China Real Estate: Easing Policy Measures Insufficient for a Sharp Turnaround

1. Investment Research Services REPORT China Real Estate: Easing Policy Measures Insufficient for a Sharp Turnaround

2. China Real Estate: Easing Policy Measures Insufficient for a Sharp Turnaround The Backdrop of the ‘Three Red Lines Policy’ China’s rising real estate prices over the last two decades (last decade: +8.3% CAGR) have underpinned a belief that real estate is the safest investment avenue. As a result, almost 90% of Chinese families already own an apartment, whereas a vacancy of ~20% of the total homes in the country raises a concern. Moreover, the unwarranted rise in housing prices further stretched the affordability of millions, thereby widening the gap between the rich and the poor. Figure 1: Residential housing prices Residential housing prices* CNY 25,000 20,000 15,000 10,000 5,000 0 May-20 May-22 May-14 May-16 May-15 May-18 May-19 May-13 May-12 May-21 May-17 Source: CRIC, SGA Research *Based on 50 cities On the other hand, developers, in a bid to meet the never-ending speculative demand, over-burdened themselves with high financial leverage; one-fourth of the bank loans in China are property-related. The developers were also partly responsible for driving up the land prices, as many of them gobbled land parcels to build land banks. The top 30 developers together held close to CNY 2bn worth of land parcels in 2020. 2

3. China Real Estate: Easing Policy Measures Insufficient for a Sharp Turnaround Figure 2: Land banks and property loans to total loans Real estate loans to total loans Land bank of top 30 developers CNYm 30% 2,000 1,800 29% 1,600 28.3% 1,400 28% 1,200 27.1% 27% 1,000 800 26% 600 25.2% 400 25% 200 24% 0 12/31/2019 12/31/2020 12/31/2021 Jan 2020 Dec 2021 May 2022 Source: Company Filings, SGA Research Source: CEICDATA, SGA Research Looking at the risk of a potential housing bubble, the People’s Bank of China and the Ministry of Housing and Urban- Rural Development (referred to hereafter as the authorities) imposed the ‘three red lines policy’. What is the ‘Three Red Lines Policy’? The authorities with an expectation to curb the debt levels and improve the financial health of the highly leveraged developers introduced three criteria called the ‘Three Red Lines Policy’ in August 2020. The policy includes the following criteria: 3. Cash should be at least equal to short-term borrowings To limit the extent to which a developer can grow their debt every year, the authorities introduced a color code scheme that would decide the allowable annual growth in debt levels based on the number of red lines breached by a developer. 1. Liability to asset ratio (excluding advance receipts) of less than 70% 2. Net debt should not exceed equity Table 1: Allowable annual growth rate in debt based on the red line breaches Color Code Number of Red Lines Breached Allowable Annual Growth in Debt Green 0 15% Yellow 1 10% Orange 2 5% Red 3 0% 3

4. China Real Estate: Easing Policy Measures Insufficient for a Sharp Turnaround Scenario When The Policy was Introduced The Chinese government was worried about the speculative real estate market for a long time but the turmoil around Evergrande and other big developers enforced the government to bring three red lines policy in effect. The authorities initiated the policy with a pilot asking 12 developers to submit detailed reports of their financing situation for evaluation. The evaluation body consisted of the People’s Bank of China and the Ministry of Housing and Urban-Rural Development. estimates. We evaluated the top 50 developers based on the authorities’ three criteria to understand its implication. We found in our analysis based on the latest filings that around nine developers are still not able to satisfy all the three policies (Greenland, Evergrande, Financial Street, Tibet Urban, Zhongtian Financial, China Fortune, Gree Real Estate, Jiangsu Zhongnan, and CCCG Real Estate). Only a quarter of the top 50 developers were able to meet the green status by satisfying all three criteria. Only 6.3% of the S&P-rated developers could fully comply with all three red lines, according to the July 2022 S&P Figure 3: Top 50 developers – Number of red line breaches Number of red line breaches 27 30 23 21 20 12 10 9 9 8 10 6 6 4 0 2019 2021 Latest Filing 0 1 2 3 Source: Company Filings, SGA Research Looking at the risk of a potential housing bubble, the People’s Bank of China and the Ministry of Housing and Urban- Rural Development (referred to hereafter as the authorities) imposed the ‘three red lines policy’. Another move by The Regulators - This time to Safeguard The Banks from Default Risk In December 2020, China’s regulators (The People’s Bank of China and the China Banking and Insurance Regulatory Commission) took a step to safeguard the banks from default risk by issuing a regulation to cap property loans issued by the banks. Based on the functions of financial institutions and their asset size, the upper limits are set in different categories for property loans and mortgage loans. 4

5. China Real Estate: Easing Policy Measures Insufficient for a Sharp Turnaround Table 2: Upper limits on loans issued by the banks to the real estate sector CAPED (% of Total Loans) Property Loans Home Mortgage Loans Large Banks 40% 32.5% Medium-sized Banks 27.5% 20% Small Banks Adjust up/down 2.5% based on the region’s economic performance Source: Reuters of the ongoing defaults and liquidity catastrophes experienced by them. Thus, the prices of the newly built home continued to decline for 10 consecutive months, from September 2021 (Figure 4: Cumulative MoM decline of 1.75% from Sept 2021 to Jun 2022) and resulted in a 0.1% decline YoY for the first time in near 7 years in May 2022, followed by 0.5% decline in June 2022 (Figure 4). Both the leading indicators, property investment (-9.4% y/y June 2022) and new constructions (-45%) suggest that the sentiments continue to worsen in the real estate sector in June despite the easing of lockdown measures from mid-May. China’s property sales to fall by 25–30% in 2022, according to Fitch Ratings. Developers might not return to the public land market in the near term unless they are able to raise more debt, despite better deals being offered by the local government agencies. Developers with good financial health and state- owned property firms will focus on acquiring projects from distressed peers leading to less focus on government land sales in the short run. This, in turn, would result in a decline in the tax revenue for the local governments and would impact China’s economic growth. Eventually, the real estate sector started impacting China’s GDP (~25% contribution to GDP comes directly and indirectly from the real estate sector) from September 2021, hence the policy easing measures were introduced at the end of 2021. Moreover, the rising number of cases of COVID-19 in 2022 and subsequent lockdowns to curb the virus in 2022 might delay the expected recovery of the real estate sector. If the banks miss the requirement by less than 2%, the regulators grant them 2 years grace period but if they miss the requirements by more than 2%, then the grant would be for 4 years. This would limit the developers’ access to funds, as many of them are already highly levered. The three red lines policy controlled the demand while the property loan management rules controlled the capital supply. • Impact on the sector — post-policy measures by the regulators • to stricter rules and deleveraging campaigns by the regulators. Consequently, one of the leading Chinese developers, China Evergrande, faced a liquidity crisis and reported a default on December 26, 2021. It also has 1.6m undelivered apartments. In June 2022, Fitch Ratings withdrew its rating on China Evergrande, as it would no longer have sufficient information on the world’s most indebted developer, with over USD 300bn of total debt. Other property developers, including Shimao and Sunac China Holdings, have also missed their debt repayment deadlines. • estate (~50%) started declining as the sale of land- use rights for state-owned plots saw a downward trend. According to the Ministry of Finance of China, from January to May 2022, the revenue from land donations paid for state-owned land use rights was CNY 1.86tn, down by 28.7% YoY. Government agencies are cutting down costs to overcome the decline in tax revenue. • delaying their investments due to a risk of non- completion of the project by the developer, because Financial stress on the developers increased due • • The local governments’ tax revenue from real • • Home buyers are becoming more cautious and 5

6. China Real Estate: Easing Policy Measures Insufficient for a Sharp Turnaround Figure 4: Newly built house prices YoY change and MoM change China newly built home prices YoY change* China newly built home prices MoM change* 0.5% 4.7%4.6% 5% 0.4% 4.2% 0.4% 3.8% 0.3% 4% 3.4% 0.3% 3.0% 0.2% 3% 0.2% 2.6% 2.3% 0.1% 2.0% 2% 1.5% 0.0% -0.1% 0.7% 1% 0.0% -0.1% 0.1% -0.1% -0.2% -0.1% 0% -0.3% -0.1% -0.3% -0.3% -0.2% -0.5% -1% -0.3% -0.4% May-22 Mar-22 Jan-22 Fab-22 Jun-22 Aug-21 May-22 Apr-22 Nov-21 Dec-21 Sep-21 Jun-21 Mar-22 Oct-21 Jan-22 Fab-22 Jun-22 Aug-21 Apr-22 Nov-21 Dec-21 Sep-21 Jun-21 Jul-21 Oct-21 Jul-21 Source: National Bureau of Statistics, SGA Research *Based on China’s 70 major cities Policy Easing to Boost The Economy In December 2021, The People’s Bank of China announced that most banks’ reserve requirement ratio was to be dropped by 0.5%, releasing CNY 1.2tn of liquidity. Moreover, the cap on debt-financed acquisitions was removed to encourage large and state-owned property developers to acquire stakes in debt-ridden property developers or their assets. 4.5bn) allowed the firm to avoid a technical default that could have complicated its restructuring. The regulators accepting the extension of overdue loans helped the developers to obtain funding to prevent their projects from being halted, boosting consumer confidence, and giving them several M&A opportunities. The latest deals should propel optimism in the consumers as well as the stock and bond investors. Simultaneously, the eased curbs on home purchases in more than 80 cities in 2022 should bode well for the property market in China. Thus, we saw multiple M&A activities in the last 6 months, starting with Agile Group Holdings and Shimao Group Holdings selling its stake in companies to state-owned enterprises (SOEs) to raise cash. Evergrande’s Hengda Real Estate Group’s deal with the bondholders (CNY 6

7. China Real Estate: Easing Policy Measures Insufficient for a Sharp Turnaround Recovery Ahead? On the back of policy easing by the Chinese government as well as the ease of access to debt and the lockdown being lifted from May 2022, the real estate sector may witness recovery in the mid-term. However, it would not be a V-shaped recovery because the real estate policy easing alone would not help to rejuvenate the economic growth, as in the long run, the authorities would limit the space for policy easing. The new home prices’ YoY growth has been reflecting a declining trend since September 2021. Additionally, the YoY growth became negative for the first time in May 2022 (-0.1%) and declined further in June 2022 (-0.5%). We expect new home prices to remain flat in 2022. measures to shift their dependency on the property market to other growing markets like technology to boost their tax revenue. All 22 of China’s high-yield real estate bond issuers either defaulted on dollar bonds or undertook bond exchanges in 2022 to defer their repayment of debts. However, exchanging the bonds or pushing maturity dates ahead would provide short-term relief but would not resolve the credit crisis. We may see more defaults by property developers in 2022 due to increased pressure on bond maturities and the difficulty to free up cash to settle their outstanding debts amid the property sector crisis. The poor customer sentiments can be gauged by the recent development in which there has been an increase in the number of disgruntled homebuyers who are boycotting mortgage payments on stalled projects. As of 13 July 2022, homebuyers have stopped mortgage payments on at least 100 projects in more than 50 cities, according to the research firm China Real Estate Information Corporation (CRIC). This remains a serious concern as it could lead to a surge in the default rate of banks that are exposed to such assets, thereby bringing instability to the financial sector. We anticipate a slow growth ahead and the home prices to remain flat in 2022, as there would be less property speculation due to decelerating long-term growth expectations. We also need to accept the fact that there is a high probability of a low birth rate in the coming decades, implying that the existing supply of homes should be sufficient to cater to China’s housing demand. According to a research study conducted by a team led by economist Ren Zeping, the ratio of finished residential units to the number of households rose to 1.09 in 2018 from 0.8 in 1978, implying a comfortable supply for the demand. However, one should keep in mind the President’s statement that “housing is for living and not speculating.” The policy easing measures by the government did not aid to revive the industry. The government should assist developers in restructuring debt and promoting better governance and reporting mechanism to grow sustainably. Additionally, there is a need to bring in more policies to boost people’s confidence in the real estate sector. On the other hand, given the slow recovery expected in the real estate market in the short term, the local governments in the country should start taking 7

8. China Real Estate: Easing Policy Measures Insufficient for a Sharp Turnaround Annexure Three red lines ratios of the top 50 developers in China Liabilities to Total Asset Net Debt to Equity Cash to Short term borrowing Name 2019 84% 78% 74% 63% 89% 87% 75% 89% 75% 65% 68% 57% 79% 79% 58% 81% 76% 60% 90% 88% 49% 35% 84% 69% 14% 77% 76% 77% 75% 84% 86% 82% 36% 59% 40% 83% 82% 88% 49% 81% 84% 76% 91% 87% 62% 73% 49% 79% 19% 53% 2021 80% 78% 75% 68% 85% 82% 76% 89% 75% 67% 68% 59% 79% 75% 53% 79% 69% 57% 84% 82% 61% 32% 85% 69% 17% 72% 74% 76% 75% 79% 80% 73% 32% 62% 44% 93% 84% 83% 53% 79% 95% 73% 88% 87% 66% 75% 68% 76% 22% 41% LF 80% 78% 75% 68% 85% 82% 76% 88% 74% 66% 66% 60% 79% 75% 51% 55% 68% 57% 83% 82% 61% 32% 83% 69% 20% 71% 72% 75% 75% 79% 80% 73% 32% 60% 44% 94% 85% 83% 53% 79% 94% 73% 89% 88% 64% 76% 68% 76% 21% 42% 2019 45% 61% 58% 30% 56% 31% 57% 173% 87% 48% 111% 50% 69% 66% 39% 133% 164% 65% 210% 49% 52% 0% 176% 21% -46% 92% 189% 96% 142% 139% 122% 178% 21% 65% -12% 184% 100% 115% 64% 176% 198% 187% 244% 92% 24% 52% 42% 81% -30% 15% 2021 39% 60% 54% 36% 57% 54% 53% 128% 63% 52% 98% 72% 55% 63% 1% 64% 68% 56% 115% 60% 97% -6% 161% 41% -35% 94% 147% 85% 149% 81% 74% 83% -2% 55% 21% 214% 99% 63% 83% 145% 830% 175% 144% 228% 61% 83% 123% 64% -8% 26% LF 43% 74% 54% 38% 57% 52% 58% 113% 73% 55% 127% 66% 55% 63% 12% 64% 60% 56% 97% 60% 104% -3% 118% 36% -40% 91% 154% 90% 135% 83% 74% 75% -9% 12% 24% 209% 94% 63% 83% 152% 753% 163% 119% 207% 56% 92% 123% 64% -8% 26% 2019 1.7x 1.9x 4.1x 1.4x 2.1x 1.7x 1.3x 0.6x 1.0x 0.7x 0.2x 1.6x 1.4x 2.8x 1.0x 0.4x 0.6x 0.5x 0.8x 1.5x 0.6x 20.7x 0.4x 7.1x 234.6x 1.0x 0.7x 1.8x 0.7x 0.9x 0.7x 0.6x N.A. 0.7x 3.9x 0.3x 0.7x 2.1x 0.5x 0.9x 0.6x 1.1x 0.5x 1.9x 1.0x 1.5x 1.2x 1.2x 1.0x 1.5x 2021 2.3x 2.3x 5.5x 1.8x 1.9x 1.3x 1.7x 0.5x 2.4x 52.1x 0.5x 0.7x 2.1x 2.6x 1.2x 3.3x 0.9x 0.5x 1.1x 1.2x 0.6x 16.7x 0.5x 7.8x 30.3x 1.1x 1.4x 1.4x 0.5x 0.7x 1.2x 1.7x 5.5x 0.5x 2.0x 0.1x 0.6x 1.7x 0.2x 1.4x 0.1x 0.2x 0.4x 0.6x 0.5x 1.2x 0.3x 1.6x 70.1x 0.2x LF 2.3x 1.9x 5.5x 2.1x 1.9x 1.6x 1.5x 0.5x 1.8x 23.1x 0.2x 2.2x 2.1x 2.6x 1.0x 4.3x 0.9x 0.5x 1.1x 1.2x 0.5x 15.4x 0.4x 7.7x 47.7x 1.4x 1.0x 1.7x 0.7x 0.6x 1.2x 1.8x 6.7x 1.7x 1.6x 0.3x 0.6x 1.7x 0.2x 1.3x 0.2x 0.6x 0.6x 0.9x 0.5x 1.4x 0.5x 1.6x 75.9x 0.3x China Vanke Co Ltd Poly Developments And Hold Longfor Group Holdings Ltd China Merchants Shekou Ind Country Garden Holdings Co Seazen Holdings Co Ltd Gemdale Corp Greenland Holdings Corp Lt Shenzhen Overseas Chinese Hainan Airport Infrastruct Shanghai Lujiazui Fin&Trad Shanghai Lingang Hldgs Cor Greentown China Holdings Cifi Holdings Group Co Ltd Zhejiang China Commodities Tianjin Guangyu Developmt Xinhu Zhongbao Co Ltd Red Star Macalline Group C Sunac China Holdings Ltd Seazen Group Ltd Shanghai Zhangjiang High Vantone Neo Development Gr China Evergrande Group China Enterprise Co Ltd Shanghai Wanye Enterprise Cinda Real Estate Co Ltd Financial Street Holdings Grandjoy Holdings Group Tibet Urban Development Jinke Properties Group Co Radiance Holdings Group Co Zhuhai Huafa Properties Co China World Trade Center Shanghai Jinqiao Export Pr China-Singapore Suzhou Ind Zhongtian Financial Group Risesun Real Estate Devel Midea Real Estate Holding Lt China Logistics Property Hol Beijing Capital Developmen China Fortune Land Develop Gree Real Estate Co Ltd Jiangsu Zhongnan Construct CCCG Real Estate Corp Ltd Shanghai Shimao Co Ltd Shenzhen New Nanshan Holdi Shanghai Smi Holding Co Lt Logan Group Co Ltd Shenzhen Tellus Holding Co Suning Universal Co Ltd 8

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