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Morningstar | Drastic Changes to Presale Unlikely; Market Overreaction Provides Entry Point for Quality Developers

Chinese media outlets reported on Sept. 21 that the Guangdong Real Estate Association had issued a notice, "Emergency Notice on Opinions Regarding Pre-sales Permits for Commodity Housings." The notice referenced a document from the Ministry of Housing and Urban-Rural Development. The MOHURD document contains a paragraph requesting six provincial branches of MOHURD to provide comments on modifying the current presale practice. The current presale practice allows a developer to receive sales proceeds before the completion of the project.

The market interpreted the document as the government’s intention to eliminate the practice of property presales. As a result, the shares of major developers dropped. We believe the market reaction is unwarranted. The MOHURD document suggests a very preliminary review of the current presale practice. In our view, current high property prices are mainly driven by low inventory levels after successful destocking over the past two years. We believe a restriction on the presale practice will further reduce housing supplies available in the pipeline and discourage developers from making new investments. Such a move would cause extreme volatility in the physical property market and probably result in higher prices. Hence, we expect, at worst, a fine-tuning of the requirements that the developers must meet in order to obtain the presale permit. Any overhaul of the current practice is extremely unlikely.

Many developers’ shares are undervalued at this point, and the recent market pessimism provides a good entry point to several quality names such as China Vanke, China Overseas Land & Investment, and China Resources Land.

Despite the story being widely reported, no official document has been posted on MOHURD's website. The original notice from the Guangdong Real Estate Association is also not posted on the organization’s website. The practice of presale has been in place since the beginning of the Chinese commodity housing market. The elimination of the system, if true, will be a multistep process requiring years to fully implement. An abrupt change to the system would severely affect the amount of salable resources in the market, resulting in large price increases.