In the current landscape of real estate adjustments, a noteworthy divergence is emerging between property developers who focus on development and those who specialize in holding propertiesThe former group has seen several companies default on their obligations, with profits still struggling to show signs of recoveryIn stark contrast, hold-type real estate firms have generally maintained a record of zero defaults and are experiencing a stabilization in profitsThis difference can be attributed to the financing characteristics, cash flow, and asset monetization capabilities associated with hold-type real estate businesses.

As we close the books on the interim reports for 2024, it's clear that while real estate companies continue to grapple with ongoing adjustments, a delineation is surfacingLeading developers focused mainly on construction have reported significant losses, with some firms facing profit declines exceeding 30%. Conversely, hold-type giants such as China Resources Land, Longfor Group, and Xincheng Holdings have managed to keep their profit declines largely under 30%, showcasing an average reduction that is substantially better than the industry's average speed of decline.

The business model of hold-type developers is fundamentally different from purely development-focused firms

These entities balance the operations of shopping centers alongside residential development and salesHistorically, the residential property sector has been more lucrative, allowing those engaged primarily in residential offerings to dominate the real estate marketHold-type developers have often found themselves in the minority, with notable public companies listed on both the Hong Kong and A-share markets, including Xincheng Holdings, China Resources Land, Longfor Group, Joy City and Hopson Development, in addition to non-listed entities such as Wanda CommercialAmong these firms, two are state-owned and four are private, and the total assets of leading hold-type real estate companies surpass 300 billion RMB, deriving significant income from rental revenue generated by shopping centers.

During this phase of real estate adjustment, the hold-type developers have demonstrated commendable debt repayment capabilities, resolutely maintaining a record of zero defaults

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Since the real estate sector began to undergo regulation in the latter half of 2020, over 40 out of the top 100 listed developers in 2021 experienced various levels of defaults, while not a single hold-type real estate developer faced default.

Overall, the resilient performance of hold-type real estate businesses owes itself to the long-term nature of the loans secured against their shopping center properties, allowing them to effectively manage the debt pressures arising from a slowing sales environmentThe robust cash flow generated by high-quality shopping centers, along with the relatively simple process of monetizing these assets, has also furnished them with tools to withstand the impacts of fluctuations in the real estate market.

A closer look at the mid-year performance reveals a degree of disparity between leading hold-type developers and their residential counterparts

On August 23, Longfor Group reported its mid-term performance, revealing a revenue of 46.855 billion RMB and a net profit attributable to the parent company of 5.866 billion RMB, both reflecting decreases of 24.48% and 27.2% year-on-year, respectively.

Following this, China Resources launched its own mid-year performance report, posting a revenue and net profit of 79.127 billion RMB and 10.253 billion RMB, with a year-on-year increase of 8.4% in revenue, albeit a profit reduction of 25.37%, underscoring their ability to manage profitability amidst subtle revenue growth.

At the end of August, Xincheng Holdings revealed figures showing a revenue of 33.904 billion RMB and a net profit of 4.1768 billion RMB, which indicated declines of 18.83% and a stark 42.16% year-on-year, respectivelyIn contrast, leaders in residential development faced significantly steeper declines

Vanke, Poly Developments, and China Overseas Land and Investment secured the top three spots, as Vanke reported a loss in its half-year earnings report, Poly Developments witnessed profitability decrease by over 30%, and China Overseas experienced a drop exceeding 23%.

Among the trio of hold-type developers with total assets exceeding 300 billion RMB, the average profit decline was kept under 30%, which aligns with the industry’s overall averageAccording to data from the China Index Academy, during the first half of the year, the average operating revenue of 105 listed companies (excluding those that defaulted) in A-shares and H-shares was 11.591 billion RMB, reflecting a 13.00% decrease, while the average net profit was a mere 145 million RMB, down 82.05% year-on-year.

As per statistics from Industrial Securities, as of the end of the first half of the year, the asset-liability ratio of real estate listed companies, excluding pre-received payments, stood at 68.5%, representing a drop of 0.7 percentage points compared to the end of 2023, while the net debt ratio reached 76.3%, reflecting a rise of 7.3 percentage points

The cash to short-term debt ratio was 0.95, down from 1.19 in 2023. The real estate sector has continued its trend over the past three years of deleveraging via timeHowever, hold-type developers have maintained relatively low debt levels despite the industry downturn.

In this context, most property firms have opted for steadier operations, resulting in an overall asset-liability ratio of 76.8% in the first half of 2024, slightly down by 0.26 percentage points compared to the end of 2023. More specifically, the asset-liability ratios for China Resources, Longfor Group, and Xincheng Holdings stood respectively at 67.51%, 65.12%, and 76.06%, all below the average industry level.

As of now, the net debt metrics for China Resources and Longfor Group continue to improve, maintaining their ratios at relatively low levels

Although Xincheng Holdings displays a higher asset-liability ratio, the proportion of interest-bearing debt relative to its total assets is also low, with an increasing trend in long-term bank loansThe debt indicators for these three hold-type developers exhibit signs of stabilization.

The issue of long debt duration further enables these firms to navigate sales adjustments effectivelyFrom 2021 to 2023, China's commodity housing sales peaked at 18.19 trillion RMB in 2021 before descending to 13.33 trillion RMB and 11.66 trillion RMB in subsequent years, continuing a downtrend into the first half of 2024 with a decline of 25%. This declining trend poses notable challenges for the recovery of real estate firms' balance sheets.

When examining the impact on individual companies amidst this round of real estate adjustments, it is evident that many developers are facing defaults pivoting on mismatched sales cash flow and liabilities, particularly in pure residential development

Conventionally, development loans are the primary financing model for real estate firms, with the loan duration seldom surpassing 3 yearsWhen sales are hampered and the sales cycle elongates, previous long-term loans no longer suffice to support projects until turnover, leaving purely development-focused firms susceptible to loan interruptions or defaults when banks tighten credit or bonds come due, particularly given how publicly traded bonds attract significant investor attentionThis discrepancy underscores the prevalent wave of bond defaults seen among developers in the market.

However, for hold-type developers, their portfolios are significantly characterized not only by substantial inventory but also by a significant portion of investment properties focused on shopping centersWhile the former may feel the strain of market adjustments, these firms can leverage operational property loans to mitigate the issues associated with short loan durations typical in development loans

Operational property loans have thus become a critical financing tool for hold-type developers.

Illustrating this, Longfor Group managed to navigate pressures during the real estate industry's downturn in 2021 without succumbing to default risks due to its strong properties, extending the average length of its loansPublic data shows that Longfor extended its average loan tenure from 1.58 years in 2009 to 6.59 years by 2021 and eventually to 9.19 years as of the latest semi-annual report, allowing the firm adequate buffer time to deal with sales adjustments.

As of the first half of 2024, Longfor Group's net debt ratio (net debt/ shareholder’s equity) stood at 56.7%, with cash on hand totaling 50.06 billion RMBIts combined borrowing amounted to 187.42 billion RMB, with an average financing cost of 4.16% and an average loan contract length of 9.19 years.

Leading firm China Resources Land has adopted a similar financing strategy

By June 30, 2024, the company accumulated 97.8 billion RMB through asset pledging, with a loan balance standing at 61.5 billion RMB across varying terms from 1.2 years to 25 yearsThe overall borrowing for China Resources approximated 251.13 billion RMB, with cash and bank deposits around 118.33 billion RMBThe ratio of interest-bearing debt over fixed equity (including minority stockholders) was at 33.6%, which, despite a 1 percentage point increase from the end of 2023, remains exceptionally low within the wider real estate sector.

Although exact loan durations are unspecified, mortgage loans backed by shopping centers are also a significant financing mechanism for Xincheng HoldingsAt a recent investor communication session for its semi-annual report on September 2, Senior Vice President and Financial Officer Guan Youdong shared that as of the end of June 2024, the firm had mortgaged investment real estate worth 94.1 billion RMB, leaving nearly 30 billion RMB in investment properties still unencumbered, meeting its future financing demands

At the reporting period's close, Xincheng recorded a total interest-bearing debt of 55.9 billion RMB, comprising approximately 7.2 billion RMB in corporate bonds, 8.2 billion RMB in offshore dollar debt, 33.6 billion RMB in bank loans, and other interest-bearing debts approximating 4.2 billion RMB.

From January to August 2024, Xincheng secured an additional 12 billion RMB in financing backed by Wuyue Plaza as collateralIn 2023, the firm similarly acquired around 14 billion RMB in operational property loans and other financing utilizing Wuyue Plaza as a mortgage, putting it on course to approach the 2023 total in just the initial eight months of 2024.

In early January 2024, new regulations were introduced to further orient operational property loansPreviously, the mortgage ratio in practical applications did not exceed 50%-60%. The new rule allows a maximum of 70%. Prior regulations restricted operational property loans solely to repayments for loans related to their construction or upgrades, but the new regulations broaden the allowable use of funds to include repaying these entities and their affiliates’ outstanding loans within the real estate sector and public market bonds up until the end of 2024. The new regulations also stipulate that the typical term for operational property loans shall not exceed 10 years, with a maximum of 15 years, and that the due date must precede the property ownership certificate’s expiration by at least five years.

The fixed-income research team at Haitong Securities points out that the general loan duration for operational property loans is set at 5-8 years, with maximum limits of 10-15 years, making these loans considerably longer and larger with less restrictive usage compared to development loans and public bonds.

Notably, shopping centers not only enable loan-backed financing but also generate substantial cash flow

Over the past three and a half years, supported by a steady stream of new shopping center openings, rising occupancy rates, and escalating rental income, the commercial revenues of these three hold-type developers have demonstrated year-on-year growth.

From 2021 to 2023, China Resources derived revenues from shopping centers amounting to 13.9 billion RMB, 13.76 billion RMB, and 17.85 billion RMB, respectivelyLongfor Group's rental income, not including taxes, reached 10.41 billion RMB, 11.88 billion RMB, and 12.94 billion RMB in that period, while Xincheng Holdings registered 7.97 billion RMB, 9.22 billion RMB, and 10.63 billion RMB, respectively.

During the first half of 2024, China Resources saw its income from shopping centers rise to 9.48 billion RMB, representing an increase of 9.7%. Longfor recorded a rental income of 6.66 billion RMB, marking a growth of approximately 5%. Meanwhile, Xincheng's overall commercial operations revenue (inclusive of tax) was 6.212 billion RMB, boosting a near 20% growth year-on-year.

Post-COVID, consumer habits have changed, leading to a slow growth pace for physical retail

While some street shops have experienced vacancies, shopping centers have remained relatively insulated from these effects.

According to China Resources' half-year report, the 82 operational shopping centers achieved retail sales of 91.62 billion RMB, marking a year-on-year increase of 21.9%. Additionally, 69 of these centers ranked among the local top three in terms of retail sales, and six newly opened centers reached an impressive occupancy rate of 97.8%. Longfor and Xincheng’s shopping centers reported occupancy rates of 96% and 97.24%, respectively, maintaining robust occupancy figures.

Rental income not only provides essential cash flow but also boasts gross margins typically exceeding 75%. After accounting for associated costs and expenses, significant profits follow.

In its semi-annual report, Longfor Group disclosed a core net profit of 4.75 billion RMB, where operational income (primarily from rental) reached 13.1 billion RMB, reflecting a 7.6% year-on-year growth, with profits comprising over 80% of the total.

Xincheng Holdings follows a similar pattern

Since 2021, its sustained revenue from commercial operations has surpassed accrued interest expenses, with this metric increasing to 2.71 times in the first half of 2024. The firm's chairman, Wang Xiaosong, remarked during the shareholders' meeting at the end of May 2024 that the total expected revenue from the company's commercial management should hover around 12.5 billion RMB, with a gross margin of 70%, supplementing cash flow with an anticipated net profit over 4 billion RMB.

The inherent monetization capacity of these assets is markedly strongThe liquidity-backed advantages of shopping centers allow hold-type real estate firms to capitalize on public sales or transfers to garner funds when facing liquidity risks, an avenue that has proven increasingly valuable over the recent years.

As numerous developers have faced defaults in recent times, many real estate firms have found it increasingly challenging to issue bonds in domestic and international markets

This constricted the available financing channels significantlyFor example, during the peak period in 2020, real estate enterprises issued bonds totaling 60.2 billion USD; however, by 2023, this figure had dwindled to only 9.18 billion USD.

Despite the tightening conditions for raising capital, holding high-quality assets enables hold-type developers to identify new avenues for financingReal Estate Investment Trusts (REITs) have emerged as a new avenue for fundraising over the past couple of yearsStringent regulatory support for developing REITs has been evident, stimulating frequent REIT issuances linked to essential community commercial projects like department stores and shopping centers.

In March 2024, the first batch of consumer public REITs—Hua Xia Jin Mao Commercial REIT, Jiashi Wumart Consumer REIT, and Huaxia China Resources Commercial REIT—was listed on the Shanghai and Shenzhen stock exchanges, with Hua Xia China Resources Commercial REIT clocking in as the largest issuance at 6.902 billion RMB.

The underlying asset for the recently listed Huaxia Commercial REIT is Qingdao MixC

This shopping center features the largest floor area and the most brands in Qingdao, standing as one of the flagship commercial projects within China Resources' portfolio, encompassing approximately 300,000 square meters of high-quality commercial space, which has maintained an occupancy rate above 98%.

Following this, the issuance of consumer-oriented REITs accelerated, with seven products already introducedDue to their stable returns, these offerings have garnered notable interest from investors, exemplified by the recently concluded fundraising by Huaxia Fund, Joy City Group, and CITIC Securities, which aimed to raise 3.323 billion RMB but concluded with total subscribed amounts reaching 4.812 billion RMB, a staggering 1.44 times the original target.

Furthermore, properties epitomized by shopping centers, recognized for their steady rental income and sustainable long-term appeal, have drawn attention from insurance capital, facilitating liquidity for non-listed hold-type real estate firms such as Wanda Commercial.

Since the regulatory shifts that began in the latter half of 2020, Ping An Life has been at the forefront of insurance investments in real estate

In 2021, it invested 33 billion RMB to acquire stakes in six Raffles assets under CapitaLand, later spending 5.015 billion RMB on the Orient Centre project in Beijing in 2022. Current reports from the China Insurance Association indicate that Ping An Life has funded five significant real estate projects totaling an impressive 54.951 billion RMB.

At the beginning of 2024, New China Life initiated a 10 billion RMB fund aimed at real estate, entering into a limited partner agreement with CICC Capital to co-establish a fund of a similar scale, where New China Life is proposing to contribute 9.999 billion RMB and CICC Capital contributing 1 million RMBInsights from Tianyancha reveal that on April 12, Dalian Wanda Commercial's former full owner exited the company, with the newly formed joint enterprise of New China Life and CICC holding a staggering 99.99% stake.

Dalian Wanda Commercial is not the sole asset seller, with other entities also seeing transactions