Fed rate cut effect: The darkest period has passed, will the real estate sector usher in a valuation repair opportunity?

The real estate sector hits bottom and rebounds, with the Fed cutting interest rates by 50 basis points at its September meeting, exceeding market expectations, and the property sector in Hong Kong continues to rise.

According to the Securities Times app, on September 19th, the Fed cut interest rates by 50 basis points, lowering the target range to 4.75%-5%, exceeding the market's expected 25 basis points. Fed Chairman Powell stated that the 50 basis point rate cut is not a recessionary rate cut and does not set the pace for future rate cuts. The risks of declining employment have increased while the risks of rising inflation have receded, but the battle against inflation is not yet fully won, and decisions will continue to be made based on data.

In fact, the Fed's monetary policy has a significant impact on the capital markets in Hong Kong. With Hong Kong adopting a linked exchange rate system, as an international financial market, exchange rate trends directly affect capital flows. The US interest rate hike cycle is set to begin in mid-March 2022, with 11 rate hikes totaling 5.25%, coupled with poor profitability, leading to long-term liquidity depletion in the Hong Kong stock market. This rate cut is seen by the market as the start of the Fed's rate cut cycle, providing a good opportunity for bottom fishing in the Hong Kong stock market.

The real estate sector is not only affected by liquidity but also by the industry being in a downturn, which puts pressure on sector valuations. The bottoming out rebound and investment opportunities still require support from the industry's fundamentals.

The industry is in a downturn, but the darkest period has passed

Looking at the development of the real estate industry, before 2016, benefiting from policies and continuous price increases, industry demand maintained double-digit growth. However, starting in 2017, it entered a slow development period lasting 5 years, with growth continuing to slow down. The Evergrande default event intensified industry cleansing in 2022, officially entering a downturn, entering a period of negative growth, and has been declining for three consecutive years.

In the first 8 months of this year, real estate demand has been very sluggish. Due to ongoing international conflicts, concerns about risks, a decrease in marriage rates leading to reduced rigid demand, and pessimistic macroeconomic expectations, the public has suppressed real estate consumption, with an unprecedented willingness to hold cash, leading to an explosive growth in deposits. By August 2024, the sales area and sales volume of the real estate industry were 6.06 billion square meters and 5.97 trillion yuan, respectively, down by 23.6% and 18% year-on-year.

There is a serious oversupply of real estate capacity, and destocking remains the main theme in the medium term. According to the China Index Research Institute, as of July 2024, the national residential "started but unsold inventory" was 2.52 billion square meters, with the current "started but unsold inventory" clearance period at about 3.4 years, facing great destocking pressure. The most important demand remains low, and the price decline has made more rigid demand groups wait and see, which may lead to an unfavorable clearance period.

On the policy front, the central bank has reduced reserve requirements and interest rates, commercial banks are providing financial support to homebuyers and the real estate sector, and both the supply and demand sides are continuing to exert efforts, but the effects will take time to materialize. On the market side, the dual-line development system of "guaranteed housing and commercial housing" is stirring up the industry market, and state-owned enterprises' inventory acquisitions are reshaping the industry landscape: first, inventory acquisitions are a direct means of destocking, being implemented nationwide to accelerate clearance and eliminate backward real estate companies; Secondly, improve the supply of protection to stabilize prices, stabilize the development of real estate, and implement the policy of "housing is for living in, not for speculation".

According to the monitoring of the China Index Research Institute, as of the end of August 2024, about 30 cities have issued announcements for the collection of commercial housing for affordable housing. In terms of progress, for example, in August, the first project in Wuhan officially landed, providing more than 500 sets of affordable rental housing for the whole city; the second batch of acquisitions in Chongqing has signed contracts for the transformation of existing commercial housing into affordable housing, with 7 projects able to provide more than 2600 sets of affordable housing after renovation.

With many industry leaders facing bankruptcy, even Vanke has not escaped the industry crisis. However, with efforts from various parties, it still struggles to maintain a healthy financial situation. The market will gradually clear out, and the darkest period of the real estate industry has passed, with dawn perhaps just around the corner.

Severe industry differentiation, high-quality real estate enterprises show resilience

According to the Zhitong Finance and Economics APP, although the real estate industry is going through an unprecedented dark period, most real estate enterprises are suffering huge losses, but there are still some high-quality real estate enterprises maintaining profitability. Looking at the financial reports for the first half of 2024, taking leading companies as examples, China Resources Land (01109) achieved a revenue growth of 8.44%, with a net profit of 10.253 billion yuan; Longfor Group (00960) saw a decline in revenue but still achieved a net profit of 5.866 billion yuan.

In contrast, Vanke, the former industry leader, no longer shines brightly. Its revenue dropped by 28.9% in the first half of the year, with a staggering net loss of 9.852 billion yuan; China Evergrande's revenue rebounded from the bottom, but still suffered a huge loss of 33.012 billion yuan; Sunac China's revenue declined by 41.4%, with a net loss of 14.96 billion yuan. In addition, some small and medium-sized real estate enterprises also showed differentiation, with companies like Zhongliang Real Estate and Agile Property recording revenue declines and losses.

From January to August this year, based on the sales data disclosed in the Hong Kong stock market, Vanke, China Overseas Land & Investment, China Resources Land, Longfor Properties, and Greentown China were the top five in terms of sales in Hong Kong. Vanke's sales area and sales amount were 12.076 million square meters and 163.78 billion yuan respectively, down by 25.7% and 34.1% year-on-year, with an average price decrease of 11.4%. The other four companies also experienced varying degrees of decline, but some maintained business resilience by improving product quality to raise prices, such as China Resources Land, which saw a relatively stable sales amount in August, with an average price of 26,900 yuan per square meter from January to August, up by 19.2% year-on-year.

The performance of major real estate enterprises has been fully reflected in the capital market. Although China Resources Land's valuation has retreated in recent years, it is still far below the industry's decline, maintaining a long-term bullish trend and becoming a bright spot in the real estate sector. Vanke started to decline in 2020, with prices dropping from a high of 36 Hong Kong dollars to less than 5 Hong Kong dollars currently, resulting in a market value shrinkage of up to 86%. Sunac China also dropped from 46.2 Hong Kong dollars to a low of 1.04 Hong Kong dollars, with a market value shrinkage of up to 97.8%.

As mentioned earlier, the darkest period of the real estate sector has passed, whether in physical operations or the capital market, both have hit rock bottom. Under the blunting of negative news, funds will be very sensitive to any positive news. So, in the sector opportunities, which real estate enterprise will have the opportunity for valuation correction?

Fed rate cuts trigger effects, focus on valuation repair opportunities

In fact, the most direct impact of this Fed rate cut on the Hong Kong stock market is capital inflow, with the Hang Seng Index seeing incremental capital inflows, driving the rebound of the real estate sector. Real estate is highly sensitive to interest rates, and the Fed rate cut is expected to trigger a series of rate cut effects. As central banks around the world implement loose policies, the impact of the financial market on the real estate industry will also be realized in the physical market, and the improvement of industry fundamentals will further drive sector valuation repair.

First is Vanke, which has severely shrunk valuation. Currently, Vanke's PB ratio is only 0.3 times. The main issue at present is the drag from the development business, but the continuous growth of non-development businesses including property management, long-term rental, and commercial sectors will bring expectations for business turnaround. In addition, the company's debt problem is gradually being alleviated, with interest-bearing debt amounting to 331.3 billion yuan by 2024, and monetary funds amounting to 92.4 billion yuan.

The company focuses on cash flow security, postpones land acquisition pace, and the huge loss in the first half of the year is more affected by asset/credit impairment. It is expected to see significant improvement in the second half of the year. Under the policy of reducing inventory and holding cash, financial pressure is expected to decrease. As long as the company's finances do not encounter problems, Vanke is still the industry leader. With its current debt repayment ability and government support, the probability of following in the footsteps of Evergrande is low, and it is also favored by major banks.

Next are high-quality real estate enterprises, including China Resources Land and Longfor Group. Taking China Resources Land as an example, its development business sales have remained resilient. Although overall sales in the first half of the year have declined due to market impact, the structure has improved, with 50.6% of signed contracts for inventory at the beginning of the year, and the proportion in first-tier cities (including Hong Kong) rising to 38%. As of June, the company's unsold signed sales amount to 321.4 billion yuan, of which 166.1 billion yuan is planned to be settled in the second half of 2024.

From 2024 to 2025, China Resources Land's settleable area is approximately 32.5 million square meters, with 82% located in first and second-tier high-energy cities. Its rich high-quality resources ensure the company's performance with high-quality and stable growth. Moreover, the company's finances are very healthy, with a total interest-bearing debt ratio of only 38.9% as of June 2024, far below the industry average. The cash-to-short-term debt ratio is 1.54 times, and the financing reserve-to-short-term debt ratio is 1.38 times, showing superior financial security capabilities compared to peers.

In conclusion, the turning point of the real estate sector's valuation may be approaching, but there are still certain risk points, such as lower-than-expected industry demand, etc. Investors can focus on investment opportunities in high-quality real estate enterprises