Morgan Stanley: Initial emergence or flash in the pan for China's real estate?

Since March, the unexpected rebound in the transaction of second-hand homes has reignited discussions on whether there will be an inflection point for China's real estate market.

Morgan Stanley provided a cautious answer in its latest report released on May 20: it advises waiting for more clear signals as the first phase of valuation repair has already factored in the expectation of sustained growth in transactions.

The rebound is real, but its sustainability is questionable

Morgan Stanley acknowledges that the recent strong rebound in second-hand home transactions may indicate that the worst period for some first and second-tier cities has passed.

However, the report also lists several major reasons for being skeptical about its sustainability: limited improvement in macro and real estate indicators; the trends of new and second-hand homes diverge, with the recovery of second-hand home transactions possibly encroaching on new home sales through more competitive pricing, rather than driving overall demand expansion; homebuyer confidence remains weak, with the proportion of residents expecting housing prices to fall in first and second-tier cities even further increasing compared to March 2025.

Morgan Stanley raises its forecast for total sales volume in 2026 by 3 to 4 percentage points to be essentially flat year-on-year, expecting a low single-digit percentage decline in 2027, with housing prices still showing a continuous but moderate downward trend on a month-on-month basis during this period.

The report identifies May to August as the key observation window to verify whether the inflection point has truly formed, advising investors to closely track the number of visitors to intermediary stores, the quantity and listing prices of second-hand homes, transaction structure, and rental levels.

If sales remain strong in the second half of the year, second-hand home prices may shift to a month-on-month increase, but the time required may be longer than the recovery cycle from 2014 to 2015 - when first and second-tier cities achieved a positive shift in prices on a month-on-month basis about 3 and 9 months, respectively, after the rebound in transaction volume. The current macro, demographic, and market environment are relatively less favorable.

Valuation has exceeded the bull market average, and stock selection is better than pure beta game

On the valuation front, Morgan Stanley issues a warning: both the expected P/E ratio for 2028 and the enterprise value/gross merchandise value ratio have exceeded the average levels during the bull market from 2016 to 2020.

The current market value corresponds to a historical peak core profit P/E ratio of about 4.5 times for state-owned developers, and the peak profit level is more than 2.5 times higher than the forecast for 2028. Given the developers' leverage constraints, the convergence in land acquisition strategies, and the continuous drag from existing inventory, their mid-term sales, profit margins, and return on equity are unlikely to recover to pre-downturn levels.

Under these circumstances, Morgan Stanley believes that the overall industry risk-reward leans towards the downside, suggesting waiting for more clear signals of the inflection point and screening for real beneficiaries that both benefit from industry recovery and have their own improvement abilities.

However, even if the market stabilizes, Morgan Stanley still believes that the likelihood of imbalances between cities and an L-shaped recovery is higher, given the long-term demographic challenges.