How to Make Money in China's Property Sector Now

The recent slew of credit tightening measures and higher downpayment requirements for home buyers in China have begun to slow the country's red-hot property market and that could lead to more small- and mid-cap Chinese property developers being taken private, presenting an opportunity for investors, according to Daiwa Capital Markets.

Apartments in China
Apartments in China

“We believe China’s current credit-tightening environment will increase the industry’s capital intensity and competition. As such, the possibilities of M&A activity will also increase,” Danny Bao, Daiwa’s Hong Kong and China property sector analyst wrote in a note to clients.

By the bank's calculations, property prices in Beijing, Shanghai and Shenzhen recorded an average decline of 1.6 percent year-over-year in the first five months of this year.

As a result, investors have been growing extremely worried about the sector, pushing down the stocks and making them cheap by historical standards. Daiwa believes the discount is steepest in the case of small- and mid-cap developers, given investors over-reliance on large-cap developers.

"We believe the key criteria for potential privatization deals are: depressed underlying equity valuations, wealthy controlling shareholders and long listing histories," Bao said.

In a precedent earlier this year, Fosun International, the parent company of Shanghai ForteLand took the company private paying a 30 percent premium to the traded price.

For buyers with a high-risk tolerance and a longer investment horizon, Daiwa recommends shares of Hopson, Shui On Land and CC Land.

But the bank says, for investors with a weaker stomach, there are still selected opportunities among the large-cap names.

That's because Daiwa's Bao sees no signs of a hard landing for China's real estate market. He points out gross floor area sales and average selling prices for resident property in the mainland rose modestly in the first five months of 2011.

“We expect valuations to improve amid continued improvements in major developers' contract sales. We recommend that investors take advantage of any further sector weakness to accumulate holdings,” said Bao.

Among the big caps, Daiwa has a "buy" call on Guangzhou R&F Properties and China Overseas Land.