The improvement in the credit environment is putting Chinese real estate developers in a better position to secure funding, but potential risk factors continue to exist, especially for smaller developers, according to a CBRE report.
More channels of financing have been opened for Chinese developers since 2014; not only are banks more willing to write construction loans, but the government is actively promoting a functional onshore bond and asset-backed securities markets and interest rates remain at historic lows.
In addition, the domestic bond market offers a much lower interest rate, at 5.4 percent versus 8.1 percent for the offshore bond market. With the lower cost of capital, many developers can refinance to reduce repayment pressure.
Developers also benefit from a revival of the national housing market in upper tier cities, which provides them with sufficient cash flow to repay debt. For example, Chinese residential sales surged by 40 percent year-over-year in first eight months of 2016, far greater than the 9 percent growth during the same period in 2015.
However, Canon Yau, senior director, Capital Advisors, CBRE Asia Pacific, warned: “Despite the availability of alternative domestic financing channels in China, developers should be prepared for the possibility of future policy changes as well as an interest rate reversion that may subsequently impact their cost of capital and debt maturity exposure.”
Among the largest risks is small developers’ ability to repay debt in the future due to narrowing profit margins. Demand for housing market is concentrated in tier I and tier II cities, while smaller developers are more vulnerable to the sluggish residential sales in lower tier cities where they focus, the report notes.
Leverage is another concern. According to the report, regional developers have been aggressively taking on a significant amount of leverage without sufficient understanding on the sustainability of the residential sector. Changes in government policy which Yau alluded to could lead to a fall in developers’ revenue and cash-flow.