By Sherry Qin and Jiahui Huang
Some of China's biggest developers are doubling down on asset management and investment property rather than home building, seeking more stable sources of income as hopes for a turnaround in the country's real-estate sector fade.
That shift, an effort to boost profit stability after years of weak property sales and tightened sector regulations in the world's second-largest economy, should give investors a clearer road map into earnings while also boosting company valuations and financial health, analysts say.
At the front of the drive are China Resources Land and Longfor, two developers with mature investment properties that include some of the biggest shopping malls in China.
CR Land said this month that it expects recurring business to make up 40% of profits by 2025 and 50% over the longer term, up from 34% last year, helping it strike a balance between cash flow, profitability and asset turnover. It plans to open 16 malls in China this year and boost its total portfolio in 2027 to 117 from 76 currently.
In Longfor's case, nearly two-thirds of core profit last year came from the rental business and property management services, up from 27% in 2022. Last year was an inflection point for Longfor to "transform to a landlord model," Jefferies analysts said in a recent research note.
Longfor now plans to add 14 malls this year to its portfolio of 88 under management.
"Both Longfor and CR Land had in a way sacrificed some of their short-term profit over the past decade to grow their commercial empire," Daiwa analyst William Wu said. That strategy "is now paying off."
Other companies have similar aspirations, if on a smaller scale. Yuexiu Property said this week that its 2023 rental income from commercial properties rose 50% to nearly half a billion yuan, and that it's seeking to steadily boost contributions from such properties.
Analysts say the pivot to recurring income is a natural, long-term move as developers seek to diversify risks and create sustainable business models amid a prolonged housing downturn. China's new home prices fell for a seventh straight month in February, with analysts saying a bottom isn't yet in sight.
In contrast to "highly cyclical property sales, recurring income enjoys more stability," Morningstar analyst Jeff Zhang said.
It's also in line with Beijing's call for a new model of operations in the heavily indebted sector, analysts say. China's top policymakers this month emphasized building a "new property development mode" in an annual government work report.
The shopping mall rental business tends to enjoy much higher gross profit margins than the home construction business. Both CR Land and Longfor posted 2023 investment property gross margins of 70% and 76%, compared with overall margins of 25% and 17%, respectively. Morningstar said in a recent research note that it expects growth in recurring income to lift CR Land's gross margin to 27% by 2028.
"Landlords have higher visibility and lower volatility on their top lines and profits than their developer peers," said Bruce Pang, JLL's Greater China chief economist.
The shift could also help stock valuations, given that many brokerages use net asset value as a key metric to value China's property stocks. A heavier reliance on recurring income will help boost the predictability of asset values, making it easier for analysts to evaluate a company's cash flow and come up with a more reasonable valuation level.
Shares of CR Land and Longfor are down about 11% this year, slightly ahead of a 14% decline in the broader Hang Seng Mainland Properties Index. Yuexiu is down 32%.
Investors "should like this pivot," Morningstar's Zhang said, pointing to the higher margins of the mall rental business. "The development business will still represent the bulk of developers' earnings, [but] we expect profit from asset management and property investment to see a larger mix over time."
Write to Sherry Qin at sherry.qin@wsj.com and Jiahui Huang at jiahui.huang@wsj.com
(END) Dow Jones Newswires
March 28, 2024 06:51 ET (10:51 GMT)
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