The Capital Cycle Podcast - Chinese Property Opportunity

Episode Date: August 29, 2025

The industry appears to be entering a favourable turn in its capital cycle. Edward Chancellor talks to Kai Chen, an Emerging Markets Analyst.For more information, or to access select articles from Marathon’s Global Investment Review publications which accompany this podcast series, please visit www.thecapitalcycle.co.uk Hosted on Acast. See acast.com/privacy for more information.

Hello, this is Edward Chancellor here with another episode of the Capital Cycle podcast, the first anniversary of our first podcast. So that makes it the second season. With that, I have with me today, Kai Chen, who is an emerging markets analyst with Marathon. And we're going to talk about China's real estate market. Throughout the last decade, many commentators argue. that China's property bubble would never burst, that Beijing wouldn't allow that to happen. The Bloomberg chief economist even published a book in 2020 entitled The Bubble That Never Pops. Well, that turned out to be a bad call because in the same year, President Xi Jinping moved to rein in the over-leveraged Chinese property developers. His protests at the time was a property was for living in, not for speculation, which is a viewpoint that didn't attract many home buyers

over the last decade who were buying for speculative purpose. But since Xi imposed tightening measures back in 2020, China's real estate bubble has been continuously deflating. And today, I think it's fair to say that the sentiment towards Chinese real estate is almost unanimously negative. For instance, last week, Bloomberg reported that Chinese home prices had been falling continuously since August 2021, with a decline in prices accelerating last month in July for new units. Evergrand, once the world's largest real estate developer and whose failure inaugurated the Chinese housing bust is being delisted. and Chinese real estate, says Bloomberg, has shown itself to be impervious to any measures, whether local or national, to boost it, including interest rate cuts. But Yu Kai have reasons to be guardedly optimistic about Chinese real estate

and have written an interesting piece comparing the current situation in Chinese housing market to the aftermath of the Japanese property bubble in the 1990s, and the U.S. real estate bubble that burst prior to the global financial crisis. And from your perspective, the structure of the real estate industry, and whether that industry undergoes consolidation or not, is a key aspect of the analysis. That's right. Currently, the Chinese poppy sector is clearly in very deep down cycle. But that stress is really creating a classic capital cycle opportunity.

and whether the sector comes out stronger and more profitable or simply just slips into long stagnation will really depend on how the industry structure evolves from here. History from the U.S. and Japan has shown us a clear playbook. The U.S. embrace creative destruction after 2008, allowing companies to fail and the industry to consolidate, and the leading home builders emerged much stronger from that crisis. But on the other hand, Japan prop up the zombie companies in the 90s and prevented industry consolidation. As a result, the Japan property sector endured decades of deflation and poor profitability. You're saying that China property is at a crossroads.

It could turn the U.S. route of consolidation, or it might go the Japanese route in which there isn't the consolidation and therefore you would expect further weakness. Yeah, it might be helpful to take a step back. look at the experiences U.S. and Japan had. First, looking at the U.S., if we look at the 2008 global financial crisis, in the subsequent aftermath of that crisis, the property sector actually underwent huge consolidation. Just to put some numbers into perspective, we saw the number of home builders cut in half. The weak players were allowed to fail, and the strong players were basically getting stronger and stronger. And at the national level, the top 15 home builders

nearly doubled their market share to 34% by 2019. But the consolidation was even more dramatic at the local level. A Johns Hopkins study found that by 2015, 60% of the local market had already got to a level that is considered highly concentrated as measured by the Herfindal Index. Although we're not going to talk about it now, one of the things that distinctions, the UK property market and homebuilding market from the US prior to the global financial crisis was that the British home builders was incredibly concentrated market and had much less overbuilding, whereas the US had fragmentation going into 2008, massive overbuilding. It took, I'd say, sort of five to six years for that excess capacity to blow off.

And then what you're saying is that after that you get capital discipline from a more consolidated home building industry in the US. Exactly correct. One metric that we can look at is the cumulative housing starts for the decade before the global financial crisis and after the financial crisis. So if we take that full decade for after the global financial crisis, the housing starts would basically half of the level of what they were the decade before. And the less supply means the home price just kept going higher and higher. And if you thought home prices were expensive and unaffordability was what contributed to the crisis in the first place, new home prices actually surge another 70% because of the insufficient supply caused by the consolidation of the market. That's interesting too, because we have a tendency to look at bubbles solely in terms of price.

And so you see up to the US real estate bus, you'd see that the ratio of home prices to average incomes, to median household incomes, was very elevated. More than two standard deviations from the mean. And then that came down after the bust. But then what's interesting, as you point out, is actually we're back. We returned in the US to inverted commerce bubble levels without the mechanism for a bubble to burst, namely the oversupply. the oversupply. And people, when they're analyzing real estate markets, often failed to consider that capital cycle perspective, the amount of new supply that's being added. Anyhow, to go back to the US home builders, you say that they've enjoyed higher sales and profits, even as new home

construction remained depressed. It's because of the new home construction remained depressed. That led to lower supply in the subsequent years. If you look at new home sales in the US, it was still at half of the historical peak level. So new homes sales are still weak. But if you look at the industry consolidators, for example, D.R. Horton and Lender, which are the top two home builders in the U.S., their revenue have reached all-time high and sold their profit, primarily because they were able to gain massive amount of market share during this process. And at the same time, because of the supply discipline, and as home price continue to increase,

they enjoy much higher profitability per house built compared to before. Let's turn our attention to Japan, where a rather different story emerges after Japanese real estate peaks in 1990. It's probably the greatest real estate boom of all time price-wise. There wasn't actually quite as much overbuilding in terms of new units in the housing stock in the 1980s as compared to the US up to 2006, 7, or to China, which you can talk about shortly. However, you point out that Japan had a very long decline in part due to the fragmentation of the home builders. Obviously, Japan had a huge bubble primarily in the price. And after the bubble,

unlike the case in the US where we saw a big increase in industry consolidation, In Japan, the home building industry never really consolidated. It continued to stay very fragmented. Also, in terms of the number of home builders, it only declined by about 20% over the subsequent decade, nowhere near the 15% job that we saw in the US. And during this period, all the market leaders never really gained significant market share. So the industry fragmentation in Japan resulted in lack of supply discipline, and that's what we observed. The decade after the bubble burst, and comparing to the decade before, the total number of new housing starts were exactly the same at around 14 million units. So supply never really declined and industry

never consolidated. As a result, the Japanese home building market or industry continue to face price deflation for the decades after the bubble burst. And the industry probability remain very depressed for many years. We're talking about Japanese homebuilders, but that fragmentation of industries supply and the failure to contract during the lost decades of Japan, that was characterized across many different industries in Japan. And actually, you know, one of the themes of the Marathon Global Investment Reviews and some of the podcasts I've been doing with Bill Ahr and other marathon colleagues has been pointing towards how that is beginning to shift in the last five years or so.

But there was a two-decade period of the absence of consolidation. which you argue was responsible for oversupply, weak pricing and presumably relatively poor performance from Japanese home builders. And now let's turn our attention to what we're really going to talk about, China's real estate market. I've done a lot of work on Chinese real estate market, or at least I did, you know, 15, 16 years ago, came quite early on to conclusion that this was the greatest real estate bubble in history. The way I came to that conclusion was that, If you put the aggregate Chinese real estate valuations relative to GDP, according to data, I think, produced by Savils, it was about 550% of GDP, roughly 75 points higher than Japan got to in 1990. And I think sort of roughly three times higher than US got to in 2006, then you had this incredible investment in real estate where it was said China was building as much new property in two weeks as the city.

of Rome contained. So Rome wasn't built in a day, but the Chinese were building the equivalent in two weeks. And then you've got, you know, tremendous credit, boom and boring on the back of that. People thought that the bubble would never burst. Now in the bear market, people had come round the idea that this is a great real estate bubble and that this is a big bust. And now their mentality is that this is a perpetual bust. Let's talk where you think China's real estate market stands today. Like you said, back in 2020, the Chinese property sector was probably in a big bubble. There was a lot of speculation demand and the prices were soaring. And it clearly violated President Xi Jinping's core principle that poverty is to be lifted and not to be speculated on.

But the bigger threat was to the financial stability. Many real estate developers just had too much debt. Their debt levels was so high that they could crack. the financial system. So in the second half of 2020, the government decided to act. So they introduced the three red lines policy, which essentially put strict limits on how much developers could borrow based on the existing debt level. The problem is this created an immediate liquidity crunch. The developers were so dependent on constant borrowing to fund their operations. When the credit was suddenly cut off, they just couldn't lead their financial obligations. And one of the highly leveraged developers, the poster trial of this crisis, is China Evergrand. It was one of the

first to default, but its default also brought about the contagion that spread to other major developers. Moreover, because of the defaulting developers didn't have sufficient money, they couldn't finish the property projects already sold to the consumers. And this created a big crisis in consumer confidence, and property sales just took a nose dive, and it basically triggered a problem. a vicious downward cycle for the entire sector. And you say in your piece, among the top 10 developers from 2025 entered into a state of financial distress, with their contracted sales falling by over 90%. Yeah, that's correct.

So these developers include companies like Evergrand, Sunac, or Country Garden. So they were one of the biggest developers in the world. And now they are basically barely hanging on to, exist. So you do see a lot of these weaker players basically just falling by the wayside. And if we look at some of the market data in terms of the default and restructuring of the debt, and we aggregate all that data, it would suggest that more than half of the Chinese developers have either defaulted outright or are facing severe financial trouble. So only the state-owned enterprises and a handful of private developers are now left standing.

Kai, you're saying that China's current position is now different in the homebuilding market to Japan's. That's right. Because if we look at Japan, the number of developers only declined by about 20%. And here we have basically more than half of the Chinese developers are in serious financial trouble. And the most likely scenario that they will exit the market. And maybe there's another measure. And again, if we look at the new Home Start metric, The current situation is that we are seeing a big supply reduction in terms of new home starts. New home starts have basically fallen by almost 70% from 2020 to 2024. And just as a reminder, for Japan, the new home starts name really fall for the first five years.

And for the entire decade, the new home starts were basically roughly the same, the decade after the crisis and the decade before. So we are seeing some structural changes, both in terms of number of players in the market, also the supply reduction that we are seeing in China. Tell us a bit about the consolidation among Chinese home builders. Yeah, so a leading indicator, which is land acquisition. So now the top 10 developers account for about 55% of land purchase, and this is up from about under 40% previously. And the top 20 developers basically account for 70% of land acquisitions.

And so the consolidation within the land acquisition market would basically translate into the sales consolidation in future years. But you think that the industry is, as you say, at a crossroads. It's not clear exactly which path it will take. So the biggest risk to us here is that the Chinese policy makers might make the same mistake Japan make in the 90s. Basically, what Japan went through was that the banking system kept the zombie companies alive instead of letting them fail. There is some recent policies in China that bears some resemblance to the Japan approach during the 90s. Particularly in late 2022, China brought out the three-airroad support package, which allows for the refinancing and extension of the loan that would otherwise be in default.

That's exactly the kind of approach that kept Japanese zombie companies on life support for decades. Now, to be fair, there is an important distinction. The support here is primarily focused on helping the developers complete existing projects that have been sold to consumers to prevent the whole system from collapsing. The intention is not to rescue these weak developers. Going forward, it's really important to see whether such support measure will continue. knew to prop up these potentially zombie companies. And if China goes on the path of Japan of supporting these really weak distressed developers, then we could potentially be looking at the decades of

stagnation and self-industry consolidation and rebirth. That's an interesting point, because as you will know, with regards to the banking system, China has had a record over the last 25 years of evergreening bad loans. And it also has a record of keeping so-called zombie businesses alive, chiefly, I think, for employment purposes and economic stability. So based on historic records, definitely a possibility that China doesn't go down the US hyper-capitalist consolidation group. But as you say, so far, there has been more consolidation and contraction, definitely than the market was expecting five years ago. Now, let's talk about the stock that attracted your attention.

In this basic capital cycle opportunity here, earlier this year, we initiated a position in China Resources Land. We believe that it's well positioned to be a winner in a potential industry consolidation scenario here in China. First, China Resources Land has a very robust balance sheet. It's net debt to equity ratio is only 30%. That's remarkably low for the industry. They also have one of the lowest foreign costs, and they have maintained access to capital throughout this entire crisis. And in a crisis like this, access to capital is everything. And second, China Resources Land has a very strong portfolio. Most of their projects are in tier one and core tier two cities, often in prime locations, where there's genuine real demand for housing.

And they've largely avoided those lower tier cities where demand was mostly driven by speculation. With the Chinese building boom, was most of the overbuilding in the lower tier cities in tiers three, four, and five, and not so much in the top Beijing and Shanghai and Chongqing and so forth, was it not so much overbuilding in the tier one areas? Yeah, there is definitely a lot more overbuilding in lower tier cities than core tier one and courtier two cities. A big part of the reason was that there's home purchase restrictions in tier one. in tier two cities during the property boom. And so there is a lot of speculative demand that got spilled over to lower tier cities. Moreover, the land supply in these top tier cities is much lower

than the lower tier cities. So taken together, you basically have a lot less overbuilt. And also in terms of demand, there's quite a lot of speculative demand in lower tier cities. Because if you look at the population, inflow and outflow, there's definitely a lot of. lot more inflow going into the core cities and there's outflow from these non-core lower-tier cities. So the demand in these lower-tier cities was basically propped up by speculative demand. And so once the cycle started to turn, you basically left with a lot of empty houses that are currently still sitting in the lower-tier cities. And go back to China Resources Land. You point out that they have a residential development in Chongqing,

which is doing reasonably well, which is surprising considering all one hears his negative stories about Chinese real estate. Yeah, so Alex Duffy, a colleague of mine and I went on a property trip in Chengdu and Chongqing. We went to a city center of Chongqing and visited one of the projects by China Resources Land. When we got there, we were looking at a lot of these buildings that are getting erected. We actually were quite worried. Basically, there's so many of these new houses, are they ever going to get sold? But when we actually talk to the sales representative, they told us that property units were sold as soon as they came onto the market. And that's because the location was basically in the city center of Chongqing. And there is a lot of people with a lot

of money to either through upgrade demand or generating real demand for their children. So all of these basically led to a very robust demand for the projects that China resources land had in Chongqing. You think that the stock is reasonably priced considering the relatively robust demand for its properties in Tier 1 cities. Yeah, valuation looks reasonably attractive in our opinion. It's trading below book at 0.7 times and the price earning ratio of around 8 times and both are historically low level. In addition, the stock is also offering 4 to 5% dividend yield while we wait for the capital cycle to work its magic.

So overall, I think at current level, is still quite attractive. And you're confident about the book values, book values for home builders during housing bus can be sort of inflated and then come down, but you don't expect China Resources Land to have to write down its book values. You are absolutely right to be concerned here. during the global financial prices, the top three US home builders saw their book value declined by about 50 to 60%. And a big chunk of that was coming from asset impairment on the book.

So naturally, you would ask, would China Resources Land face similar level of write down analysis on this issue. And while we cannot completely rule out the big impairment, there are several key difference between China and US that give us comfort, that we won't see a big impairment. At first, there's a fundamental difference in terms of business model. In China, the developers mainly use a pre-sell model. They start selling the units just six months after purchasing the land. And once sold, the risk of the asset value is essentially transferred to the buyer, even though the asset still sits on the developer's balance sheet. And if you look at US back in 2008, most of the homes were sold upon completion, and the typical home development cycle is about three years.

This means the U.S. developers assume the full asset risk during the entirety of the three-year project development. So today, if you look at China Resources Lands Book, close to 60% of the residential development assets have already been pre-sold, so the risk have been transferred to the buyers, and the company is not bearing that the full downside. risk to asset value decline. And another point is leverage really matters. China Resources land has a lot lower leverage than as U.S. counterparts back in 2007. For example, is net debt to equity ratio. It's only half of what the top three U.S. developers had at that time. And lower leverage just means when the assets do get written down, book value doesn't get eroded as much. And then it's also what we talk about. In real estate, there's a same location,

location location. As we discuss, most of China Resources Land projects are in basically prime areas in Tier 1 and quarter two cities. So these places are areas with genuine real pausing demand. And as a result, even today, their projects are still quite profitable at the operating level. And this contrast with the U.S. developers who are recording operating loss during the global financial crisis. And finally, China Resources Land's business is more diversified. If we look at this book value, with the asset value, 40% of its assets are in investment properties like shopping malls that generate recurring income. And these continue to perform pretty well. So I think book value impairment is a real risk and we'll continue to monitor closely.

But given the structural differences that we talk about just now, I think the big risk of the book value decline, like we saw in the US, is probably a lot lower. That's a very good answer, Kai, thoughtful. I think the takeaway for listeners, in case they didn't pick that up beforehand, is that if you want to invest in home building, or even if you want to understand real estate markets, you need to follow the capital cycle. And from an investment perspective in the stocks, looking at a degree of industry consolidation and capital discipline. And I think, Kai, I haven't seen anyone up to now making the argument. that China's exhibiting potentially more capital discipline after years of capital profligacy. So good luck. We'll see how that turns out. And I look forward, Kai, too, speaking to you again soon. Thank you so much, Everett. Thank you for your time today. I hope you will listen to the next edition of the capital cycle. This communication is provided for information purposes only. Please refer to Marathon's website and the global review for further information, including important disclosures.