Mainland China’s property sector has suffered a painful two years on the back of a shifting regulatory landscape and deteriorating economic conditions. After the Chinese government promoted (the unofficial) Three Red Lines policy in August 2020, property developers faced a new and challenging operational landscape when acquiring financing. The required deleveraging, coupled with uncertainty over future sales and liquidity, led China Evergrande, one of the largest developers at the time, to default in late 2021.1
The event contributed to a negative feedback loop: Developers, unable to gain financing, stopped work on existing projects and canceled new ones, limiting cash flow. Meanwhile, consumers stayed on the sidelines as property prices fell amid growing uncertainty and slowing economic growth.
The zero-COVID policies of the last three years added to the pressure as sudden lockdowns and halted economic activity further dented already fragile consumer sentiment. As a result, the property sector experienced a cascade of defaults, credit downgrades, and withdrawn credit ratings in 2022.
Overall, the J.P. Morgan Asia Credit Index (JACI) China Real Estate Index (total return) suffered a 71.4% loss from May 2021 to November 2022;2 however, the Chinese government released a raft of new policies in late 2022 to bolster the beleaguered sector.
The People’s Bank of China and the China Banking and Insurance Regulatory Commission issued 16 measures in November 2022 to boost sector liquidity and ensure the completion of unfinished property projects. The policies ameliorated the prevailing illiquid funding environment while reducing overall default risk.
The noted change in government policy tone and the faster-than-expected exit from zero-COVID catalyzed a market rally. The JACI China Real Estate Index rebounded roughly 100% between early November 2022 and late January 2023, retracing roughly 40% of its losses since May 2021, while remaining well below precrisis levels.3
Drawdown and rebound in Mainland China’s property sector
Source: Bloomberg, J.P. Morgan Asia Credit Index/China/Real Estate/cumulative total return index, as of January 31, 2023. It is not possible to invest directly in an index.
What’s next after the rally?
With the recent strong rebound in performance, investors may be asking: Do opportunities still exist in the space and, if so, which segments are attractive?
We believe that the sector is unlikely to suffer a drawdown comparable to 2021/2022 again; the recently released policies, coupled with the reopening of the economy, have likely put a floor in the broader market.
Having said that, we also believe the opportunity set in this space has narrowed in light of recent market action. Indeed, opportunities in the quality U.S. dollar-denominated high-yield space are more selective in nature and require robust credit research to separate the contributors from the detractors.
To understand where the potential opportunities lie, we must first look at the challenges the sector still faces.
2023: challenges remain amid economic uncertainty
In 2023, we foresee a broadly stabilized funding environment for investment-grade credits, but it should remain difficult for some of the weaker high-yield names. Indeed, offshore defaults may still occur amid the nascent economic recovery and continued ructions in the property sector; however, we believe they won’t have the same deleterious market impact as they did in 2021/2022.
Perhaps, more important, we see macroeconomic recovery potentially playing a more critical role in 2023 along with sector-based policy initiatives. Government policy played a critical role by supporting tepid investor sentiment in 2022. Yet the government will likely assess the market’s reaction to existing policies and may introduce further measures to enhance existing initiatives after the National People’s Congress is held in early March.
At this point, the government is likely focused on preventing the emergence of systemic risk in the sector and could intervene further if weak economic growth prevails. Therefore, we believe economic growth and improved consumer sentiment should be the main catalyst behind further credit improvements in 2023.
Housing sales depend on sustained recovery and rising consumer sentiment
While we’ve witnessed some progress on the supply side through government policy, property demand is still a challenge. Indeed, primary home sales remain volatile and haven’t achieved consecutive months of growth, thereby indicating weak signs of recovery. We’ve seen some positive developments in secondary home sales; however, these transactions primarily benefit exiting homeowners, not developers.
Top 100 developers aggregate contracted sales (2019-2023)
Source: CRIC (www.cricchina.com) and Manulife Investment Management, as of January 2023. -43% represents the change in contract sales in January 2023 versus the four-year average (January 2019-2023).
Overall, we believe that sustained recovery of primary home sales is unlikely until at least the second half of 2023. This is because housing sentiment is broadly tied to consumer sentiment, which has only started to recover with the reopening of the economy since late 2022.
Although retail sales ended 2022 with three consecutive months of contraction and remain far below pre-COVID-19 levels,4 positive signs of improving sentiment were observed during the Lunar New Year period. Further, unemployment levels remain elevated relative to the historical average, particularly among younger workers. Any recovery is expected to be gradual.
With government policy aimed at stimulating broader consumption demand—coupled with improving sentiment—primary property sales should gradually stabilize.
Overall, we don’t expect real estate generally or home sales specifically to return to previous levels. The sector’s halcyon days, when it accounted for roughly 20% to 30% of the country’s GDP, are well behind it. That said, a sustained recovery should go a long way to boost the bond prices of lagging developers, and this is where we see attractive sectoral opportunities in 2023.
Select credit opportunities in weak but not distressed names
We see potential credit opportunities in this space which can be divided into three categories.
1 Quality names within the sector are primarily large developers, including many investment-grade credits, which have already benefited from government stimulus policies. We think a large portion is already trading at fair value after the recent run-up, as investors broadly believe they will survive over the long term. We see limited opportunities for further upside in this group until we see a sustained primary sales recovery in the sector.
2 Distressed names refer to firms that have already defaulted or are in financial distress and face near-term default. Valuation for this group will likely be driven more by idiosyncratic developments in debt restructuring and asset liquidation. Given the long timeframe involved and uncertain recovery outcomes associated with this type of investment, we believe there are more attractive risk/reward opportunities elsewhere in this space.
3 Weak but not distressed firms refer to stretched developers in the high-yield space that possess the potential to survive and whose valuation remains attractive due to considerable uncertainty. Robust credit research is needed before investing in these names because they depend heavily on specific funding streams as refinancing needs arise, which is highly idiosyncratic.
We’ll look closely at two major factors that can differentiate these credits on a case-by-case basis:
- Contracted sales performance—this represents a proxy for having adequate cash flow available to service debt repayment obligations.
- Secondary sources of funding—this could include tapping onshore credit lines, asset disposals, and selling existing projects to service debt commitments. Refinancing options, however, remain limited. Although the Chinese government has recently supported banks to offer outbound guarantees for some developers to secure offshore funding, this has largely been limited to larger developers with significant assets.
These aggregate funding sources are compared against developers’ upcoming bond maturity profiles—some have bonds maturing in 2023 versus others with a longer maturity runway over the next two to three years.
Although we expect a bumpy ride ahead for the country’s property sector in 2023, select opportunities exist in the high-yield space after the recent significant market run-up. More robust economic growth, including a sustained recovery in primary home sales, could be a key condition for this group of credits to outperform. Credit selection should remain vitally important in this volatile market environment to identify credits that will outperform.
Appendix: China high-yield spread historical changes
Source: Manulife Investment Management, ICE BofA Emerging Market China High Yield Spread-to-worst Index as of February 6, 2023. PBoC refers to the People’s Bank of China. Bps refers to basis points.
1 The developer was set to formally enter default on October 23, 2021, when the grace period ended for its missed bond payment. 2 Bloomberg. JACI China Real Estate Index Total Return. The index reached its peak on May 26, 2021, and hit a bottom on November 3, 2022. 3 Bloomberg, as of January 31, 2023. 4 National Bureau of Statistics of China, as of December 31, 2022.
A widespread health crisis such as a global pandemic could cause substantial market volatility, exchange-trading suspensions and closures, and affect portfolio performance. For example, the novel coronavirus disease (COVID-19) has resulted in significant disruptions to global business activity. The impact of a health crisis and other epidemics and pandemics that may arise in the future, could affect the global economy in ways that cannot necessarily be foreseen at the present time. A health crisis may exacerbate other pre-existing political, social and economic risks. Any such impact could adversely affect the portfolio’s performance, resulting in losses to your investment
Investing involves risks, including the potential loss of principal. Financial markets are volatile and can fluctuate significantly in response to company, industry, political, regulatory, market, or economic developments. These risks are magnified for investments made in emerging markets. Currency risk is the risk that fluctuations in exchange rates may adversely affect the value of a portfolio’s investments.
The information provided does not take into account the suitability, investment objectives, financial situation, or particular needs of any specific person. You should consider the suitability of any type of investment for your circumstances and, if necessary, seek professional advice.
This material is intended for the exclusive use of recipients in jurisdictions who are allowed to receive the material under their applicable law. The opinions expressed are those of the author(s) and are subject to change without notice. Our investment teams may hold different views and make different investment decisions. These opinions may not necessarily reflect the views of Manulife Investment Management or its affiliates. The information and/or analysis contained in this material has been compiled or arrived at from sources believed to be reliable, but Manulife Investment Management does not make any representation as to their accuracy, correctness, usefulness, or completeness and does not accept liability for any loss arising from the use of the information and/or analysis contained. The information in this material may contain projections or other forward-looking statements regarding future events, targets, management discipline, or other expectations, and is only current as of the date indicated. The information in this document, including statements concerning financial market trends, are based on current market conditions, which will fluctuate and may be superseded by subsequent market events or for other reasons. Manulife Investment Management disclaims any responsibility to update such information.
Neither Manulife Investment Management or its affiliates, nor any of their directors, officers or employees shall assume any liability or responsibility for any direct or indirect loss or damage or any other consequence of any person acting or not acting in reliance on the information contained here. All overviews and commentary are intended to be general in nature and for current interest. While helpful, these overviews are no substitute for professional tax, investment or legal advice. Clients should seek professional advice for their particular situation. Neither Manulife, Manulife Investment Management, nor any of their affiliates or representatives is providing tax, investment or legal advice. This material was prepared solely for informational purposes, does not constitute a recommendation, professional advice, an offer or an invitation by or on behalf of Manulife Investment Management to any person to buy or sell any security or adopt any investment strategy, and is no indication of trading intent in any fund or account managed by Manulife Investment Management. No investment strategy or risk management technique can guarantee returns or eliminate risk in any market environment. Diversification or asset allocation does not guarantee a profit or protect against the risk of loss in any market. Unless otherwise specified, all data is sourced from Manulife Investment Management. Past performance does not guarantee future results.
Manulife Investment Management
Manulife Investment Management is the global wealth and asset management segment of Manulife Financial Corporation. We draw on more than a century of financial stewardship to partner with clients across our institutional, retail, and retirement businesses globally. Our specialist approach to money management includes the highly differentiated strategies of our fixed-income, specialized equity, multi-asset solutions, and private markets teams—along with access to specialized, unaffiliated asset managers from around the world through our multimanager model.
This material has not been reviewed by, is not registered with any securities or other regulatory authority, and may, where appropriate, be distributed by the following Manulife entities in their respective jurisdictions. Additional information about Manulife Investment Management may be found at manulifeim.com/institutional
Australia: Manulife Investment Management Timberland and Agriculture (Australasia) Pty Ltd, Manulife Investment Management (Hong Kong) Limited. Canada: Manulife Investment Management Limited, Manulife Investment Management Distributors Inc., Manulife Investment Management (North America) Limited, Manulife Investment Management Private Markets (Canada) Corp. Mainland China: Manulife Overseas Investment Fund Management (Shanghai) Limited Company. European Economic Area Manulife Investment Management (Ireland) Ltd. which is authorised and regulated by the Central Bank of Ireland Hong Kong: Manulife Investment Management (Hong Kong) Limited. Indonesia: PT Manulife Aset Manajemen Indonesia. Japan: Manulife Investment Management (Japan) Limited. Malaysia: Manulife Investment Management (M) Berhad 200801033087 (834424-U) Philippines: Manulife Investment Management and Trust Corporation. Singapore: Manulife Investment Management (Singapore) Pte. Ltd. (Company Registration No. 200709952G) South Korea: Manulife Investment Management (Hong Kong) Limited. Switzerland: Manulife IM (Switzerland) LLC. Taiwan: Manulife Investment Management (Taiwan) Co. Ltd. United Kingdom: Manulife Investment Management (Europe) Ltd. which is authorised and regulated by the Financial Conduct Authority United States: John Hancock Investment Management LLC, Manulife Investment Management (US) LLC, Manulife Investment Management Private Markets (US) LLC and Manulife Investment Management Timberland and Agriculture Inc. Vietnam: Manulife Investment Fund Management (Vietnam) Company Limited.
Manulife, Manulife Investment Management, Stylized M Design, and Manulife Investment Management & Stylized M Design are trademarks of The Manufacturers Life Insurance Company and are used by it, and by its affiliates under license.