consumer spending. China is a
"housing-led economy," says UBS economist Jonathan Anderson, who
estimates that property co
nstruction alone accounted for 13% of gross

domestic product in 2010, twice the share of the 1990s.

While China's anticipated growth is still well above that of other
large economies, any reduction could have deep consequences. The
global economy is now even more dependent on China for demand for
anything from commodities to luxury goods, given the tepid recovery in
the U.S. and Europe's continuing sovereign-debt problems.

If the Chinese housing market slows faster than people had expected,
the impact would be felt in a number of markets that export heavily to
China. Many Latin American and African economies have shifted their
focus toward Chinese demand for their raw materials, and many Western
firms, including U.S. retailers and fast-food chains, now bank on
Chinese consumers feeling wealthier to make up for stagnating sales
elsewhere. Also, plans by local Chinese governments to improve
infrastructure loom large for heavy-equipment makers like Caterpillar


The red-hot demand for Chinese housing that has fed such growth plans
is now ebbing. Data from Soufun, a Beijing real-estate consultant,
show average property prices in China in May rose 5.1% compared with
the year earlier, a slowdown from rapid rises in 2009 and 2010.

Standard Chartered Bank estimates that China's so-called tier-two
cities, such as Dalian and Tianjin, may have 20 months of housing
inventory by year end, putting "substantial" pressure on prices.
Standard Chartered forecasts price cuts of 10% to 20% "in many

A number of analysts think official data, which have continued to show
a slight rise in prices, understate the slowdown as the government can
affect the numbers by pressing developers to withhold or add
high-value properties to the market depending on what it wants the
data to show.

Ardo Hansson, lead economist at the World Bank's Beijing office, said
Wednesday that China should consider boosting interest rates further
to tame consumer prices and head off bubbles in housing and other
assets. He didn't comment on whether the current real-estate slowdown
would harm economic growth, but stressed the importance of the
property sector to the Chinese economy, especially in such sectors as
steel and cement.

Partly as a result of the Chinese real-estate slowdown, prices for key
industrial metals used in construction have softened. Spot copper
prices have lost 5% since early March, and have now fallen to around
69,000 yuan ($10,647) a ton after racking up 34% in gains between June
2010 and March this year. Major steelmakers have been consistently
cutting their product prices since February.

Chinese officials, facing widespread anger from ordinary citizens who
can no longer afford to buy a home, have sought to slow the rise in
housing prices. The unanswered question is whether the government can
manage to reduce prices gradually in a way that won't undermine
economic growth.

???Agence France-Presse/Getty Images A building site in Chongqing.

Since January 2010, the Chinese government has introduced a number of
measures to stem speculation, including boosting down-payment
requirements on mortgages for second homes to 60% from 40%, barring
state-owned enterprises outside the real-estate sector from investing
in property and lifting the amount of cash banks must hold in reserve
11 times???essentially reducing funds banks can lend.

"In some ways, [real-estate] prices are really crazy," said Guo
Shuqing, chairman of China Construction Bank, in an interview last
week. He says the cost of apartments in big cities is well beyond
young couples' means.

Beijing has one of the most expensive real-estate markets in the world
relative to the income of its citizens. Calculations based on Soufun
data show that in the opening months of 2006 an average-price new
apartment in China's capital would cost around $100,000???the equivalent
of 32 years' disposable income for the average resident. By 2011, the
average price had more than doubled to $250,000, but relatively modest
increases in income mean it would now take 57 years of saving for the
average resident to cover the cost.

In Shanghai, apartment sales tumbled 37% in April, to 11,000 units,
compared with 17,500 units in January, according to the Shanghai Real
Estate Trading Center. With business so slack, Midland Realty, a unit
of Hong Kong-based Midland Holdings Ltd., closed eight of its nine
offices in Shanghai. "The government's policy on purchase restrictions
had a huge impact on both selling and buying, leading to transactions
drying up," said Xu Feng, senior director of Midland's development
center in Shenzhen.

According to Dragonomics, sales volume in the nine cities it tracks
fell by about half since the start of the year. In Beijing, that has
meant rising rents, say real-estate agents. Zhang Kai, an agent at
Home Link in middle-class neighborhood Tuanjiehu said the number of
sales had dropped by half since February and monthly rents for small
apartments jumped to about 3,000 yuan ($460) in June from 2,500 yuan
($385) a month earlier. Many apartment owners don't want to sell, he
said, because they are waiting for prices to turn around.

???AFP/Getty Images A woman rides a bicycle by a group of newly-built
properties in Hefei, a city in eastern China's Anhui province.

One real-estate agent elsewhere in Beijing said regulations that
required buyers to have formal Beijing residence and proof of having
paid taxes for five years straight were crimping sales.

The housing slowdown comes at a time when there is evidence China's
growth is slowing. Last week, two surveys of purchasing managers
showed a slowing of manufacturing activity. China, the world's
second-largest economy after the U.S., grew at 9.7% in the first
arter from a year earlier. In late May, Goldman Sachs lowered its

estimate of Chinese second-quarter growth to 8% from its previous
estimate of 8.8% as the government continues to tighten monetary
policy to fight inflation and import demand from the U.S. weakens.UBS
economist Tao Wang says she thinks the price decline will be
short-lived as Chinese investors, with few other options, will again
pour money into real estate and as local governments push up the price
of land they sell to developers. Real-estate prices will rise for
another three to five years, she estimates. A sharp fall then would
batter investors, banks, construction firms and other sectors.

Esther Fung in Shanghai and Tom Orlik, Helen Qu and Chuin-Wei Yap in
Beijing contributed to this article.

On Jan 19, 2011 Fund Manager at Large Cap Global Equities Fund wrote:

I had to dig up some old charts…??

Chinese house price increases viewed in isolation look scary but adjusted for income growth – for which nominal gdp growth is a decent proxy, they appear less so…??



But trends in affordability are worsening (vs. trend since early 2000s esp. in large cities) thanks to that huge spike in property prices in 2009 and 2010 and the govt knows this and have announced a massive public housing program to be implemented in 2010 and 2011 + are introducing city-specific measures to cool the pvt market. They have only had limited success so far. ??Their efforts to beat the great global recession have been fabulously successful but dealing with the hangover is proving harder than expected.??

Also, real estate's share of GDP (c10%) has remained fairly stable over a long period…might have perked up in 2009/2010 but the govt has been trying to clamp down on this with varying degrees of success for the last 15months, unlike in some of the neighbouring countries which saw a sustained jump in gdp share over almost a decade in the lead up to the asian crisis. Also, here I would differentiate the north (incl china)/south-east asian countries from other emerging countries – as these countries pursue the export growth model driven by huge fixed asset investment and high savings rate…(without getting into the merits of this model!)??



It is in this light that the capital stock will continue to grow in china despite the headlines about the gazillion miles of roads, rail tracks and a million airports already built…and there is the whole of western china to deck up….sure the returns on these investments are not optimal…pity the chinese savers…??

Also other things to consider to put chinese market in perspective??
1/ there was virtually no private market in chinese real estate before mid-late 90s. So it would be hard to compare trends in china vs. other markets that have had a long history in pvt housing i.e. pent up demand needs to be taken into consideration. I don't quite know how to adjust for this…??
2/ Anecdotal evidence suggests that avg life-span of a building is below 30 years vs >100yrs in the Uk and c70yrs in the US => more pulling down and putting up buildings. Also, you wouldn't want to live in the houses govt built in the 80s..??
3/ Chinese govt statistics don't take into account depreciation in calculating per capita living space + unregistered rural people in cities are not accounted for i.e. the per capita living space is potentially overstated??

Despite all the above were excesses committed in chinese housing market? Without a doubt??
Could it all end in tears. Of course.??
Has the chinese govt woken up to the risks? At least 15months ago.??
Do they have the wherewithal to trigger a softlanding in the real estate market? Yes.??
Could they fail? Yes, but one only hopes they have learnt a lesson from their 2007 effort to cool things down that killed the real estate market. This time round it could kill the nascent global recovery.??
Do they have the balance sheet strength to absorb most of it? you bet..??



Anyway, we have had a negative view on chinese banks and real estate stocks for the last 18 months and both those sectors have underperformed.??

But that doesn't mean that the sector couldn't collapse from here. So if you want to short this theme, apart from shorting TAO you could buy CDS protection on chinese real estate company debt – there is lots of it. One hedge fund manager is buying CDS protection on Japanese steel companies! You can try the Koreans..or some of the smaller aussie commodity plays..??


On Tue, Jan 18, 2011 at 6:51 PM, Chauncey??wrote:




Thanks for this.

???? I had checked??TAO's Holdings??and saw that they had about >70% exposure to HK based companies. But I had presumed (without doing a deeper dive) that a lot of these companies had significant exposure to mainland projects. E.g. CKH has these??mainlaind projects. Again, CKH also has other non-real estate business which creates a buffer. I need to do a deeper dive on these underlying names though. TAO is not perfect and would rather have direct exposure to the actual names but not sure how the exact trade would work.

???? Reg the Mckinsey chart, I??skimmed through the actual report??(attached): The chart there is a bit apples to oranges comparison because developing economies will by definition have a lower capital stock per capita because they have a lower GDP per capita. So, basically as GDP increases, capital stock increases. Another chart on Page 20 (Exhibit 4) seems more of an apples to apples comparison i.e. GDP to Capital Stock Ratio and China is actually above average. A few more interesting observations:

o The capital stock is not actually broken down to its specific??constituents i.e. Residential Real Estate, Machinery etc…. Although in the methodology (Page 73), McKinsey seems to have the data separately for residential real estate & productive assets.??

o Although, they have not broken out real estate to GDP ratios in a chart form, they have an interesting snippet of information in Page 35, that talks about Residential Real Estate as a % of GDP:

?? Most developing countries invest less in residential real estate than mature economies as a share of GDP, reflecting their lower household income levels. India and Brazil currently invest just 1.6% of GDP in residential real estate, far below the mature market average of around 4.6% percent in 2008. But over time, this will change as incomes rise.??China is already an exception because of its large fast growing urban population and expanding middle class. China invested 8.9% of GDP on housing in 2008, far above the US peak of 6.2% in 2005.

o The above information seems to imply that not only is China way above its peer group (developing countries) in Residential Real Estate to GDP, they are in fact even higher than a developed economy during its peak real estate bubble i.e. US in 2005.

Look forward to your thoughts.

On Jan 18, 2011 Fund Manager at Large Cap Global Equities Fund wrote:

The only thing I'd say about TAO is that >50% of the holdings are HK holdings – that have little or nothing to with the mainland. These names wouldn't obviously do that well if China goes to hell (can't imagine regional/global equities and esp. commodities doing that well either) but are very closely tied to fed's policies via the ccy peg. Unless you have a strong view on policy tightening in the US in the next few months/quarters, these names would have some tailwind supporting them.??

Also, consider this chart from a recent Mckinsey report…China and urban China don't seem that deviant from historic trends of more developed countries..(unless they take off vertically from here)??


From Analyst at $400M Hedge Fund: on Jan 17th 2011

More on the China Real Estate Issue: Funds being set up specifically to short China.??

On Sat, Jan 15, 2011 at 4:00 PM, Chauncey Wrote
More China real estate??Madness in the NY Times article here.????

Anyhow: based on some quick research, the 1st order, direct co-relation to short on Chinese real estate is :??TAO??(An ETF on Chinese Real Estate & Property Stocks). There are a bunch of 2nd derivative plays on this short (See here for an example here of 2nd derivative plays). ??I am not convinced of the 2nd derivative plays especially when the direct Put option is cost effective.????

A Put Option on TAO for June 11 @ Strike price of $19 is available for $1. This stuff may not blow up by June 2011 but a 5% chance to keep yourself in the markets is worth evaluating. The current price is $21.??

On Fri, Jan 7, 2011 at 3:59 PM, Chauncey wrote:
I just read quite an interesting article on Fortune Magazine about Jim Chanos's – China Short thesis (on the plane so no link). I know I am extremely late to hear this view of Chanos.
But, the numbers seem unbelievable reg China's real estate market.
-5×5 office cubicle for every man/woman/child in China

New Residential real estate accounts for 15% of GDP

-60% of GDP is towards fixed asset investment
-Buyers in China purchased 44% more residential space than they did in
-Dubai during its peak had 240 sq. Mtrs/1million dollars in GDP. China has 4x that.
-Lending went up 95% yoy 2009-2008 and up 60% through 2010
-Perpetual China Bull – Goldman is forecasting a 10-20% decline in housing prices in 2011.
-Chinese vacancy rates are accepted to be unusually high but exact numbers are extremely high. The Chinese investors essentially treat real estate investing as investing in Gold without even bothering to rent them out because of the unusually low rents.

This was not there in the article but almost every person who has visited China and who I have spoken to has told me about the empty office/residential buildings in China.
The bull/(nothing here, move on…) point of view is that there is no
leverage used in buying those assets and the economy is growing so its
not so bad.

Still- just because there is no leverage (e.g. Dot com bubble) doesn't mean that there is no bubble there.

Key question- since the timing is going to be uncertain- how does put on
a 2 year short on this thesis.

I am going to dig more into this.??




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