China Property:Divergence divergence

Between diff tier cities, and between physical/equity pricesThe government has been supporting the property market but we see thesupport as a double-edged sword. The policy brings forward demand butreduces future growth. And while property prices go up land prices go upeven faster. We see consolidation in the next two years. And suggestinvestors stay with top developers who are more competitive in biggercities and whose low funding cost and geographic diversity will cushionmargin as the industry goes through consolidation.

CRR land market update

In Oct 15, the 26 big listed developers CRR monitors bought 258% more land YoYinvolume and 301% more YoY in value off a low base.

During Jan-Oct, total new land bank added by our basket of developers fell 9% YoYin volume but rose 12% in value. Some 64% of the added land bank was in Tier 1and 2 cities and 36% in Tier 3 cities. Interestingly, ratio bought in tier 1&2 cities islower than compared to the 74% of 2014.

We believe the above reflects competition the bigger developers are facing fromstronger players with past focus on tier 3 cities moving back into tier 1&2.

Land sales volume picked up 25% YoY in Tier 1 cities, but fell 19% YoY in Tier 2and 6% YoY in Tier 3 cities during Jan-Oct, according to Soufun data. Soufun dataalso show that GFA prices rose 7% and 20% YoY in Tier 1 and 2 cities, but fell 1%YoY in Tier 3 cities during Jan-Oct.

Divergence between cities

Property sales YTD Oct have beaten our expectations thanks to measures such asinterest rate cuts, RRR cuts, lowering of downpayments for second homes (sinceMar), lowering of mortgage rate, and opening up of cheaper corporate bond fundingchannels for developers.

There is a wide divergence between bigger and smaller citiesNationwide property sale by GFA has gone up by 8% YoY(our forecast for FY15 of2.5%), driven by 24% growth in tier one, 6.3% growth in tier two and 7.5% growthin tier three cities (our forecast: 15.4%, 8.8%, and -1%).

But 100 city price index up by 2.1% falls short of our forecast for 5.2%, with tierone posting 13.7% growth but tier two down 1.6% and tier three down 2.6% (ourforecast: +12%, +6% and +2%) which suggests the recovery in tier three, and tosome extend cities, is still fragile.

Policy support will continue

The market momentum had lost a bit of steam though.

Nationwide sales volume growth momentum has slowed in Oct, from up 14.4%YoYof 2Q15 to up 5.9% of Oct.

And price growth slowed also, with 100 cities price index MoM growth slowing from1% MoM in Aug, to 0.3% MoM in Sep and Oct.

In response, President Xi Jianping has made a special comment that propertyinventory is an issue to be resolved.

The likely support policies will be to reduce downpayments in tier two and threecities further, to lower the entry barrier of the housing market.

This will bring forward demand but at possible cost of reducing future growth.

Divergence between physical and equity price

We believe the sector will outperform given the positive support from policies andresulting volume/price upside. But a major re-rating is unlikely as competition,resulting from the revived weaker players, will push up land prices and reducemargin across the sector until industry consolidation is done.

We prefer COLI, CRLand, Vanke and Longfor.