UBS analyst in bold bet on China property
Lam sees a gradual recovery in market
HONG KONG: When it comes to Chinese real estate, John Lam is a lone wolf.
The UBS analyst shocked markets three years ago with a rare sell rating on China Evergrande Group, 11 months before it defaulted and became the poster child for the property collapse. Now Lam is going against the grain again, forecasting a gradual recovery in a moribund market that most analysts say hasn’t hit bottom.
“After three years of being bearish, we’re turning more positive on the China property sector for the first time due to government aid,” Lam, the head of China and Hong Kong property research at UBS Group AG, said in an interview in Hong Kong.
Lam predicts home demand and supply will return to historical averages sometime next year, and developers with sizable portfolios in 21 major cities will likely see their stocks rebound. He upgraded several companies, including Longfor Group Holdings Ltd, to buy in January.
And just as he did on Evergrande in 2021, Lam is combining a deep data dive with his own gut feeling to make the unconventional bet on China’s housing sector.
“It was from instinct that something was just not right,” said Lam, 38, recalling his brief, 10-line report on Evergrande that raised alarm bells about the meltdown that would follow.
Much like his Evergrande call, the rebound bet is a gutsy one. Home sales tanked and prices plunged in March at an even faster annual pace than the previous month, extending a threeyear decline. Bloomberg Economics expects the sector to account for just 16% of China’s economy by 2026, from a peak of 24% before the slump. Some five million jobs will be lost or curtailed along the way, BI says.
Yet Lam was proven right on
Evergrande, downgrading the stock just as the high-flying developer was riding a boom in Chinese real estate. At the time, Evergrande had a market value of about $47 billion, making founder Hui Ka Yan one of the richest men in Asia.
As far back as 2017, some fuzzy math caught Lam’s attention: Chinese developers were voraciously snapping up plots of land to build houses, but their leverage remained broadly unchanged. That led him to dig into the data, shining a light on the murky corner of offbalance sheet debt that was fuelling the expansion.
REPORT CAUSED A STIR
Groundwork for the research was done by UBS’s Evidence Lab, a global team of more than 300 people specialising in building independent datasets from scratch. In China’s property space, that ranged from scraping two decades of housing launch data to taking the pulse of sales at 1,200 shopping malls.
For Lam, a long-distance runner who has completed half-marathons, it was a long slog, poring over about 10,000 residential projects owned by the major developers he covers. His conclusion: the gearing — or debt to equity ratio — of Chinese builders was on average 170% as of June 2019, compared with a reported 108%.
That meant that China’s developers would be cash-strapped as their massive refinancing needs peaked over the next two years, Lam cautioned. Evergrande was one of the riskiest, with its short-term debt to cash and net gearing among the five worst, Lam noted.
That led to his downgrade in January 2021, making him the only analyst among 19 covering Evergrande to slap a sell rating on the firm and cut the target below the share price. He reduced his target to HK$6, compared with the HK$14.50 price at the time.
The report caused a stir. Evergrande said in a written response that the UBS estimate had “no factual basis,” and that the company was confident it would reach its 2021 sales target. Lam’s note also drew ire from investors. Many ignored his call, while some ridiculed him as the shares moved higher in the following days. One global asset manager said: “stock is up, means no one listens to his calls.”
Lam’s concerns were quickly borne out, of course. Evergrande’s shares tumbled more than 90% before trading was suspended 14 months later. The company defaulted on its debt and the crisis soon spread to other firms. In all, developers have defaulted on more than $122 billion in bonds since the saga began.
POISED FOR SLOW RECOVERY
Now, after years of pain, the sector is poised for a slow recovery, says Lam, a graduate of the Hong Kong University of Science and Technology who previously worked for Morgan Stanley.
While he doesn’t expect sales and prices to rise this year, the declines will ease. Residential sales will likely drop 7% by area, he says, down from a record 27% tumble in 2022. New starts are likely to fall 7%, narrowing from a 39% slide in 2022. Prices may slip 10% in tier-1 and tier-2 cities.
“Once prices stabilise, we think pentup demand will come back due to the three-year property price down cycle that has led people to delay their purchases,” Lam said in a separate email.
Ironically, the key to recovery lies in the record number of defaults, according to Lam.
Since most private companies have lost access to funding, many have stopped buying land and building homes, reducing oversupply. New housing starts by Chinese developers have tumbled 58% amid the slump, much more than the 37% drop in real estate sales by area.
This “destocking” could bring housing inventory down to a more typical level of 24 months by January, in a bull case scenario, or next December in the bear case, Lam says.
Other economists and analysts are less sanguine. Goldman Sachs Group Inc. says the market has still not hit bottom. Bloomberg Intelligence agreed:
“China’s housing correction is far from over. That reflects weaker readings on housing indicators despite incremental policy support. Tumbling housing sales are squeezing the developers’ finances, keeping default risks elevated. The sustained property slump will continue to hobble the economy in 2024.”
Indeed, it took Japan about 15 years to bottom out from an epic housing bust in the early 1990s, and the US needed about six years to recover after the subprime mortgage crisis. China’s home price drop of almost 20% from peaks is a far cry from a 70% decline seen in Hong Kong after its 1997 housing bust.
‘INSUFFICIENT FUNDING’
Lam says China’s property market is healthier than Japan and Hong Kong during their crises, citing the lower urbanisation rate and household leverage, along with strict foreign exchange controls.
These will empower the Chinese government to manage its property bubble better than Japan did, he said.
China is trying to wield that power. A campaign of redeveloping so-called ‘chengzhongcun,’ literally “villages in the middle of the city,” is quietly unfolding in 21 mega cities. A sudden jump in low-cost funds that the central bank injected into lenders late last year suggest the push is real, and more cash support could be on the way, Lam said.
“We should expect stabilisation in property prices and new starts,” by June 2025, Lam said. “Right now, the biggest debate is the macro question of how homebuyer demand can recover.”
To do that, more support is needed. Lam estimates that China’s delayed and suspended residential projects amount to about 7 million units as of March. The required money is about 2 trillion yuan ($276 billion). “So far the funding coming from the government is probably not enough,” he said.
When it comes to differentiating future winners and losers, Lam looks at which developers shift their business model to have more commercial property exposure, which generates more recurring rental income and shields a developer from a cyclical drop of housing demand.
Another key sign is which developers are still acquiring land, as this determines earnings outlook three or four years later, Lam said. “Land acquisition also tells investors indirectly whether they have access to funding,” he said. “Usually when the developer slows down land acquisition, that’s not a good sign.”