Morgan Stanley Flags Low Project Returns in China's Recent Land Auctions

Recent land auctions in China's major cities are yielding unattractive returns for property developers, even when land is acquired at the reserve price, according to a new research note from Morgan Stanley. The bank's analysis suggests that structural issues are eroding project profitability, indicating that a recovery in the sector will take time.

Muted Bidding Fails to Boost Returns

Morgan Stanley analyzed 12 major residential land transactions in Tier 1 and Tier 2 cities since the beginning of September. The report noted that developers remain highly selective, with 9 of the 12 plots selling at the minimum bid, or reserve price.

Despite the lack of intense competition, the project economics appear weak. Key findings from the analysis include:

• A median estimated net profit margin of 16.5%.
• A median internal rate of return (IRR) of 9.8%.

The bank calculates that this combined return metric is 36% lower than the benchmark for projects under China's previous pre-sale system. Morgan Stanley stated that while on-paper profit margins under the current model of selling completed homes may seem healthy, the structure ultimately weakens a project's overall rate of return.

Outlook and Key Indicators

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The report cautions against viewing the recent trend of low land-price premiums as a new normal, suggesting that adjustments to auction prices will be crucial for restoring project viability. However, Morgan Stanley believes this process could take several months or even quarters.

Upcoming land auctions in Beijing and Shanghai will serve as important indicators for the health of the market and developer sentiment, the bank added.

Analyst Stock Preferences

In this environment, Morgan Stanley highlighted several companies. The bank is optimistic about KE Holdings (BEKE), viewing it as a primary beneficiary of the rising proportion of transactions in the secondary, or pre-owned, housing market.

Additionally, the report recommended that investors accumulate shares of China Resources Land (01109) and Seazen Group (01030) at their current price levels.