Morgan Stanley just gave two reasons to remain cautious on China's property market recovery

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Earlier this week markets received news that Chinese new home prices had fallen 6.1% in the year to April.

While unchanged from the decline registered in March, it was enough to see Huw Mackay, Westpac’s resident China expert, declare “the overall market has left the very worst behind it”.

The question many are now asking is how strongly will the rebound in Chinese property prices be, if it indeed eventuates? Mackay suggests “the recovery trajectory will be very timid, with sales unlikely to move sustainably into positive year-ended territory prior to Q3 with starts lagging behind”.

Following the release of a note from Morgan Stanley late Tuesday, it’s clear he’s not alone in this view.

John Lam, Jacky Chan and Angus Chan, members of Morgan’s Asia-Pacific research team, point to two factors that suggest demand for property, hence property prices, will remain “lacklustre” despite recent monetary policy and regulatory easing.

Unfavourable demographics and weakening lead indicators for property sales.

Here’s their assessment on the outlook for the property sector.

“We think the key question to the sector is whether sales will further increase after this series of policy easing? Our answer is probably not. Our recent trip to eight cities in China, meeting with local property sales officers, online and offline property agents and local management developers suggests property sales recovery is weaker than in the last easing cycle in 4Q14 as some of the pent-up demand was released in 4Q14. Second, compared to previous easing cycles in 2009 and 2013, property sales recovery has been weaker due to a higher base and more saturated demand. Third, our property sales leading indicator suggests the number of potential homebuyers is slowing down”.

While they note unfavourable demographics as a result of China’s one-child policy will slow household formation and therefore demand for housing, it’s their analysis on lead indicators for property sales that suggests any recovery will be limited in nature.

Using the number of hits to property websites within China, they discovered a relatively-strong correlation that exists between property searches and future property sales.

“We believe tracking the number of visits to online property portals, e.g. Soufun can gauge the number of potential homebuyers, and hence the transaction volume afterwards. Back-testing the number of visits to online portals against property sales data suggest it leads property sales by 6-8 months”.

As the chart below suggests there is a more-than-reasonable correlation between the two and, given property search levels are subsiding, sales may be about to slow too.

Based on historic evidence and Chinese authorities’ urbanisation plans, they suggest property markets in larger cities will perform better than most.

“We prefer tier 1-2 cities as we expect continued population inflow into those cities due to better social resources and work opportunities. Japan’s urbanization history in the past 90 years suggests its three major metropolitan regions captured most of the national population growth. The Chinese government plans to urbanize by a ‘city clusters’ model, i.e. positive to tier 1 and 2 cities, which are the hub of city clusters”.

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