China Property Investment Update:Advent of Golden Season brings rising volumes and ASPs

As the China NDRC Property Price Index rises over the next twomonths, we expect a shift in the product mix of Chinesedevelopers towards premium products less sensitive to higherprices. In other words, we expect developers in search of higherASPs and margins to rush to meet stronger-than-expected “upgradedemand” (i.e. demand for larger houses in favorable locations) bylaunching more high-end projects located in urban areas, particularlyTier 1 cities. Overall strong demand for property is showing no signs offlagging judging by the high take-up rates of presales we observed forrecent launches. At the same time, mounting inventory is putting pressureon developers to push new launches (see margin chart at right).

Fewer mortgage discounts due to the limited loan quotasfor small banks, including China Everbright Bank and Ping AnBank, has resulted in: (1) lower ASPs for low-end projects tocompensate for higher borrowing costs for first-home buyers,and (2) developers launching more premium products andapartments of larger sizes, as luxury home buyers are lesssensitive to borrowing costs.

We favor premium home builders with extensive land bankexposure in urban areas. These developers normally havegreater pricing power and tolerance for rising costs of sales andmarketing. In contrast, developers operating primarily in ruralareas have to contend with rising inventory levels, launchdelays for new projects, and thinning profit margins.

Good prospects for earnings reversals for property namesgenerating strong sales, especially those that recentlyincreased their full-year sales targets, with high “sold butyet-to-be-booked” sales. But even these developers felt thesting of surging costs in 1H12 from rising salaries and bonuses.

Given the degree of uncertainty in the market, majordevelopers adopted a conservative approach to purchasingland bank in 1H12. Property names with stable cash balancesand improving net gearing ratios stand to benefit fromNAV-enhancing land deals over the coming months, possiblyleading to the re-rating of some names.

We recommend Shimao Property (813 HK, Outperform)and CR Land (1109 HK, Outperform), two premium homebuilders with extensive land bank in urban areas. In general,we see good entry points for certain China property stocks inthe very short term due to cheap valuations and upbeatexpectations of rising property sales within a stabilizing policyenvironment. We advise selling into strength in late Septemberor early October (“Golden Season”) when news is likely tocome out of surging volumes and ASPs, prompting calls for aclamp down on property prices, which in turn will push up ASPs.