KKR says China’s real estate correction may only be halfway through

BEIJING – China’s real estate woes are likely far from over and the sector’s problems must be addressed quickly if overall GDP growth is to pick up significantly, according to a report released Thursday by global investment firm KKR.

That’s one of the two biggest takeaways from a recent trip to China by the firm’s head of global and macro asset allocation, Henry H. McVey. It was his fourth visit in just over a year.

“A fundamentally overbuilt real estate sector needs to be addressed – and quickly,” he said in the report, which co-authors Changchun Hua, KKR’s chief economist for Greater China.

“Second, confidence must be restored to reduce cuts,” McVey said, noting that this would encourage consumers and businesses to spend money on upgrading to higher quality products, as Chinese authorities have promoted.

Real estate and related sectors once accounted for about a fifth or more of China’s economy, depending on the scope of analysts’ calculations. The real estate sector has collapsed in recent years following Beijing’s crackdown on developers’ heavy reliance on debt for growth.

Based on comparisons with housing corrections in the US, Japan and Spain, China’s housing market correction may only be halfway complete in terms of depth, the KKR report said.

“Both price and volume must come under pressure to complete the purification cycle,” the report said. “However, so far it has largely been a contraction in volume.”

While KKR’s report did not provide many details on expectations for specific real estate policies, the authors said more action from Beijing to improve China’s real estate sector could “materially change investor perception.”

Amid geopolitical tensions, the real estate market slump and stock market decline have made many foreign institutional investors hesitant to invest in China.

“According to some of our own research work, many allocators have been considering reducing exposure to China to 5-6%, from 10-12% today, at a time when we think fundamentals in the economy have likely bottomed out ,” the KKR report said.

Many of China’s official figures at the start of the year exceeded analyst expectations.

Chinese officials have said the real estate sector is still in a period of adjustment as Beijing shifts emphasis to manufacturing and what it considers “high-quality development.”

Authorities have also launched policy measures to promote financial support to selected property developers, while many local authorities – although not necessarily the largest cities – have significantly relaxed restrictions on house purchases.

KKR expects a modest slowdown in Chinese GDP growth to 4.7% this year and 4.5% next year, with real estate and Covid-related factors halving the negative impact on the economy from 1.4 percentage points in 2024 to 0.7 percentage points in 2025.

“Our bottom line is that: with continued [property] correction and some potential further policy support, we believe this will act as a brake [the] the overall economy should moderate somewhat in the coming years,” McVey said in a separate statement. He is also Chief Investment Officer of KKR Balance Sheet.

Catering, accommodation and wholesale will modestly increase their contribution to growth over the next two years, while digitalisation and the shift towards a more carbon-neutral, green industry are expected to remain the biggest drivers of growth, the report said.

For investors, the report said, a more important development than China’s GDP growth is whether authorities could make it easier for companies and households to tap capital markets.

“Repair soft spots [the] The economy, especially in housing, will ultimately improve the cost of capital and also allow new consumer companies to access the capital markets, likely at better prices as real estate and confidence perform better,” McVey said in the statement.

Beijing announced a GDP target of around 5% for this year in March. Minister of Housing and Urban-Rural Development Ni Hong said last month that developers should go bankrupt if necessary and that authorities would promote the development of affordable housing.

Recent data indicate some stabilization in the real estate sector slowdown. The seven-day moving average of new home sales in 21 major cities fell 34.5% year-on-year as of Monday, better than the 45.3% decline a week earlier, according to Nomura, citing Wind Information.

Compared to the same period in 2019, that sales average was only 27.8% lower as of Monday, down from a 47% decline a week earlier, Nomura said, noting that most of the improvement was in China’s largest cities.

KKR said the bulk of its local portfolio consists of consumer and services businesses, whose operations reflect how middle- to upper-income Chinese people spend modestly to improve their lifestyles.

“Sales growth is solid, margins are holding up and consumers are spending money on less flashy items like ‘smart homes’, pets and recreational activities,” the report said. “Domestic travel is also strong.”

Retail sales rose a better-than-expected 5.5% year-on-year in January and February, boosted by significant growth in holiday spending over the Lunar New Year.

In the longer term, KKR still expects that China can follow historical precedent in changing policies to become more ‘investor-friendly’.

“While our message is not a clear-cut signal to intervene,” the report said, “it is a reminder – using history as a guide – that as China changes its domestic policies to be more investor-friendly, (particularly if it is about supply-side reforms), this market could recover significantly from current levels.”