Why You Need to Think Long-term with Chinese Real Estate Stocks

Why You Need to Think Long-term with Chinese Real Estate StocksWhile the U.S. real estate market is showing some encouraging signs, there continue to be concerns towards a possible real estate crash in Mainland China. The Chinese government has been trying to corral the price increases in housing with some success.

My feeling is that the short-term risk is high, but there is excellent long-term growth in China’s real estate sector. (I also like China’s retail sector; read “Luxury Retailers Loving China.”) You need to be patient and be aware of the risk.

There are over 300 million middle-class consumers in China, and as a group, they are hungry for a lifestyle similar to ours. Real estate is a key goal for the Chinese.

Standard & Poor’s analysts believe the real estate market in China is stabilizing, with buyers returning and home prices continuing to decline.

And in an ironic twist, at a time when California’s real estate market is struggling, the California Public Employees’ Retirement System (CalPERS), a state pension fund, announced it would be investing about $530 million in two new China real estate funds managed by ARA Asset Management, which is positive longer-term. (Source: “California State Employees Bet On China Real Estate,” Forbes, September 24, 2012.)

To play China’s real estate market, you can take the more conservative approach and buy the Guggenheim China Real Estate (NYSE/TAO) exchange-traded fund (ETF) with a year-to-date return of 25.5% as of August 30. The fund holds mainly large value-oriented Chinese real state stocks.

Guggenheim China Real Estate Chart

Chart courtesy of www.StockCharts.com

But to take a more speculative and potentially higher-return opportunity, an emerging small-cap Chinese real estate company that I like longer-term is Xinyuan Real Estate Co., Ltd. (NYSE/XIN), which has a market cap of $200 million.

Xinyuan is down from its 52-week high of $3.95, but it has outperformed the S&P 500 over the past 52 weeks.

Xinyuan Real Estate Co., Ltd. Chart

Chart courtesy of www.StockCharts.com

Xinyuan buys land and develops large-scale, high-quality residential real estate projects that are targeted towards the growing middle class in China’s Tier II cities. The company looks for cities that are large and growing, with developed urban areas.

Targeted cities have above-average gross domestic product (GDP) and population growth and are currently comprised of strategically selected Tier II cities, including Hefei, Jinan, Kunshan, Suzhou, Zhengzhou, Chengdu, and Xuzhou. The combined population of these cities is over 34.5 million people, according to Xinyuan.

Projects include multi-layer apartment buildings, sub-high-rise apartment buildings, high-rise apartment buildings, retail outlets, leisure and health facilities, and educational facilities.

Xinyuan recently acquired a development site in New York City for $54.2 million via its U.S. development unit, XIN Development Group International.

Annual sales grew sequentially in each year over the past nine years, from $12.8 million in 2002 to $688 million in 2011.

Xinyuan has been profitable in seven of the last 10 years, with increases in the last three years.

Based on the estimated earnings per share (EPS) for 2013, Xinyuan is trading at a cheap forward price-to-earnings (P/E) multiple of two times its estimated earnings of $1.45 per diluted share. Be careful, as the low P/E discounts the China risk factor.

As a concluding note, be advised that any stock mentioned is meant only for illustrative purposes and should not be construed as a recommendation.