What’s at stake as China cleans up its property mess
REAL estate has been the main engine of China’s economic growth since President Xi Jinping came to office a decade ago. Now the industry is in a slump, major developers have defaulted on their debts and the government is trying to organise a bailout.
Economists say the intervention should be enough to hold off a disorderly crash of the property market and may even generate a slow recovery. The stakes are high, as a total collapse could undermine China’s financial system and jolt the world economy.
What fuelled the boom?
In 1998, China created a nationwide housing market after tightly restricting private sales for decades. Back then, only a third of its people lived in towns and cities. That has risen to two-thirds, with the urban population expanding by 480 million. The exodus from the countryside represented a vast commercial opportunity for construction firms and developers. Money flooded into real estate as the emerging middle class leapt upon what was one of the few safe investments available, pushing home prices up by six times over 15 years. Local and regional authorities, which rely on sales of public land for a chunk of their revenue, encouraged the development boom. This also helped the central government to meet its annual targets for economic growth, which often hit double digits.
What triggered the slump?
The property craze was also powered by debt, as builders rushed to satisfy expected future demand. The boom encouraged speculative buying, with new homes pre-sold by developers who turned increasingly to foreign investors for funds. Annual sales of dollar-denominated offshore bonds surged to US$64.7 billion in 2020 from US$675 million in 2009.
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Opaque liabilities made it hard to assess credit risks. The speculation led to astronomical prices, with homes in boom cities such as Shenzhen becoming less affordable relative to local incomes than in London or New York. In response, the government moved in 2020 to reduce the risk of a bubble and temper the inequality that unaffordable housing can create. That touched off a cash-flow crisis for developers that was exacerbated by the impact of aggressive measures to contain Covid-19.
Did the government cause the crisis?
State officials were anxious to rein in the industry’s debts, as they feared that serial defaults could ravage China’s financial system. The government began to squeeze new financing for developers and asked banks to slow the pace of mortgage lending.
New borrowing metrics introduced for real estate firms proved to be a game changer. Called the “three red lines” by state-run media, they placed stringent metrics for debt ratios and cash holdings. Many firms were unable to adhere to the new rules as their finances were already stretched. By early 2023, however, authorities were said to be considering relaxing those restrictions, just as they had done in late 2022 with the abrupt ditching of the suffocating Covid controls. For example, property firms may be allowed to add more leverage by easing borrowing caps, and push back the grace period for meeting debt targets set by the “red lines”, Bloomberg News reported.
What happened to the developers?
Those that did not have enough cash to cover their liabilities found themselves in a bind. With access to credit markets largely closed, developers have defaulted on more than 140 bonds in 2022, as indicated by data compiled by Bloomberg. Overall, developers missed payments on a combined US$50 billion in domestic and global debt based on issuance amount. That group includes China Evergrande, once the country’s biggest developer, and also Kaisa Group and Sunac China. Fears of further contagion weakened consumer confidence and roiled global markets that had long assumed China’s real estate titans would be bailed out by the government. As the crisis dragged on, it began to engulf developers that had been regarded as the stronger players, such as Longfor Group. Even state-backed real estate debt – which was viewed as safer – ran into trouble.
How is the government trying to end the crisis?
Avoiding a “Lehman moment” – when the failure of the US bank in 2008 sent shockwaves through global markets – is a priority for the government. It has unveiled measures centred on boosting equity, bond and loan financing for developers to alleviate the liquidity crunch. They are being allowed to access more money from pre-sales of homes, the industry’s biggest source of funds, and 200 billion yuan (S$39.3 billion) is being advanced as special loans to complete stalled housing projects. The government has tweaked financial rules to try to stabilise the situation, allowing the central bank to increase support for distressed developers and instructing banks to ensure growth in both residential mortgages and loans to developers in some areas. Lenders have lowered their benchmark rates.
Is it working?
By December 2022, there was hope that prices were reaching a floor, just as China’s government was loosening its strictest Covid containment policies. However, the shockwaves from the crisis were still being felt. The sweeping measures have yet to arrest the slump in China’s housing sector, which was also slowed first by sporadic Covid lockdowns, and then by a surge in virus cases that followed the abrupt lifting of most “Covid Zero” restrictions.
New home sales dropped 31 per cent in December from a year earlier. Citigroup’s analysts expect sales to fall another 25 per cent in 2023, as the recovery will be constrained by reduced supply, and buyers’ expectations will take time to turn around. There was still the risk of another sell-off in offshore bonds that could spread to the much larger domestic credit market, and from lower-rated property companies to stronger peers and banks.
What does it mean for prospective homebuyers?
Across China, millions of square feet of unfinished apartments have been left to gather dust. Economists at Nomura International HK estimated in mid-July that Chinese developers had delivered only about 60 per cent of the homes they pre-sold from 2013 to 2020. (Buyer protections commonly used abroad, such as escrow accounts and instalment payments, have tended to be weak.) By mid-2022, wildcat mortgage boycotts by owners of unfinished homes had spread to over 300 housing projects in about 90 cities. The protests later subsided. But with more than 70 per cent of urban China’s wealth stored in the housing sector, many livelihoods are at stake, and the threat of popular unrest lingers. BLOOMBERG
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