HSBC warns of 15% drop in Chinese residential real estate prices

In 2H11, we expect to see more meaningful price cuts emerge in major cities, as developers seek to stimulate sales volume amid a backdrop of lukewarm sentiment and the need to deliver growth in sales targets. The contract sales target lock-in ratio is noticeably lower compared to the same period last year, and we expect to see more companies struggle to hit these targets.

Broad-based price cuts are imminent…. We are introducing 12-month forward NAV estimates to our analysis, which will capture our forward physical price assumptions. Our discount to NAV-based target prices are now tagged to forward NAV assumptions.

We expect residential price falls of 5-15% in the coming 12 months, which supersedes our previous flat price assumption. Over the next 12 months, we expect residential prices to fall by 15% in first-tier cities and by 5% in second-tier cities, while prices in tier-3 (or lower) cities remain flat. We are also building in flat price assumptions for office and retail.

We believe our property price forecasts are reasonable in light of a more competitive sales landscape due to abundant new supply across the country, and large developers competing intensively for increasing market share. The recent political tone still points towards the need to see softening price trends; as such we see the house price growth targets set by local governments (GDP/CPI growth-based) more as a ceiling rather than an actual target.

The differing degree of price correction across the different cities is a reflection of pricing trends in
the past year as well as accounting for the impact of the secondary market. Our more aggressive
price cut assumption in tier-one cities reflects our belief that their much more liquid secondary
market will pose a more competitive threat to primary project pricing.

…and may bring us closer to an equity market inflection point. The emergence of a more meaningful price correction in the coming months may be a blessing in disguise for the property stocks. For the policy makers, this will be a sign that administrative measures that had been put in place since 2010 are finally taking effect, and hence this reduces the chance of introduction of more draconian demand side policies.

Stabilization on the policy front is an important first step for investors to gain comfort with the sector in our view. Moderate price cuts may also act as a stimulant for sales volume, which could buffer the weakness of the primary market that is just beginning to show through in the April primary sales statistics and the developers’ May contract sales data. We believe the market places a much greater weight on volume and developers’ ability to deliver volume growth than ASP growth.