Abstract: Unlike SARS, the novel coronavirus epidemic should not be taken simply as an exogenous shock event, as it has profound implications for the short-, medium- and long-term operation of the Chinese economy. Though less affected than the manufacturing or the trade sector, the real estate sector in China would nonetheless see changes after the epidemic. Specifically, the impact of the epidemic on the real estate sector will manifest itself in eight ways. First, there will be no particularly significant adjustments to real estate policies. Second, the market demand for real estate is still there, only delayed. Third, the renewal of old residential communities may become a particularly interesting topic. Fourth, real estate-related companies may undergo alterations in their governance and management. Fifth, these companies must reconsider the need to launch REITS for their investment properties. Sixth, the popularity of green, medium and low density residential properties, as well as second homes will increase. Seventh, policy may become more lenient with homebuyers demanding for upgrades. Eighth, the layout of the real estate industry might be skewed toward the southeast coastal regions in China.
I. Novel coronavirus outbreak should not be simply seen as an external shock event
First, I want to emphasize that the novel coronavirus outbreak is a catastrophe. It has brought a huge disaster to the Chinese people and the whole world, for which we have paid a heavy price. In the face of disasters, the most people can do is to survive them and then gradually resume one's normal life. The long course of human history has witnessed numerous disasters, and we may encounter many more in the future.
Secondly, I want to make it clear that the impact of the novel coronavirus outbreak is different from what we experienced in the past. For example, it is significantly different from the SARS outbreak in 2003, and should not be simply regarded as an external shock.
There is an economic term called shock event. If the coronavirus outbreak is seen as a shock event to the Chinese economy, the economy will become stronger post the event, and the depression caused by it will bounce back. However, the coronavirus outbreak is not a short-term shock, as there are still many uncertainties surrounding its medium and long-term impact on the Chinese and even the global economy. At present, as the epidemic continues its global spread, people are not sure about the effects it will further bring.
Therefore, I hope everyone understands that novel coronavirus outbreak is not a short-term external shock where economic stimulus can be used to offset the negative impacts. It is more than an external shock, as it is an uncertain factor that has profoundly changed the short-, medium- and long-term operation of the Chinese and even the global economy.
II. Comparison between the impacts of SARS and novel coronavirus outbreak on Chinese economy and the real estate sector
Since the end of the SARS epidemic, China's real estate sector has ushered in a round of strong and sustained growth. Even today, China's real estate still makes a considerable contribution to GDP. In this case, let us first compare the impacts of SARS and novel coronavirus outbreak on the Chinese economy and the real estate sector. Differences are summarized as follows.
First, impacts of the two outbreaks are of different scopes. During the SARS outbreak, two regions, Beijing and Guangdong, were seriously affected. At that time, Beijing's GDP accounted for about 3% of the country total, and Guangdong about 10%. Together, the two accounted for 13% of China's GDP. Today, although the epidemic has been tentatively controlled and the situation has improved, affected provinces contribute to over 90% of the country's GDP.
Second, China's economy today is largely different from that in 2003. China's GDP was about 14 trillion yuan around 2003, and per capita GDP just exceeded 10,000 yuan. And now the country's GDP is close to 100 trillion yuan, and per capita GDP has just crossed the USD 10,000 mark. Moreover, China has become more intensely integrated into globalization today. Therefore, the Chinese economy has a more significant impact on the world economy, and also can be more deeply and widely affected by the world economy compared to 2003. In other words, when China was hit by the SARS epidemic in 2003, the international community was relatively calm, because China's economy was not large enough at that time. But today the novel coronavirus outbreak has brought a huge shock to China as well as the world.
Third, the urbanization rates are different. In 2003, the urbanization rate in China was probably lower than 40%, with 400 million plus people living in cities, counties and townships. Right now, the number is over 850 million. Generally speaking, urbanization in China, including the development of cities, counties and townships, is progressing at a fast pace. However, the highly dispersed rural communities are, to some extent, naturally resistant to epidemics. Therefore, back in 2003, the vast rural areas in China helped cushion and guard against the blows of the SARS outbreak. But this barrier no longer exists. Nowadays, there is only a rural population of 500 million plus in China, while over 800 million urban residents are affected.
Fourth, the population moves faster at a larger scale now. During the SARS outbreak, people and resources did not move so frequently as they do now. With highly developed transportation systems, flow of population peaks both before and after the Spring Festival, much faster and at a much larger scale than in 2003. According to the National Development and Reform Commission, the current frequency and velocity of population movement is about four times that in 2003, which has made it harder to prevent against and contain epidemics.
Fifth, China was in different economic cycles when the two epidemics attacked. When SARS broke out in 2003, China had just undergone profound institutional reforms that started in 1997 triggered by the financial crisis in east Asia that year and an overheat in its own economy during 1994 and 1996. Specifically, China made several efforts to improve its exchange rate management, including introducing a unitary exchange rate regime, and reforming the foreign exchange settlement and sales systems; unprofitable state-owned enterprises underwent three years of restructuring to improve their financial performance; and the fiscal system also saw tax distribution reforms. Moreover, upon entering the WTO in 2001, China systematically cleared laws and regulations that ran against WTO rules. In other word, China's internal reforms and opening-up were in full swing for the years before 2003, and that has resulted in an overheat in its economy, which did not cool down until after the SARS outbreak.
In contrast, the Chinese economy now is experiencing a long, downward cycle. Ever since 2012, its development slowed down amid a transition from high-speed growth to high-quality growth, featuring intensive supply-side reforms in both real economies and the financial field.
Sixth, policies on the real estate sector are different. For a while after the SARS outbreak, the Chinese government carried out reforms of land policies targeting the real estate sector, stipulating that the right to use profit-oriented lands must be transferred by means of bidding, auction or listing, which significantly changed the distribution of profits and interests in the real estate sector as local governments became important stakeholders. This, of course, has strongly and systematically pushed up house prices in China. However, there will be no such policy shifts at present. The current regulatory framework for the real estate sector has not seen fundamental adjustments, featuring a set of long-term mechanisms and the suppression of real estate speculations.
To sum up, SARS and the novel coronavirus attacked at different stages in China’s economic development. After the SARS crisis, China’s economy saw strong, long-term growth that lasted until 2011, which was mainly attributed to the combined effects of multiple dividends, including the dividends of opening-up, industrialization and urbanization, alongside the demographic dividend. But now, these dividends have significantly faded, if not disappeared.
The above comparisons show that the SARS outbreak may be counted as a short-lived shock event for China's economy, which could be weathered through short-range stimulus policies. However, the novel coronavirus epidemic has brought uncertainties to China's development in the short, medium and long run. Besides, China is in the middle of an economic transformation, so the novel coronavirus outbreak should not be taken simply as an exogenous shock event like SARS given the different context.
III. The novel coronavirus outbreak may result in supply chain restructuring and global industrial shifts
In response to the epidemic, while macroeconomic policies can be used to buffer its short-term blows, we have to be cautious when dealing with the medium- to long-term impacts. I would like to share two observations about this.
First, the epidemic is not a "stress test", but an actual, short-term "hard decoupling" between the Chinese economy and the global economy, which is bound to ignite rethinking of global industry and trade chains.
Some said that the coronavirus outbreak is a stress test whereby the epidemic forces China to decouple from the global economy. Stress test is also an economic term, which involves running simulations to calculate the impact of a shock event that has not happened. It is nothing but a hypothesized scenario. Unfortunately, it is clear that the virus has actually halted China's economic progress and put strong pressures on its supply chain and even the global supply chain system. It is not a hypothetical test, but an actual short-term decoupling between the Chinese economy and the world economy.
We cannot underestimate the impacts of the decoupling on China and the world. In the long-term, it is likely that a backup supplier will rise to replace China. We all know too well the importance to spread risks. For instance, key systems in commercial banks and financial institutions, such as big data and core business systems, must be supported by many backup systems for disaster recovery. Similarly, global industries and businesses who find it hard to sustain without supplies from China during the coronavirus outbreak may consider to select another relatively safe spot as a production base to provide immediate substitute supplies and capacities after China’s supplies get cut off. However, it remains to be seen whether they can find such backup suppliers amid a global pandemic. Should they fail, such industrial shifts would be less likely to happen.
In addition, China has a huge variety of industries that enjoy the support of relatively complete supply chains, strong infrastructures, as well as sound governance and commercial environments. Therefore, it remains uncertain if countries in other regions such as central or eastern Europe and Southeast Asia with relatively robust economic development, infrastructures and governance can serve as a backup for China's supplies and production capacities.
Second, industries in China may shift towards other countries, but it is also possible that the shift will take place within the country itself. The short-term hard decoupling between China and the global economy has led Chinese businesses and the entire transnational community to reflect on the distribution of global industry chains and production capacities, and how to secure their sound and uninterrupted operations amid worldwide emergencies such as a pandemic. As a result, industries, together with capital, businesses, people and production capacities, will shift towards and concentrate in regions with more capable and responsible governments—in China, or in other countries. Within China, firms will likely flow towards southeastern coastal provinces, which will deprive central and western provinces of development opportunities and exacerbate regional imbalances.
I would also like to refute some popular arguments that the novel coronavirus outbreak is China's own problem, because it is not the pivot of global manufacturing or trade. The basis for this conclusion is that the epidemic in China had no effect on European and American stock markets, which had stayed strong since the coronavirus broke out until February 28, especially in the days before February 25.
That is not true. China is indeed the pivot of global manufacturing, contributing to around 23-24% of total manufacturing value added worldwide, compared to about 7% back in 2003 when SARS attacked. Moreover, it is also very important in global trade. Currently, the global trade volume stands at about 30 trillion US dollars, and China accounts for nearly one-fifth of it (more than 40 trillion yuan).
Therefore, there is no denying that China is at the center of global manufacturing and trade. It is the biggest and most important trading partner of more than 120 economies in the world, and the supply chain restructuring and industrial shifts brought by the hard decoupling shall not be underestimated. In fact, with the coronavirus outbreak spreading worldwide, stock markets across the globe sensed the danger and began making adjustments ever since February 25.
IV. As demands for houses delay, real estate sector in China is not expected to see big policy adjustments
The novel coronavirus has had varied influences on different industries in China. For example, it is destructive for service providers such as hotels, restaurants and airlines, as well as sectors like tourism and transportation, but it has boosted demands for medical and protective supplies.
The epidemic’s impacts on the real estate sector in China have been less than on manufacturing and trade, for two reasons. First, generally speaking, demands for real estates are localized, because houses are immovable properties; second, demands for real estates are what we call "delayed but not diminished demands", because even though people can buy houses at a later time, they still have to buy—the demands are always there.
Some believe that demands for restaurants and tourism will see retaliatory rebound after the epidemic is brought under control. I doubt that, because people are not likely to catch up on what they did not consume in the first quarter even if they go on a binge in the following three quarters. The lost demands for fast moving consumer goods or food and beverages will hardly be compensated for in the rest of the year. In contrast, real estate is a non-tradable sector, and the unfulfilled demands are more likely to be delayed until the epidemic is over. Hence, the epidemic's influence on the real estate sector is a bit different from that on other industries.
Specifically, the impact of the epidemic on the real estate sector can be summarized as follows:
First, there will be no particularly significant adjustments to real estate policies. Real estate, especially commercial residential housing, involves cement, building materials, upstream and downstream industries, home furnishings, home appliances, automobiles, etc. With a long industrial chain, it is indeed a major physical commodity.
However, we must realize that with or without the epidemic, neither the anti-speculation stance nor the black box of so-called "long-term mechanisms" that we do not know enough about is expecting many changes. That is to say, policies concerning real estate will not go through major adjustments because of the epidemic. Even under adjusted short-term macroeconomic stimulus policies, the real estate sector will not be the main beneficiary. This is the policy tone that we must understand.
Second, the market demand for real estate is still there, only delayed. Winter is not the peak time for delivering real estate construction projects, nor is it a peak selling season. Due to seasonality in construction, increasingly stringent environmental protection requirements and the epidemic, almost all projects under construction are suspended and difficult to resume. With postponed delivery, sales would be delayed as well.
Considering that the epidemic is still ongoing, we are unclear what is the current rate of construction resumption and how well would it turn out to be, but in general, there will be no significant improvement on the supply side of real estate before April. This also means that given delayed demand and reduced supply, the real estate market in the second half of the year may pick up after all. The relatively stable demands throughout the year have been piling up and will be released after the epidemic when people's life and economic activities return to normal.
Meanwhile, the real estate industry obviously also suffered from negative shocks, mainly on supply side rather than demand side. Demand is only delayed, not going to disappear. So we can expect a comparatively benign environment for real estate in the second half of the year, based on the asymmetric shocks on supply and demand.
Third, the renewal of old residential communities may become a particularly interesting topic. After the epidemic, the government might launch some major projects to ensure the achievement of such goals as securing?a?decisive?victory?in?building?a?moderately?prosperous?society?in?all?respects. The central government also mentioned that it is confident and capable of pursuing the overall goal of social-economic development in 2020, which was set in 2019. In the real estate sector, the most practical project is probably the renewal of old residential communities that not only concerns the Chinese people, but also does good to the government reputation.
In 2019, the Ministry of Finance, the Ministry of Housing and Urban-Rural Development and the National Development and Reform Commission jointly conducted a nationwide survey. The results show that there were 170,000 old residential communities that need to be renovated, involving over 100 million residents. The renovation of these communities includes the renewal of power supply, networks, elevators and community roads. In fact, the epidemic has underlined the urgency to renovate these old communities. The reason is that, according to Dr. Zhang Wenhong of the Shanghai Center for Disease Control and Prevention, more than 90% of the unfortunate deaths caused by the coronavirus are elderly people aged over 75. Since the elderly are relatively concentrated in old residential communities, opening the channels to social services and emergency medical care for the elderly and improving residential quality has become one of the most pressing problems.
That is why I believe the renovation of 170,000 old communities may be worth considering, after all, it may involves at least trillions of investments. Of course, certain practices may need to be upgraded in a timely fashion. Currently, we employ an owner-oriented, community-led, local government-guided and policy-supported approach. But in fact, the overall upgrade and renewal of old communities requires enormous resources. Without top-down policies and resource allocation, it would be extremely challenging to complete the task solely relying on the owners, communities and local governments.
Fourth, real estate-related companies may undergo alterations in their governance and management. Real estate developers pay more attention to maximizing company value and shareholder value. In the past, they typically pack different units such as construction, properties for sale, properties for investment, property management, and technology units to get listed together as a group. Few would choose to list individual business segments separately. However, as a matter of fact, the impacts of the epidemic on different business segments of these firms are asymmetric.
Where do these asymmetries manifest? For example, during this outbreak, residential property management has played a more intimate role in providing convenience to residents quarantined within their apartments, compared with government-run community management bodies.
Therefore, the property management units of some superior real estate companies have grown in popularity and valuation. Residence for sale, mainly commercial residential housing, has been subject to plenty of policy restrictions in recent years, hence its valuation is passable. As for the commercial sector, some malls, office buildings and hotels are closed for now, when they reopen, parts of the building may need to be remodeled, such as the central air-conditioning system, which will probably affect their valuation.
Some real estate companies may have technology or big data units. The epidemic has highlighted the importance of home technologies that can provide high comfort levels by maintaining constant temperature, humidity, sunlight, and especially good air quality.
Therefore, properties for investment, properties for sale, property management and related technologies have differed popularity and valuation in the market. They used to go public as a whole. After the epidemic, leading real estate companies may need to take corporate governance reform into consideration. Some of the large real estate groups may implement modular management, or pursue equity carve-outs.
Fifth, real estate companies must reconsider the need to launch REITS for their investment properties. Due to the impact of the epidemic, the income of investment properties, including office buildings and shopping malls, is limited. It is not clear how the epidemic will affect commercial activities concentrated in these properties. Generally speaking, commerce, trade, retail and catering businesses are mostly small in scale. There are about 17 to 18 million small and medium-sized enterprises in China, as well as over 80 million individual businesses. Whether they would rebound fast enough to have the reopened businesses thrive again is still uncertain. As stated in the beginning, the overall policy and environment are comparatively neutral, yet they will definitely not turn incredibly loose. In this context, the tighter capital flow forces real estate companies to think twice about the need to launch REITS for investment properties.
At the end of last year, many real estate companies were already considering listing REITS of investment properties overseas to gain cash flow. After the epidemic, real estate companies with higher proportion of investment properties will have more incentives for the overseas listing of such properties. The price may be less favorable, considering the decrease in revenue. Nevertheless, if REITS can improve corporate finances, especially stabilizing the cash flow, there will still be a considerable number of companies willing to promote the listing of their investment properties.
Sixth, the popularity of green, medium and low density residential properties, as well as second homes will increase. Before the novel coronavirus outbreak, people tended to care more about floor area compared with the quality of the house. The latter will become particularly important after the epidemic, along with property location. So one of the possible changes as a result of the epidemic would be the increase of popularity of technology-enabled homes (especially homes with advanced fresh air system), green real estate and second homes, while the enthusiasm for living in megacities, particularly in districts with ultra-high FAR located in these cities' core areas would decline.
Many people may doubt the necessity of living in an extremely crowded city. Compared with living in the 16 cities with a population of more than 10 million, why not live in those with a population between 5 million to 10 million? In addition, why not choose green, low-density residential districts? For people who live in downtown or have luxury homes there which provide the convenience for commuting to work and social life, why not have second homes in the suburbs which could keep them away from the hustle and bustle of city life or even isolate them from a disease outbreak like the novel coronavirus? These are the possible reasons for the rising popularity of green residential properties with medium and low density and second homes, while people's interest in living in bustling and crowded downtown areas would decline. In addition to location, the demand for higher property quality would be another major change in the real estate sector.
Seventh, policy may become more lenient with homebuyers demanding for upgrades. If China wants to maintain the economic growth within a relatively normal range for some time to come, and avoid deviating too much from the growth target of about 6% this year, real estate will remain a particularly important sector. That means the real estate industry will have to dance with shackles, keeping up reasonable demand without triggering speculation or compromising the long-term mechanism of the housing market. From this perspective, homebuyers' demand for upgrades is the most important.
First-time home purchase is important to the market, but upgrade demand also matters. The latter is of non-first-time home buyers who wish to improve their living condition due to changes in living needs associated with work, children's education, retirement and so on. In some large- and medium-sized cities in China, home upgrading has become a major factor driving demand in the housing market.
The current policy framework in China is in the favor of first-time home buyers, while many policy restrictions remain for non-first-time home buyers looking to improve their housing condition. It will be worth watching whether such restrictions on upgrade demands would be relaxed when the novel coronavirus epidemic is over.
Eighth, the layout of the real estate industry in China might be skewed toward the southeast coastal regions, that is, geographical parts east of the Beijing-Guangzhou railway and south of the Yangtze River. The reasons for the rising importance of China's southeastern coastal regions for the real estate market are as follows:
First, the city clusters in the Pearl River Delta and the Yangtze River Delta can accommodate sizable population and industries. They also have better public governance. Second, medical and educational resources there are richer compared with other regions. The third factor is the vigorous economy. For instance, the Pearl River Delta boasts a number of cities with a GDP in excess of one trillion yuan, such as Guangzhou, Shenzhen, Foshan and possibly Dongguan in the future. In the Yangtze River Delta, there might be more cities in the trillion GDP club, such as Nanjing, Shanghai, Suzhou, Hangzhou and Ningbo, and probably more in the future, such as Nantong and Hefei.
In sum, when the epidemic is over, both the focus of the real estate market and the overall industrial structure will shift toward the southeastern coastal parts of China, which, to some extent, will aggravate the imbalance in the distribution of the real estate market and industrial structure.
These are the possible impacts of the novel coronavirus on the real estate industry in China. The tide in China's housing market is still far from receding, as the overall living condition and urbanization rate are not high in China. Half of the 850 to 860 million urban population in China are currently living in houses built after 2000, and the other half in houses built before 2000. The living and the sanitary condition of the latter will be worrisome in the future. As there is still demand, the government, real estate companies and homebuyers will likely be more prudent and rational after the epidemic. As the epidemic continues to spread, it calls for the government, enterprises and every individual to work together.
V. How should property companies respond to cash flow difficulties?
In fact, a real estate company can do little by itself to address the cash flow problem besides slowing down purchases, reducing financial leverage, selling existing assets, and increasing promotions. But these are constringent and defensive measures, which will not fundamentally solve the problem in the long term.
The fundamental and long-term solution to the problem lies in liquidity and monetary policy. The central bank has said recently that the space for monetary policy is still relatively ample, which means that it can use a variety of monetary tools flexibly to ensure the realization of overall social and economic development goals on the agenda. This indicates that capital needs of real estate companies and many other industries would be able to be guaranteed. In the past 4 to 5 years, construction loans, development loans and mortgage loans were strictly restricted, which has resulted in a number of small- and medium-sized real state companies with high financial leverage exiting the market. Large real estate companies also experienced financial stress, but at a different level as a result of different business strategies.
The solution to the problem does not simply depend on individual real estate company's effort, but on whether post-epidemic fiscal and monetary policies are loose in a way that is targeted and countervailing.
In general, capital and fiscal policies for real estate companies are likely to be steady and slightly looser in the second half of this year, though other sectors (infrastructure in particular) might enjoy more preferential policies than the real estate sector.
VI. Will the newly created liquidity flow into the stock or the property market?
While monetary policy affects aggregate demand and supply, credit policy makes difference structurally. When additional liquidity is injected, accurately distributing funds among different sectors and enterprises is extremely difficult unless the central government directly gives money to local governments, or allocate money through the state-owned economic channels. Therefore, what is important is to prevent liquidity, once created, from flowing into the stock and the property markets, though quite difficult.
For instance, when a state-owned enterprise (SOE) is provided with funds thanks to the relatively loose monetary policy, and is asked to help stabilize the economy and offset the impact of the epidemic, it is unclear whether the SOE could separate its main business from other businesses associated with real estate. Thus, it will be very hard to prevent the newly created liquidity from flowing into the stock and real estate markets.
