HOUSEHOLDS LOOKING AT REAL ESTATE PURCHASES, BUT GROWTH

UNCLAS SECTION 01 OF 06 SHANGHAI 000291

SENSITIVE
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STATE FOR EAP/CM, DAS DAVIES
TREASURY FOR OASIA/INA -- DOHNER/HAARSAGER/WINSHIP
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USDOC FOR ITA DAS KASOFF, MELCHER, MAC/OCEA
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E.O. 12958: N/A
TAGS: CH ECON EFIN EINV ELAB PGOV SOCI
SUBJECT: HOUSEHOLDS LOOKING AT REAL ESTATE PURCHASES, BUT GROWTH
STILL LAGS


1. (SBU) Summary: Chinese households in cities across China
began to show renewed interest in residential property during
the first four months of 2009, but the boost this gives to the
economy is limited because developers are still running down
their housing inventory. Speculators, who drove investment and
purchases on the high-priced end of the market, appear to still
be mostly waiting on the sidelines. Developers, too, are
cautious of overbuilding in the current environment, and have
used the uptick in demand to finish delayed projects and run
down their inventory. As a result, fewer construction workers
are needed, although so far the overall situation is not worse
than previous years, say our NGO contacts. Furthermore, a
prolonged downturn would begin to impact banks, which are more
dependent on the sector than the data suggests. End summary.


2. (SBU) This is the first of two cables on China's real estate
sector in the first four months of 2009. The cables are the
result of collaboration across the China Mission, with input and
clearances from Beijing, Chengdu, Guangzhou, and Shanghai.
EconOffs in those posts spoke with contacts over a period of
several weeks in March-May 2009. This cable focuses on real
estate sector trends--especially among households--and the
impact on property developers and banks. Septel will focus on
the Chinese government response to troubles in the real estate
sector.

============================
Housing purchases are up . . .
============================


3. (SBU) Residential real estate trading volume in the first
few months of the year has largely bounced back across China,
leading our contacts throughout China to be more optimistic
about the real estate market. According to a senior contact in
the NYSE-listed E-House real estate firm speaking in mid May,
trading volume for properties in almost all major Chinese cities
returned to normal levels over the course of January-April. He
added that most of the increased buying volume is occurring at
the low- and medium-priced end of the market, with smaller
increases on the high-priced end. (Note: E-House's proprietary
data system, known as China Real Estate Information Circle or
CRIC, covers 40 cities, including most provincial capitals. End
note.) The general manager at a US-Chinese manufacturing joint
venture in the Chengdu Consular District noted an uptick in the
housing market following the Lunar New Year in late January,
with people who were waiting for prices to bottom out now
feeling it is time to buy. In Guangzhou, property developer
Evergrande--one of the top ten real estate firms in China--said
that their sales in the first quarter of 2009 have been better
than during the same period last year, and shared the view of
other property developer contacts in the region who anticipated
that the upward trend would continue this year.


4. (SBU) Real estate professionals and government officials
alike point to the strong demand that will continue to drive the
housing market, including:
- In Beijing, demand from recent university graduates moving
to Beijing or parents seeking to put their children in Beijing
schools, according to a contact from Regal Lloyds Real Estate.
- In Chengdu, demand from low- and medium-income buyers, about
evenly split between people from Chengdu and immigrants--80
percent of whom come from elsewhere in Sichuan, according to the
Chengdu Housing Management Administration (CHMA). CHMA further
notes that the uptick is a natural correction from 2008, when
short-term downward pressures included correcting overheated
demand in 2007 as well as the impact of the earthquake and the
global financial crisis on consumer demand.
- In Shanghai, demand from households relocated from rundown
districts, newlyweds, and immigrants, according to an official

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with the Shanghai Municipal Urban-Rural Construction and
Transportation Committee. Also, people are seeking a hedge
against inflation, said a top Citibank official.


5. (SBU) Our contacts varied on the prospects of the retail and
commercial property markets, however. One contact whose company
operates China-wide told Guangzhou EconOff that commercial
transactions were largely unaffected by the downturn, while
another who focuses on South China said that both residential
and commercial were affected equally, only that residential
showed the effects more quickly. Beijing EconOff's contact at
Regal Lloyds confirmed that the city has a large supply of empty
office space--although not on Financial Street or in the
Zhongguancun high-tech zone. A CBRE Shanghai contact in March
said that commercial office space was likely to remain at a 30
percent vacancy rate through 2013, given the overbuild in the
Lujiazui financial district, and that retail space would have a
5 percent to 10 percent vacancy rate through 2011. In
Chongqing, commercial real estate turnover was lagging far
behind that of booming residential turnover in February and
March.

============================
. . . but some question the numbers
============================


6. (SBU) Some of our contacts see evidence of real estate
developers using fake mortgages and fake pre-sales to "make up"
the recovery. A Chinese Academy of Social Sciences scholar told
EmbOffs that housing pre-sales--which could be manipulated by
sellers to suggest heightened buyer interest--were on the rise
in Beijing at the beginning of 2009. Fake mortgages are another
problem, in which developers arrange for family and friends to
snap up units in a new building, and will then take them back at
a later date. The scholar heard a rumor that in Shenzhen there
was a case involving fake mortgages for 400 apartments, and said
he has heard similar stories about the housing market in
Beijing. An industry expert from the Beijing-based Soufun
Holdings also speculated that sellers are falsifying sales to
create a "buying environment" to help with market recovery.
However, he did not think it was an endemic problem, and
speculated that just a few people are doing this in Beijing. In
Guangzhou, a major real estate investor told EconOff that the
slight increase in prices was due more to manipulation by the
real estate companies than an actual recovery.

============================
Speculators cautious for now . . .
============================


7. (SBU) Our contacts generally paint a picture of reduced
interest from domestic and foreign real estate speculators. For
instance, says a Guangdong real estate consultant, large foreign
companies have been increasingly cautious about investing in
South China, especially when compared with 2007. In Chengdu,
there are some international buyers--e.g., from Hong Kong, the
Philippines, and Taiwan--but overall domestic and foreign
investors currently account for less than 10 percent of the
demand, the proportion that existed before the spike to nearly
25 percent in 2007, according to CHMA. On the other hand, there
are some indications of renewed interest in some areas. Since
March, some Hong Kong investors have been on the lookout for
cheap properties in Chongqing, according to an investment
manager at a large local real estate agency. And in South
China, small- and medium-size enterprises have been more active
in seeking out distressed properties, according to a consultant
contact there.


8. (SBU) Trends in the sources of funds for real estate support

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this picture, according to data from the first five months of
2009 compiled by Standard Chartered Bank and CEIC. Overall real
estate investment increased 16 percent compared with the same
period in 2008. Of this, deposits and advance payments were up
17 percent--indicating increased buyer interest, especially
given that the same indicator fell by 13 percent in 2008-- bank
loans were up 16 percent, and self-raised capital was up 11
percent. But foreign investment--an indicator of speculator
interest--was down 9 percent.

============================
. . . and developers are running down inventory
============================


9. (SBU) Nationally, according to E-House data, builders are
reluctant to start new construction projects, and instead are
focusing on selling off properties already under construction.
The contact cites the National Bureau of Statistics' Developers
Real Estate Sentiment--which hit a low of 94.74 in March and
stayed at 94.76 in April--to indicate that developers may see
the bottom of the market, but are not yet in an expansionary
mood. (Note: The index in May again rebounded slightly,
reaching 95.94. A level of 100 in the index indicates positive
market sentiment. End note.)


10. (SBU) In Beijing, for example, investment in residential,
office, and commercial real estate has hit all-time lows, with
the sharpest decline in residential real estate, which fell from
a high of 36.6 percent year over year growth in June 2008 to
almost no growth in February 2009. The situation is similar in
Chengdu, where new housing construction was down in the first
quarter by 58 percent compared to same period last year,
according to the Sichuan Statistics Bureau. While overall fixed
asset investment in Chengdu was up 29.5 percent in 2008 over the
previous year, investment in real estate was up only 7.8
percent. As a result, real estate investment as a proportion of
fixed-asset investment in Chengdu has gone down by 3.8
percentage points. (Comment: The sharply slowing growth of
real estate investment in the first quarter is a drag on the
Central Government's efforts to reach 8 percent growth in 2009,
despite the signs of consumer interest in purchasing homes. End
comment.)

============================
Slowdown hits construction workers
============================


11. (SBU) According to two Beijing-based migrant worker NGOs,
construction workers, along with workers in export-oriented
factories, are the two groups most affected by the late 2008
downturn in the job market. In addition, the NGOs tell EconOffs
that wage arrears problems are up again, after declining
steadily for a few years. Despite this, experts say there were
fewer complaints from migrant workers in the construction
industry over the wage payment issue in 2008, and thanks to the
Olympic Games, the government has been paying close attention to
the wage problems for migrant workers since last year.
(Comment: This is mostly due to fear of collective unrest by
the workers. End comment.) With so many projects currently
suspended, there are still many migrants who were not fully
paid, and some not paid at all, in late 2008. In sum, project
suspensions have forced many construction migrant workers to
stop working, and most of them had to return home earlier than
ever, with only a portion of the promised annual wage, and, for
some, only a small stipend. (Note: Despite this bleak picture,
both NGOs say that the overall situation has not worsened from
past years. End note.)


12. (SBU) That said, some factors may be limiting the impact on

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workers. In Sichuan, quake reconstruction is creating strong
employment demand. Even some places outside the immediate quake
zone seem to be reviving: a contact in Chongqing observed that,
while construction activity was visibly way down in late 2008,
as of January it looked like someone flipped a switch back to
the previous frenetic pace, putting many people back to work.
And according to a real estate industry contact in Guangzhou,
all real estate companies in the region slowed their production
down dramatically, especially the production of high-end
housing, but due to low labor costs very few people were laid
off as a result.

============================
Housing prices edging up in some markets
============================


13. (SBU) With trading volume for housing returning to normal
levels, according to our E-House contact, prices in some markets
by April had begun to rise slightly. Of the 40 cities covered
by E-House, the contact pointed to Shenzhen, Hangzhou, and
Chongqing as clearly coming off their lows. For example, a real
estate agent contact told Chengdu EconOff his personal view on
Chongqing housing was that now is the time to buy, given his
sense that price and turnover signals indicate an upward trend.
(Comment: This is relatively good news for the real estate
industry, which has been quick to hype the shift in hope that
consumers, sensing a bottom to the market, will swarm back in.
End comment.)


14. (SBU) The potential turnaround in prices comes at the end
of a long nationwide decline: sales prices in Beijing for
residential, office, and commercial real estate have all seen
consistent, gradual declines since 2008, and a Guangdong-based
real estate investor noted that prices have fallen to 50 percent
of their peak levels. Markets such as Chengdu and Chongqing
avoided the extremes of the bubble, though, with a real estate
investment manager there saying prices never got out of control.
He noted that long-term oversupply, combined with an
unwillingness of lower-end sellers to price below cost, has left
prices relatively stable.

============================
Real estate sector still could be facing weak growth
============================


15. (SBU) Industry experts disagree on the short-term prospects
for the housing market. Our Shanghai-based E-House contact
predicts that trading volume will tick back down in the middle
of the year--May trading slowed down from April's--before rising
later in the year when medium-term consumer demand kicks in
again. The contact further cites sentiment in the banking
industry that loose monetary policies will be halted in the
second half, impacting mortgage lending. A leading
Shanghai-based academic in mid May told a real estate
conference, "It is too early to say that the real estate market
will revive." Even more pessimistically, Consulate Guangzhou's
real estate consultant contact strongly doubts that the market
in South China will recover as long as the world economy
continues to have problems, and another locally based real
estate executive estimates that the China real estate market
will likely not fully recover until at least 2015. By way of
contrast, a Guangzhou-based executive with Evergrande--which is
seeking to issue an IPO--sees a continuous upward trend this
year.

============================
Banks relying too heavily on real estate growth?
============================


SHANGHAI 00000291 005.3 OF 006



16. (SBU) Several of our contacts raised the possibility that
banks are underestimating risk in the real estate sector,
especially with respect to their loans to property developers,
and may see a surge in nonperforming loans in a prolonged
economic downturn. In the fourth quarter 2008 People's Bank of
China (PBOC) Monetary Policy Report, PBOC stated that 18.3
percent of bank lending in 2008 went to real estate, including
both household mortgages and loans to property developers. As
mentioned above, bank lending as a source of financing for the
real estate sector is up 16 percent in the first five months of

2009. A Chinese Academy of Social Sciences (CASS) contact,
however, noted that banks were also exposed through other
channels, including real estate investment trusts (REITs) and
illegal channeling of funds from third-party enterprises. The
contact said that these two sources make up a large portion of
real estate firms' self-raised capital, which is up 11 percent
in the first five months. Adding together these and other
factors, according to the scholar, 80 percent of bank loans are
real estate-related.


17. (SBU) The CASS scholar noted that if housing prices drop
sharply, most of the legal and illegal loans will become
non-performing. He warned that a subprime crisis may occur in
China if prices continue to fall. CBRC did require banks to do
stress tests on real estate lending in 2008, but no public
information became available on the results. A construction
expert at the Jones Day law firm in Beijing stated,
"Non-performing loans are a ticking time-bomb." He speculated
that many loans will be non-performing by the end of 2009, given
current trends in lending. He told EconOffs that banks have
thrown money at projects with little risk analysis, and will
first try "evergreening" troubled loans rather than write them
off. In Guangzhou, our real estate consultant contact said that
banks would not be able to stay in business without the real
estate industry. Given this reliance, said the contact, if
prices had dropped a further 15 percent from their lows last
year, banks likely would have begun to fail.


18. (SBU) Some banks are aware of this vulnerability, say our
contacts. The executive of a Chengdu real estate company notes
that banks there are less willing to lend to real estate
companies and continue to rate them as high risk borrowers. In
Chengdu, this has resulted in a sharp drop in lending. In 2007,
60.3 percent of commercial bank lending went to real estate;
this dropped to 18 percent in 2008, and to 12.6 percent in the
first two months in 2009. In Beijing, the Jones Day expert told
EconOffs that, while banks are more willing to lend to
construction projects, they are cautious about lending to
private developers and real estate projects. He added that
there isn't a lot of sympathy for private developers, and there
is virtually no pressure from the government to lend to them.
As a result, bank loans are not reaching smaller real estate and
development firms, and there's a sense that there needs to be
some consolidation, he said.


19. (SBU) At the same time, our contacts agree that banks are
not at risk from homeowner defaults. Chinese industry experts
told EconOffs that mortgage defaults are not the "Chinese way,"
and they are sure people will continue to make home payments.

============================
Comment
============================


20. (SBU) Our contacts describe a real estate industry that
narrowly avoided larger problems this past fall, and now is
eager to find signs that the downturn has ended and profit
growth can return. However, the short-term prospects are still
uncertain, leaving the industry in a mood to coast along rather

SHANGHAI 00000291 006 OF 006


than rev up a new wave of investment and construction. This
industry mood is further darkened by Central Government policy,
which septel describes as running contrary to real estate
developers' hopes by emphasizing low-profit affordable housing
rather than the double-digit returns of luxury apartments and
villas. All this points to real estate investment remaining low
until developers are more certain about medium term trends, and
that the boost real estate investment has given to gross capital
formation--the biggest single contributor to recent years' GDP
as measured on the expenditure side--will remain muted this year
even as the Chinese Government tries to achieve 8 percent GDP
growth.


21. (SBU) Aside from the GDP impact of construction activity,
the prospects of higher housing demand and rising real estate
valuations could provide a boost to consumer spending. Several
of our contacts noted that the simultaneous hits from the stock
market fall and the slump in real estate prices had taken a toll
in consumer confidence. This is widely regarded as true despite
high retail sales growth rates--which continue at above-GDP
growth rates, and therefore are helping to pull the
economy--since retail sales covers more than household
purchases. A Guangzhou-based executive with a real estate
developer that operates China-wide commented that Guangzhou's
local measures were aimed more at increasing consumer confidence
than actually helping the industry, implying that the government
there is making the connection between consumer spending and the
real estate market as well.
CAMP