The Motley Fool Global Gains team is headed to China in July for research. Ahead of that trip they're taking time to discuss some of the issues facing China and investors in China today.
If you thought the real estate bubble and subsequent fallout here in the U.S. was bad, know that China has a chance to be worse. Real estate investment grew 26% annually in China from 2001 to 2008, and prices in the market have tripled while capacity has doubled.
While urbanization is one driver of these trends, speculation is clearly another. The Chinese government recently tried to put on the brakes by banning loans for third homes and raising the down payment requirement on second homes to 50%. What happens next is anybody's guess. So is this an imminent disaster or no big deal, and what does it all mean for investors?
Sean Sun: The housing bubble is no doubt speculative and unsustainable, but the chances of it causing a total meltdown are slim. Chinese real estate buyers/investors/speculators face higher down payment requirements and more stringent lending regulations, and, on the whole, a larger proportion of the capital being invested in the property markets comes from people's savings accounts rather than bank balance sheets.
With less credit in the market, there's a lower chance of a systemic domino effect. That's not to say people aren't going to lose their shirts, but at least they'll probably walk away with their pants, socks, and maybe even their shoes on.
Without sounding too optimistic, I do wonder if the current hubbub has the potential to become a contrarian dream come true. Since most of the speculative investments are especially concentrated in tier-1 cities like Beijing, Shanghai, and Shenzhen, could there possibly be a tier-2 or tier-3 real estate developer that is getting unfairly hammered? I think there is: Xinyuan Real Estate
Tim Hanson: I agree with Sean that there's a discrepancy in the real estate valuations between tier 1 and tier 2 and 3 cities, although lesser cities are catching up. The price appreciation in China's real estate market has been steep and reversion to the mean tells us sector may be cruising for a bruising -- or at least a correction.
I don't, however, know the magnitude of that looming correction, which is why I'm keeping even tier 2 developers such as Xinyuan and Xian's China Housing & Land
Nathan Parmelee: Yes, the obliteration of China's economy seems like a stretch. There are simply too many Chinese looking to move upward. They should -- eventually -- absorb excess capacity. But that doesn't mean there won't be some pain.
China has had a remarkable string of growth over the last 20 years, and even though the real estate bubble is primarily a problem in tier 1 cities, my best guess is that its popping will create a good old-fashioned recession and bring this streak to an end.
The large down payments Sean referenced provide a buffer from disaster, but wealth will still be lost, and people who feel less wealthy tend to spend less. This means a slowdown in consumer spending -- the part of the economy China most needs to grow.
With China's market already off 20%, the companies that would get hit by the spillover are already priced for it in some cases. Those are exactly the kind of companies we want to be looking at now. But I recommend staying away from capital-eating, cyclical companies such as China Petroleum & Chemical
Nate Weisshaar: I agree with the idea that this bubble will pop at some point, and that it doesn't mean the end of the Chinese investment story. Few things in history have moved in straight lines, and China is no different. Most likely a collapsing real estate market will shake things up enough to frighten short-term-oriented foreign investors out of the market, giving us the chance to enter at a reasonable price.
To fully take advantage of the situation, I think you have to go along the lines of what Tim said and play the rising Chinese consumer. We've already seen signs that wages are rising throughout the country, and as this continues, China may lose some of its export advantage, but a whole new domestic consumption market should spring up. Along this line, appliance manufacturer Deer Consumer Products
If we do see strong growth in domestic consumption, exports will become a less vital source of employment, so Beijing will be less averse to letting the yuan appreciate. A stronger yuan would give Chinese consumers more buying power when it comes to imported goods. So another way to play this angle would be a premier Western brand like Coach
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Neither Global Gains co-advisor Tim Hanson nor co-advisor Nate Parmelee owns the stocks mentioned here. Neither do analysts Sean Sun and Nate Weisshaar. Coach and Sina are Motley Fool Stock Advisor choices. The Fool owns shares of China Mobile and has a disclosure policy.