HONG KONG Chinese developers such as China Overseas Land & Investment Ltd (0688.HK) and Country Garden Holdings Company Ltd (2007.HK) are likely to build bigger apartments in smaller cities to take advantage of Beijing's new urbanization drive.
The vast majority of land these companies have purchased for development is in medium-sized cities with fast-growing economies, known as Tier 2 and Tier 3. China has more than 50 cities that fit that description, many of them in the Pearl River Delta and western China, home to thousands of factories feeding the country's vast, labor-intensive export business.
Those cities, with populations up to 10 million, are expected to see an influx of potential property buyers in the coming years after China announced last week that it was revising its hukou residency registration system. Under existing rules, migrant workers who move to cities for jobs are not eligible for social services and cannot buy real estate.
As the policy is gradually eased, allowing more migrants to own property and tap social services, about 100 million people will likely move into cities over the next 17 years, according to rating agency Moody's.
"There are great opportunities in second-tier capital cities," said Liu Zhuogen, executive director at Tonic Industries Holdings Ltd (0978.HK), a Hong Kong-listed overseas platform for mainland developer China Merchants Property Development 000024.SZ.
"They have more room for growth and lower risk," he said.
His company is focusing on medium-sized cities in the Pearl River and Yangtze River deltas but avoiding smaller non-capital cities because of concerns about oversupply.
Before the policy changes were announced last week, many mainland developers were holding back, in part because of worries that Beijing would crack down on real estate speculation that has driven up prices in major cities.
The biggest developers were sitting on $25 billion in cash as of midyear, giving them plenty of money to ramp up construction now that the policy shifts are becoming clearer.
China Overseas Land, Country Garden and Shimao Property Holdings Ltd (0813.HK) each have more than 93 percent of their land banks in smaller cities, according to BNP Paribas, putting them in pole position to benefit.
The companies did not respond to requests for comment.
More than 90 percent of the new land that China Vanke Co Ltd 000002.SZ and Evergrande Real Estate Group Ltd (3333.HK) acquired last year was in second- and third-tier cities, research firm Lucror Analytics says.
"Developers are moving into smaller cities in China, either by choice or by force," the research firm wrote in a note to clients.
Over the past three years, property developers have concentrated on major cities along the wealthy eastern and southern coasts, avoiding small cities for fear of over-supply. But as empty land becomes scarce, they have ventured into less crowded markets, and the hukou reforms are making those small cities popular once again.
The next phase of development will shift further west, following the manufacturing industry that is moving inland in search of cheaper labor.
Longfor Properties Co Ltd (0960.HK) has 36 percent of its land bank in western China, and 37 percent in the Bohai Rim area surrounding Beijing and nearby Tianjin. Greentown China Holdings Ltd (3900.HK) has about one-third of its land around Bohai Rim and another third in Zhejiang province, a coastal region bordering Shanghai.
"From a longer-term perspective, developers definitely have to deploy in Tier 2 and Tier 3 cities if they want higher profit margins," said Lina Wong, China investment services managing director at real estate services company Colliers.
"If developers want to catch the demand, they can go to Tier 2 and Tier 3 cities and design their products according to the needs of farmers who first move to the city."
Last week's economic and social reforms also included easing China's one-child policy, which is expected to provide a double benefit for developers as some parents upgrade to larger units. The policy shift will translate into about 9.5 million additional babies over the next five years, BofA Merrill Lynch says.
"Relaxation of one-child policies should boost upgrade demand. Mid-size property units of 90-140 square meters should benefit the most from this," said Wee Liat Lee, property analyst at BNP Paribas.
While many analysts said larger families will spur upgrade demand and mitigate the downside risk to property demand, some cautioned that the shift could take time. That is reflected in the stock prices of Chinese property developers, which have seen little benefit from the reform news.
Shares of Country Garden have slipped 7.2 percent since Friday, when the reform plans were unveiled, while China Overseas Land has risen 1.5 percent and Evergrande has gained 2.5 percent. That compares with a 5.9 percent gain for the index of Chinese companies listed in Hong Kong .HSCE.
"(The reform) is good news. Developers will take this factor into consideration and launch more three-bedroom units," Colliers' Wong said.
"But there is still a long way to go. They may decide to buy the house 20 years after now."
(Editing by Anne Marie Roantree and Emily Kaiser)