China's Rate Cut to Impact Real Estate Activity Going Forward

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China's recent rate cut, in reaction to their plummeting stock market, will have a ripple effect across their entire real estate economy going forward, according to new market analysis by CBRE.

On August 25, 2015, the PBOC announced that it would cut its benchmark rate by 25 bps, on August 26th, and the reserve requirement ratio (RRR) by 50 bps on September 6, 2015.

This would be the fifth interest rate cut since November 2014 and the fourth RRR cut so far this year. In early August, the PBOC also made the decision to tie the RMB reference rate to the previous day's closing spot price, effectively resulting in a 3% devaluation of the currency. This series of policy measures highlights increasing downside risks for China's economic growth in the near term. The latest reading of the Caixin purchasing managers index (Caixin PMI; previously the HSBC PMI) of 47.1 in August also highlighted increasing pressures on manufacturing activities. This was the lowest reading for the Caixin PMI in the last six and a half years.

According to the IMF, China's GDP is expected to grow at 6.8% in 2015, implying that GDP growth is likely to slip from 7.0% in 1H 2015 to 6.6% in 2H 2015. On the positive side, China still has ample room to use its policy tools as well as large FX reserves to counter the slowdown. Tertiary industries, in particular IT, pharmaceutical, telecommunications and other service industries are growing rapidly, which has so far largely offset employment pressure from the manufacturing sector. This was evident in the latest Caixin Services PMI which came in at 53.8 in July 2015, well above the 50-mark that separates contraction from growth and the highest reading since August 2014.

That said, the Chinese economy is facing a number of challenges, including a stock market correction that is likely to dent market confidence and domestic consumption, sluggish export growth, over-capacity in a number of sectors and local government debts.

CBRE predictions for China's real estate sectors include:

• The latest interest rate cut has brought the effective mortgage rate to a historic low in China, therefore aiding a possible housing market recovery. However, support from lower mortgage rates could be curtailed if economic growth turns out to be worse than expected.

• Office markets in Tier 1 cities performed well in 1H 2015, underpinned by resilient demand from domestic occupiers and indicating service sector strength. In contrast, office markets in Tier 2 cities have been struggling due to a supply glut and lackluster demand. Occupier demand may turn weaker in the face of slower economic growth.

• Rising competition from e-commerce, a supply glut and a significant change in tenant mix and recent developments in the stock market as well as a slower GDP growth will add further pressure to the retail is sector.

• Domestic direct property investments will take longer to complete and investors will show a preference for core assets, driven by a flight to quality. Cap rates may potentially move up, in particular for lower-tier cities and the retail sector. CBRE believes investment activities will continue to concentrate on Tier 1 cities due to a better balance between supply and demand.

• Outbound investments, according to CBRE, in the long-term should remain positive. As the Chinese government continues to push for liberalization, a tightening of capital controls currently appears unlikely. That said, Chinese investors may turn somewhat cautious on deal selection in the near term with a focus on deal quality, in light of the uncertain economic outlook globally.