China Investors Defy Rogoff Crash Warning With Bets on Developers' Bonds

China bond investors are betting government measures to cool property prices won’t hurt real estate companies as money managers and economists warn of a crash that may slow the economy leading global growth.

Yields on China developers’ local-currency notes fell to the lowest ever relative to government debt this year, with the spread on Poly Real Estate Group Co.’s 4.3 billion yuan ($634 million) in 7 percent bonds due 2013 narrowing to a record 95 basis points on July 8, according to Shanghai Stock Exchange prices on Bloomberg. The spread tightened by 68 basis points to 138 basis points since the end of 2009.

Local investors believe “urbanization, improving standards of living and demographic growth all support the long-term outlook” for house prices, said Steve Wang, a credit strategist for Bank of China International Securities Ltd. in Hong Kong. Even if there’s a short-term decline, “China will still be a major engine for the world economy,” he said.

China may contribute a third of global growth this year as demand for its manufactured goods recovers, the Organization for Economic Cooperation and Development forecasts. Policy makers intensified a crackdown on property speculation when the economy expanded at the fastest pace since 2007 in the first quarter, prompting Harvard University professor Kenneth Rogoff to see a slowdown in price appreciation that began in May as the beginning of a real estate “collapse.”

Property Sales

Prices in 70 Chinese cities rose 11.4 percent in June from a year earlier compared to 12.4 percent in May, according statistics bureau data. The value of property sales rose 25 percent in the first half to 1.98 trillion yuan, while investment in projects rose 38 percent to 1.97 trillion yuan.

Property investment accounts for about 10 percent of gross domestic product and construction consumes half China’s steel and 36 percent of its aluminum, JPMorgan Chase & Co. estimates.

Investors “in the short term aren’t worried about the property market,” said Tan Weisi, who manages about 700 million yuan as head of Fortune SGAM Fund Management Co.’s fixed-asset department in Shanghai. “People haven’t felt a material impact from the housing market.”

The extra yield buyers demand to own China Vanke Co.’s 2.9 billion yuan in 7 percent bonds due 2013 instead of government debt fell 61 basis points to 200 basis points since the start of January and dropped to a record 153 basis points on May 21, according to exchange-traded prices on Bloomberg. China Vanke, the country’s biggest publicly-traded developer, has 137 billion yuan of assets including land in regional capitals Shenzhen, Shanghai and Beijing, its regulatory filings show.

Milord Spread

The spread on 1.8 billion yuan of five-year 7.05 percent bonds issued by Milord Real Estate Development Group Co. narrowed to 323 basis points from 351, Shenzhen exchange prices show. Milord is based in the central city of Wuhan, and reported 8.5 billion yuan of assets including properties in Beijing, Wuhan and Xi’an.

China investors “believe in the assets that these property companies own,” Ivan Chung, a senior analyst at Moody’s Investors Service, said in a telephone interview from Hong Kong.

Yuan-denominated bonds benefit from a perception that companies approved to issue onshore have a “stamp of approval” from regulators, according to Zhang Zhiming, head of China research at HSBC Holdings Plc in Hong Kong. Borrowers must undergo a “stringent approval process,” he said, and if one were to default, “to some extent regulators who approved that issue can be held responsible.”

Volatile Prices

Some investors also see bonds as a prudent place to “park money” while stock markets are volatile and bank savings rates low, said Wang Yang, co-head of fixed-income research at UBS Securities Co. in Beijing. One-year bank deposits yield 2.25 percent, while consumer prices climbed 2.9 percent in June from a year earlier. The Shanghai Composite Index has fallen 22 percent this year.

China overtook Hong Kong as the world’s hottest housing market in the first quarter, with prices rising at more than double the rate anywhere else, according to property adviser Knight Frank LLP. The government on July 12 vowed to enforce measures to dampen the market that include a ban on loans for third-home purchases, higher mortgage rates and tighter down- payment requirements for second home purchases.

While spreads on developers’ yuan-denominated notes have narrowed, the industry’s offshore dollar bonds have widened as fund managers James Chanos and Marc Faber and Citigroup Inc. economists Willem Buiter and Shen Minggao warned of a crash if a property bubble isn’t averted.

Buiter and Shen have said it may take three years for the boom to bust, while Faber said it could happen in a year.

Dollar Bonds

The spread on Agile Property Holdings Ltd.’s $300 million in 10 percent notes due 2016 increased to 709 basis points from 620 this year, ING Groep NV prices show. Agile, which builds villas and apartments in China’s southern Guangdong province and other cities in the nation, has sold only dollar-denominated notes, Bloomberg data show.

The spread on Shimao Property Holdings Ltd.’s $350 million in 8 percent notes maturing 2016 widened to 709 basis points from 625 on Jan. 1, according to ING prices.

Maggie Mui, a spokeswoman for Agile, and Shimao spokeswoman Tammy Tam declined to comment on their companies’ bond prices.

International investors have “overreacted” to the government’s housing market controls, said Thomas Kwan, a fund manager who helps oversee $250 million at ICBC Credit Suisse Asset Management Co. in Beijing. When they realize the measures aren’t “as scary or severe as they thought,” the spread on developers’ dollar bonds will probably narrow, he said.

Fueled by Cash

Because China’s property boom is fueled by cash rather than debt, it’s unlikely the market will plunge on the type of forced selling that exacerbated the U.S. subprime crisis, according to Michael Klibaner, head of China research at Jones Lang LaSalle Inc., the second-largest publicly traded property broker.

As the government oversees an orderly decline in property prices, overseas investors’ concerns about a collapse will ease, said John Sun, executive director for Citic Securities International Co. in Hong Kong.

“I don’t believe those major property names are going to go bust,” Sun said in an interview. “Nobody, including the government, wants a crash in the property market, which is a very important part of the whole Chinese economy.”

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