Effect of Fed rate cut: The darkest period is over, will the real estate sector welcome a valuation recovery opportunity?

The real estate sector has hit bottom and rebounded, with the Fed lowering interest rates by 50 basis points at its September meeting, exceeding market expectations, and the Hong Kong property sector continues to rise. It was learned that on September 19th, the Fed lowered interest rates by 50 basis points, lowering the target range to 4.75%-5%, exceeding market expectations by 25 basis points. Fed Chairman Powell said that the 50 basis point rate cut is not a recessionary rate cut and the pace of future rate cuts, with increasing downside risks to employment and decreasing upside risks to inflation, but the battle against inflation has not yet been completely won, and decisions will still be made based on data. In fact, the Fed's monetary policy has a significant impact on Hong Kong's capital markets. Hong Kong operates on a linked exchange rate system, and as an international financial market, exchange rate movements directly impact capital flows. The US rate hike cycle began in March 2022, with 11 subsequent rate hikes totaling 5.25%, coupled with poor profitability, leading to long-term liquidity depletion in Hong Kong stocks. This rate cut is seen by the market as the start of a Fed rate-cutting cycle, offering a buying opportunity for Hong Kong stocks. The real estate sector is not just affected by liquidity issues, but is also currently in a downturn, with industry valuations under pressure. A bottoming out and investment opportunities still require support from underlying industry fundamentals. The industry is in a recession, but the darkest period seems to have passed Looking at the development of the real estate industry, prior to 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 five years, with slowing growth and the Evergrande default exacerbating the industry's cleansing. In 2022, industry defaults increased, officially entering a recession, with three consecutive years of decline. In the first 8 months of this year, real estate demand has been very sluggish due to ongoing international conflicts, risk concerns, reduced rigid demand from declining marriage rates, and overall pessimism about the macroeconomy. Consumers are suppressing real estate consumption, with a significant increase in cash holdings, leading to an explosive growth in deposits. By August 2024, real estate industry sales area and sales revenue were 6.06 billion square meters and 5.97 trillion yuan respectively, a year-on-year decrease of 23.6% and 18%. Real estate overcapacity remains severe, and destocking remains a medium-term priority. According to a report by the China Index Institute, as of July 2024, the national residential "started but unsold stock" was 2.52 billion square meters, with a clearance period of approximately 3.4 years, creating significant liquidation pressure. With a major decline in demand and falling prices causing more rigid demand groups to wait and see, the outlook for destocking may not be optimistic. On the policy front, the central bank has cut reserve requirements and interest rates, providing financial support to homebuyers and the real estate sector. Both supply and demand sides are stepping up their efforts, but the results will take time to materialize. In the market, the dual development system of "guaranteed housing and commercial housing" is shaking up the industry market, with state-owned enterprises reshaping the industry landscape. Stockpiling is a direct means to clear inventory, with national implementation accelerating, facilitating the clearing and elimination of inefficient real estate firms. Increasing affordable housing supply can stabilize prices, support real estate development, and implement the "housing is for living, not for speculation" policy. According to the China Index Institute, as of the end of August 2024, around 30 cities had issued announcements to collect commercial housing for affordable housing. Progressively, in August, the first project in Wuhan was officially launched, providing over 500 units of affordable rental housing for the city; the second batch of acquisitions of completed unsold commercial housing for affordable housing in Chongqing was signed, with 7 projects providing more than 2,600 units of affordable housing after renovation. With several industry leaders experiencing defaults, even Vanke has not escaped the industry crisis. However, efforts are being made to maintain healthy finances, and the market will gradually clean up. The darkest period for real estate may be behind us, and dawn may be just around the corner. Industry differentiation is severe, with resilient premium real estate companies Despite the real estate industry experiencing an unprecedented dark period, some premium real estate companies have managed to maintain profitability. Looking at the financial reports for the first half of 2024, as an example, China Resources Land (01109) saw a revenue growth of 8.44%, achieving a net profit of 10.253 billion yuan, while Longfor Group (00960) saw a decrease in revenue but still achieved a net profit of 5.866 billion yuan. Contrastingly, Vanke's revenue fell by 28.9% in the first half of the year, with a net loss of a whopping 9.852 billion yuan, Evergrande saw a bottoming-out of revenue, but a huge loss of 33.012 billion yuan, and Sunac's revenue dropped by 41.4%, with a net loss of 14.96 billion yuan. Additionally, some medium and small real estate companies are also showing differentiation, with revenue declines for companies like Zhongliang Real Estate and R&F Properties, both of which recorded losses. In the first 8 months of this year, according to sales figures released on the Hong Kong Stock Exchange, Vanke, China Overseas, China Resources Land, Longfor, and Greentown China were the top 5 in terms of sales in Hong Kong. Vanke's sales area and revenue were 120.76 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 have also experienced varying degrees of decline, but some have maintained performance resilience by improving product quality and raising prices, like China Resources Land, who reported almost stable sales in August, with an average price from January-August at 26,900 yuan per square meter, up by 19.2% year-on-year. The performance of major real estate companies is fully reflected in the capital markets. China Resources Land's valuation has withdrawn slightly in recent years but remains much lower than the industry decline, continuing a long-term bullish trend as a refreshing presence in the real estate sector. Vanke began to decline in 2020, falling from a high of 36 Hong Kong dollars to less than 5 Hong Kong dollars, a market capitalization drop of 86%. Sunac also fell from 46.2 Hong Kong dollars to 1.04 Hong Kong dollars, a market capitalization decrease of 97.8%. As mentioned above, the darkest period for real estate has passed, and whether in physical operations or the capital markets, we have hit rock bottom with negative factors.Under the blunted market conditions, 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?The Fed's rate cuts have triggered effects, focusing on valuation repair opportunities In fact, the most direct impact of the Fed's rate cut on the Hong Kong stock market is the flow of funds, leading to increased inflows into the Hang Seng Index and driving a rebound in the real estate sector. Real estate is highly sensitive to interest rates, and the Fed's rate cut is expected to trigger a series of rate cut effects. As central banks around the world implement loose monetary policies, the real estate industry will also see the impact of the financial market the physical market, and the improvement in industry fundamentals will further drive the sector's valuation repair. First is Vanke, whose valuation has significantly shrunk, with a current PB ratio of only 0.3 times. The main issue currently is the drag from the development business, but non-development business including property management, long-term rental, and commercial sectors continue to see growing revenue, bringing expected trends to the business turnaround. Additionally, the company's debt problems are gradually being eased, with interest-bearing debt amounting to 331.3 billion yuan by 2024, and cash and cash equivalents at 92.4 billion yuan. The company focuses on cash flow security, deferring land acquisition pace, and the huge losses in the first half are more due to asset/credit impairment effects. It is expected that the second half will see significant improvement in comparison, and 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 any issues, Vanke is still a leader in the industry, with a low probability of following in the footsteps of Evergrande, and is also supported by major banks. Next are quality real estate companies such as China Resources Land and Longfor Group. Take China Resources Land as an example, the sales resilience of the development business remains strong. Although overall sales in the first half were affected by the market, there was an improvement in structure, with contracted inventory signings accounting for 50.6% at the beginning of the year and first-tier cities (including Hong Kong) accounting for 38%. As of June, the company's contracted unrecognized sales amount was 321.4 billion yuan, with 166.1 billion yuan scheduled to be settled in the second half of 2024. By 2024-2025, China Resources Land can settle approximately 32.5 million square meters, with 82% located in first and second-tier high-energy cities. Abundant high-quality resources ensure the company's performance sees high-quality and stable growth. The company's financials are also very healthy, with a total interest-bearing debt ratio of only 38.9% as of June 2024, much lower than the industry average. Cash-to-short-term-debt ratio is 1.54 times, financing reserves-to-short-term-debt ratio is 1.38 times, showcasing financial security capabilities that outperform its peers. In conclusion, the turning point in the valuation of the real estate sector may be approaching, but there are still certain risks, such as industry demand falling below expectations. Investors can focus on investment opportunities in high-quality real estate companies.