China’s Housing Rescue Has a Poor Track Record in Pilot Cities

China’s big housing rescue aims to build on smaller efforts that are already under way – and struggling to get traction.

The People’s Bank of China this month unveiled $42 billion of funding to help local governments buy excess inventory from developers. Pilot programs on similar lines have been operating last year in eight cities, but they’ve had limited effect in stabilizing property markets, and apparently managed to deploy only a fraction of the allocated funds.

The stakes in the new nationwide push are high. Beijing needs to end a real estate slump that’s left the economy dangerously dependent on exports – just when trade wars are ramping up again — before it spirals out of control, threatening the survival of premier developers like state-backed China Vanke Co.

What’s happened in the pilot cities, and various other local initiatives, shows the challenges ahead. It’s proved tough to line up incentives for the key players: local governments worried about adding more debt, developers and homeowners reluctant to sell at a discount, and banks who don’t see much profit in the whole business.

“Acquiring existing inventory involves a lot of negotiations to balance the interests of different stakeholders,” said Jacqueline Rong, chief China economist at BNP Paribas SA. Aware of the complexities, Beijing has been “prudent,” she said – keeping participation voluntary and stopping short of setting targets for the number of homes to be bought.

The PBOC set a quota of 100 billion yuan ($13.8 billion) for the trial plan. It’s not clear exactly how much has been lent out.

A person familiar with the situation said the total is now substantially more than the 2 billion yuan figure the central bank publicly disclosed at the end of March. Based on a separate PBOC announcement plus state media reports, five of the pilot cities — Fuzhou, Jinan, Tianjin, Qingdao and Chongqing — have borrowed at least 4.4 billion yuan between them.

Local authorities must turn the properties they buy into affordable rental housing – and that’s emerged as one obstacle.

Under the program the PBOC provides funds at an interest rate of 1.75%, and banks must lend to the cities at 3% or less. But even when borrowing costs are pushed down by subsidies, rental rates of return in places like Beijing, Guangzhou and Shenzhen are even lower, according to calculations by Tianfeng Securities Co. analysts including Sun Binbin.

That gap only widens when the cost of managing and maintaining the properties is taken into consideration, they wrote in a Tuesday note, suggesting that take-up of the PBOC’s new program “may be limited at the early stage.”

If the PBOC’s nationwide plan succeeds in spurring the 500 billion yuan of new credit that it’s targeting, then local governments may need to borrow another 500 billion to pay for “supplementary investments,” according to BNP’s Rong — a burden that already-indebted local authorities may be reluctant to shoulder.

She said local officials may find it more appealing to provide affordable housing by building new homes —- which generates more jobs and economic growth – than buying old ones.

And there’s another deterrent: when parts of a compound are turned into social housing, it can lower the prices of other apartments in the same project. That can trigger vocal complaints by the owners of the devalued property, creating headaches for both local governments and developers.

The national plan, unlike the pilot, gives local governments the option to sell homes they buy, not just rent them out — though it may be a limited benefit in today’s depressed market.

From the perspective of Chinese banks, by contrast, the nationwide program may be less attractive than the pilot. Instead of covering 100% of their loans with cheap central bank funding, they’ll only be able to get backing for 60% of it. That means margins will be narrower, giving the banks less incentive to lend.

To be sure, Beijing’s new housing initiative – and the prospect of further steps at a top-level leadership meeting in July – has cheered investors hoping for an end to the long slump. Bloomberg’s gauge of Chinese real estate stocks has rebounded some 50% from an April low, with Vanke among the big gainers.

Read More: China Banks Throw Support Behind Teetering Developer Vanke

There are reports of progress on the ground, too. On the first weekend after the new program was announced, Shenzhen — the city with the most excess inventory in the country — saw new-home sales jump 90% from a week earlier, the state-run Securities Times reported last week.

Purchases backed by the PBOC will set a “price-floor” for housing and prevent a further selloff, Xing Zhaopeng, an analyst at Australia & New Zealand Banking Group, wrote in a report last week.

A key question that caused problems in the earlier rescue efforts is: how low is the floor?

Since they can’t charge much in rents, local governments are under pressure to negotiate deep discounts when they buy — leading to protracted and intense bargaining with developers.

An example is Zhengzhou, where authorities aimed to buy apartments for rental to skilled workers. They tried to keep purchase costs low by targeting buildings originally designated for commercial use and then converted to residential status – typically a cheaper kind of property – according to a person familiar with the matter.

Even so, most purchases came at a 15% discount to market prices, the person said. That program started before the PBOC’s trial and it’s unclear whether it later obtained central bank support.

The prospect of big discounts has been a hurdle for initiatives in other cities that opted for a more market-based approach outside of the PBOC plan.

One popular model is for developers — often state-owned ones — to acquire old homes on condition that the owners then purchase new ones built by the same company.

Nanjing’s Anju Construction Group, wholly owned by the city government, in late April announced a pilot program to buy 2,000 homes in central neighborhoods. Sellers can use the cash to cover as much as 80% of the cost of a new apartment.

More than 3,400 qualified homeowners have signed up but only 52 deals have been inked so far, according to a person familiar with the matter, who asked not to be identified because they’re not authorized to speak publicly. Many would-be buyers hesitate, the person said, because they’re asking themselves a key question: whether it’s better to wait until the market turns upward, and they can sell for a better price.

Many remain skeptical that there’ll be a rebound. In response to an article about the prospects of housing recovery, one user wrote on China’s microblogging platform Weibo — in a comment that got more than 14,000 likes: “If you don’t do it this year, you’ll never get another chance to pay so much for a home.”