The return of Chinese property developers to the international bond markets in recent weeks highlights a surge in investor appetite for the sector even as the mainland housing market continues to deteriorate.
Having been effectively locked out of the bond markets during the second half of 2011, Agile Property, KWG Property and Shui On Land have issued a total of $1.7bn of bonds this year and more of their peers are expected to follow suit.
The rebound in sentiment towards the debt-laden developers that have fuelled China's housing construction boom has been "extraordinary", says Guy Stear, credit strategist at Société Générale.
To see the extent of the rally, consider Country Garden's $900m of bonds due 2018, which are among the most liquid in the sector. Just six months ago, as global risk aversion and worries about a mainland property crash reached a high, the bonds were trading at only 55 cents on the dollar and yielding more than 20 per cent, a level that implied significant risk of default. On Wednesday, having rallied to within a whisker of their par value, the bonds yielded 11 per cent.
Yet the revival is fast running out of steam, according to market participants.
"We are at a tipping point here," says Owen Gallimore, credit strategist at ANZ. "The Chinese property fundamentals have continued to deteriorate and bond valuations look ripe for a correction."
The total value of property sales across China contracted 20 per cent in January and February from the same period last year, according to government data. Contract sales figures provided by many of the biggest Chinese developers themselves show even sharper declines. Evergrande's sales are down 70 per cent so far this year, says Mr Gallimore, while Country Garden, Longfor and KWG have suffered declines of 65, 55, and 54 per cent, respectively.
A prolonged period of falling sales would pose a big problem for many developers. This is because they have been struggling to obtain financing from local banks and could therefore fall short of the cash needed to complete construction projects, pay outstanding land premiums and honour debt obligations.
"The worst is yet to come for Chinese developers in Asia's shaky property sector" is the title of a report released this month by Standard and Poor's. The credit rating agency has downgraded four Chinese property groups since February and warned that more downgrades are likely to follow as "continued tight regulations, growing refinancing risks, and a deepening market correction will take their toll on developers".
A stress test conducted by S&P showed that while most rated developers could absorb a 10 per cent decline in property sales in 2012, many companies, including several large players, would struggle to meet their short-term obligations if contract sales fell 30 per cent.
Most market participants, including S&P, reckon a deep or protracted sales decline is unlikely. A common view is that once property prices have fallen 5 or 10 per cent, the Communist Party will relax some of the measures it introduced last year to deter property speculation. "The government will not sit by and let the market crash," Jian Chang, economist at Barclays, wrote in a recent note.
However, for the time being, government policy appears fixed. In a speech last week, Premier Wen Jiabao said "we cannot relax the policy controls" and added that "housing prices are still far from a reasonable level".
Investors are calculating that, barring a meltdown, the biggest Chinese developers have much better survival prospects than their smaller rivals because of greater access to funding. Most developers that have sold bonds to foreigners are listed on the Hong Kong stock exchange, giving them the option to raise equity if needed.
Yet while Agile and other top-tier developers are once again able to tap the offshore bond market for funds, many of their peers have not been so lucky. The dollar bonds of most Chinese developers are still yielding more than 12 per cent. Some, such as SPG Land, Powerlong Real Estate, and Greentown China, are yielding closer to 20 per cent.
Compared with an average yield of about 4 per cent on the bonds of property companies globally, the double-digit returns offered by Chinese developers are extremely attractive. But part of the reason the yields are higher is the fact that most Chinese companies have issued bonds using a structure that results in the subordination of foreign bondholders to domestic creditors.
The bigger risk for bondholders, however, is the danger that the mainland property boom has come to an end. Should speculators start to sell the millions of empty apartments they are hoarding in cities across the country, all bets are off. As China has virtually no market for renting homes, investors hold properties solely in the expectation of capital appreciation.
According to analysts at Credit Suisse, the consensus has "severely" underestimated the amount of housing supply set to hit the market in coming years. Chinese developers own enough land to build almost 100m new housing units. Together with the sale of some empty apartments, this would be enough to satisfy China's housing demand for up to 20 years, the analysts have warned.