Check for Shifting Foundations in China Property Profits

(Bloomberg Gadfly) -- Home sales are booming in China, prompting local authorities to try to control prices. That's great news for investors awaiting a series of earnings reports from developers that operate in the mainland.

On the surface, the numbers are encouraging. Home sales reached 9.9 trillion yuan ($1.4 trillion) last year, and the 36 percent increase was the biggest since 2010.

But as stock and bondholders cheer the likely boost to the bottom line that will become apparent in the coming weeks, they should look carefully at a couple of entries in the balance sheet that tell a different story.

The 152 publicly traded developers that operate in China have been reporting a steep rise in inventories, for one thing. As of June 30, 2016, they held a combined $757.2 billion of unsold stock on their books. That's twice what they had at the end of 2012, and the equivalent of 2.8 million American homes or 126.8 million square meters of residential property in Asia's largest economy, based on respective average selling prices. 

Based on government data for January and February, it would take almost six months of total property sales in China to clear the inventories on the books of listed developers.

Perhaps more worrisome is the recent spike in investment properties.

Several developers have chosen to change the accounting treatment of some of their property in recent years. Instead of "up for sale," they have moved a good chunk of homes to the investment basket.

For accounting purposes, these no longer are counted as inventory and, more importantly, can now be carried at market value instead of cost. Gains from revaluing such properties have helped many a bottom line. Longfor Properties Co., for example, on Monday reported a 1.5 billion yuan profit last year from that item. The pile keeps growing: Listed developers had $122.1 billion in investment properties on June 30, up from $43.6 billion on the same date in 2012.

China Evergrande Group, the largest private developer in the world, tops the list with $18.3 billion in investment properties at the end of June, followed by China Resources Land Ltd. and China Overseas Land & Investment Ltd., with $11.6 billion and $8.5 billion.

While companies did diversify into managing some of the properties they developed, rather than selling them all on completion, this bulge in investment properties should be treated with skepticism.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

Christopher Langner is a markets columnist for Bloomberg Gadfly. He previously covered corporate finance for Bloomberg News, and has written for Reuters/IFR, Forbes, the Wall Street Journal and Mergermarket.

To contact the author of this story: Christopher Langner in Singapore at clangner@bloomberg.net.

To contact the editor responsible for this story: Paul Sillitoe at psillitoe@bloomberg.net.