Real estate matters a lot to China: Construction and property sales have been the biggest engines of economic growth since President Xi Jinping came to office almost a decade ago. Home prices have skyrocketed — surging sixfold over the past 15 years — as an emerging middle class flocked to property as one of the few safe investments available. The boom led to speculative buying as new homes were pre-sold by property developers who turned more and more to international investors for funds. So when Chinese officials ratcheted up steps to reduce the risk of a bubble and temper the inequality that unaffordable housing can create, it touched off a crisis that has sent some major developers into default. A sales slump that began during the pandemic was deepened by aggressive measures to contain Covid-19. So far, the state’s intervention has held off a disorderly collapse of the property market that could undermine the financial system and jolt the world economy too.
1. What fueled the crisis?
In 1998, when China created a nationwide housing market after tightly restricting private sales for decades, only a third of its people lived in towns and cities. Now almost two-thirds do, increasing the urban population by 480 million. The property sector also expanded rapidly, while struggling to keep up. Boom cities such as Shenzhen became less affordable based on price to income ratios than London or New York, frustrating a generation of would-be buyers. Local and regional authorities, which rely on sales of public land for a hefty chunk of their revenue, encouraged more development, which also helped meet the central government’s ambitious annual targets for economic growth, which often hit double digits. Debt piled up as builders rushed to meet demand. Annual sales of dollar-denominated offshore bonds -- meaning those sold mainly to foreign investors -- surged from $675 million in 2009 to $64.7 billion in 2020, leading to a swelling interest burden. Developers had some $207 billion in dollar-denominated bonds outstanding as of late last year, accounting for about one-quarter of the total from China. Additional, opaque liabilities make it hard to assess true credit risks.
2. What did China do?
It has for years tried to defuse the debt bomb amid fears it could set off a disastrous financial meltdown. In mid-2020, it began to squeeze new financing to real estate developers to try to reduce the risk of a bubble, and asked banks to slow the pace of mortgage lending. New borrowing metrics introduced for developers proved to be a game-changer. Called the “three red lines” by state-run media, they aimed to reduce reckless borrowing by setting thresholds for a developer’s liabilities, debt and cash holdings. Annual borrowing would be capped based on how many parameters were met.
3. What was the impact?
It led to funding problems for developers that didn’t have enough cash on hand to cover their liabilities. At least 18 firms have defaulted on offshore bonds since the crackdown began. China Evergrande Group, once the country’s biggest developer, was labeled a defaulter for the first time in December after it missed payments on several bonds. The establishment of a “risk management committee” dominated by provincial officials was quickly announced for the firm to stave off a disorderly collapse. (Bondholders still were left wondering how much they would collect once the dust settles.) Others including Kaisa Group Holdings Ltd. and Sunac China Holdings Ltd. followed. Fears of further contagion have reverberated throughout the industry and the wider economy, hammering domestic growth, weakening consumer confidence and roiling global markets that have long assumed China’s real estate titans would be bailed out by the government.
4. How bad has it gotten?
Property development fell into a deep slump. Combined sales at the top 100 developers halved in the first four months of this year compared to last. Property loan growth slowed to the weakest pace in over two decades at the end of March. Construction fell 14% in 2021 from the previous year, the biggest fall in six years. All this matters a lot because in China, the real estate sector accounts for almost a quarter of gross domestic product, when nonresidential construction, building materials and related activity such as real estate services are included.
5. How bad could it get?
Already across China, millions of square feet of unfinished apartments were left to gather dust as a result of developers facing cash flow problems. Home prices began to fall in September for the first time in six years. A full-bore property crisis could leave millions more homebuyers who put up money in advance in limbo. (Buyer protections commonly used abroad, such as escrow accounts and installment payments, have tended to be weak.) Fire sales would further pummel the market, squeezing other developers and rippling through related industries and suppliers. The risk of popular unrest -- more than 70% of urban China’s wealth is stored in housing -- would rise, unsettling the government. A historic selloff in offshore bonds would spread to the much larger domestic credit market, spreading from lower-rated property companies to stronger peers and banks. Global investors would sell even more.
6. Is there a way out?
The government has tweaked some rules to try to stabilize the situation. For example the central bank stepped up its support for several distressed developers and banks were instructed to ensure growth in both residential mortgages and loans to developers in some areas. Above all, avoiding a “Lehman moment” — when the failure of the US bank in 2008 sent shockwaves through global markets — is a priority ahead of this year’s Communist Party congress, where Xi is expected to be handed a third term. That political necessity most likely means the government will try to contain the crisis, at least for the near term.
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