How Chinese property developers got into such a mess



Real estate matters a lot to China. Construction and real estate sales have been the main drivers of economic growth since President Xi Jinping came to power a decade ago. But now the industry is in crisis. Developers are facing a cash flow crunch that has put some big companies into default, as well as a slump in sales and a boycott of mortgages by people angry because the homes they paid for in the advance is not over. So far, state intervention has prevented a disorderly collapse of the property market. The stakes are high, as such a crash could undermine the financial system and also shake the global economy.

1. What triggered the crisis?

As an emerging middle class flocked to real estate as one of the few safe investments available, house prices soared – up sixfold over the past 15 years. The boom led to speculative buying as new homes were pre-sold by property developers who increasingly looked to international investors for funds. In response, Chinese authorities have taken steps to reduce the risk of a bubble and temper the inequality that unaffordable housing can create. This triggered the cash crisis for developers. Then, a sales slump that began during the pandemic was compounded by aggressive measures to contain Covid-19.

2. What fueled the housing boom?

In 1998, when China created a national housing market after severely restricting private sales for decades, only a third of its population lived in cities. Today nearly two-thirds do, increasing the urban population by 480 million. The real estate sector has grown rapidly to keep pace. Booming cities such as Shenzhen have become less affordable in terms of price-income ratios than London or New York. Local and regional authorities, which depend on public land sales for much of their revenue, have encouraged more development. It also helped achieve the central government’s ambitious annual targets for economic growth, which often reached double digits. Debt piled up as builders rushed to meet demand. Annual sales of offshore bonds denominated in dollars – that is, those sold primarily to foreign investors – fell from $675 million in 2009 to $64.7 billion in 2020, resulting in a charge of growing interests. The promoters had some $207 billion in dollar-denominated bonds outstanding at the end of last year, which is about a quarter of the total of all Chinese borrowers. Additional and opaque liabilities make it difficult to assess true credit risks.

3. What did the government do?

For years he tried to defuse the debt bomb, fearing an explosion could trigger a disastrous financial collapse. In mid-2020, he began securing new funding for property developers to try to reduce the threat, and asked banks to slow the pace of mortgage lending. The new borrowing measures introduced for developers proved to be a game-changer. Called the “three red lines” by state media, they aimed to reduce reckless borrowing by setting thresholds for liabilities, debts and a promoter’s cash.

4. What happened to the developers?

Those who did not have enough cash to cover their debts found themselves in a bind. At least 18 defaulted on offshore bonds after the crackdown began. China Evergrande Group, once the country’s largest developer, was first labeled defaulter in December 2021 after missing payments on several bonds. The establishment of a “risk management committee” dominated by provincial officials was quickly announced to prevent the company from a complete collapse. (Bondholders were still wondering how much they would collect once the dust settled.) Others, including Kaisa Group Holdings Ltd. and Sunac China Holdings Ltd., followed. Fears of further contagion reverberated across the sector, weakening consumer confidence and upending global markets that have long assumed China’s property titans would be bailed out by the government. As the crisis dragged on, it began to engulf developers seen as the strongest players, such as Longfor Group Holdings Ltd. Even real estate debt considered safer because supported by the state ran into problems.

5. Where does this leave the industry?

In a deep slump. The combined sales of the top 100 developers have halved in the first four months of this year compared to last year. Home loan growth slowed to its weakest pace in more than two decades at the end of March. Construction fell 14% in 2021 from a year earlier, the biggest drop in six years. The ramifications are significant given that China’s real estate sector accounts for almost a quarter of gross domestic product, when non-residential construction, building materials and related activities such as real estate services are included.

Across China, millions of square feet of unfinished apartments have been left to dust due to developers’ cash flow problems. Economists at Nomura International HK Ltd estimated in mid-July that Chinese developers had delivered only around 60% of the homes they had pre-sold from 2013 to 2020. The mortgage protests hit the nail on the head. as the market showed signs of stabilizing, with selling picking up. in June. A full-blown crisis could leave millions of additional homebuyers who put money up front in limbo. (Buyer protections commonly used overseas, such as escrow accounts and installment payments, tend to be weak.) Fire sales would further crush the market, crushing other developers and rippling through industries and related suppliers. Because more than 70% of urban China’s wealth is stored in housing, the risk of popular unrest would increase, disrupting the government. A massive offshore bond sell-off would ripple through the much larger domestic credit market, shifting from lower-rated real estate companies to stronger peers and banks. Global investors would sell even more.

7. How serious are mortgage boycotts?

Wild boycotts are politically sensitive in a country whose leaders see social stability as a top priority. At one point in mid-July, they had expanded to more than 300 housing projects in about 90 cities, with loans of up to 2 trillion yuan ($295 billion) at risk. (Tracking the extent became more difficult after China began censoring online tallies from crowds.) While the protests only affect a portion of lenders’ combined mortgage portfolios, the speed at which they rose surprised many. In a scenario analysis published in July, Bloomberg Intelligence estimated that between 1.8% and 6.5% of China’s total mortgages could be exposed.

8. How did the government intervene in the crisis?

The boycotts have prompted authorities to promise tougher regulations on pre-sales – a popular way to buy a house or apartment in China, in which buyers must start repaying their loans even on projects still under construction. A payment grace period for some homebuyers is reportedly being considered. In Beijing’s biggest-ever financial pledge to contain the crisis, the government announced it would offer 200 billion yuan ($29.3 billion) in special loans to ensure stalled housing projects are delivered to buyers. . He changed some rules to try to stabilize the situation. For example, the central bank has stepped up support for several struggling developers, and banks have been tasked with ensuring the growth of residential mortgages and developer lending in certain regions. Chinese lenders lowered their benchmark rates. Above all, avoiding a “Lehman moment” – when the failure of the US bank in 2008 sent shock waves through global markets – is a priority for the authorities. This political necessity most likely means that he will try to contain the crisis, at least in the short term.

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