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How China’s Property Developers Got Into Such a Mess

Unfinished apartment buildings at the Phoenix City residential project, developed by Country Garden Holdings Co., in Shanghai, China, on Monday, Jan. 17, 2022. The crisis engulfing China’s property sector is impacting its biggest developer, with Country Garden’s shares and bonds hammered amid fears that a reportedly failed fundraising effort may be a harbinger of waning confidence. Photographer: Qilai Shen/Bloomberg
Unfinished apartment buildings at the Phoenix City residential project, developed by Country Garden Holdings Co., in Shanghai, China, on Monday, Jan. 17, 2022. The crisis engulfing China’s property sector is impacting its biggest developer, with Country Garden’s shares and bonds hammered amid fears that a reportedly failed fundraising effort may be a harbinger of waning confidence. Photographer: Qilai Shen/Bloomberg (Bloomberg)

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 a decade ago. But now the industry is in crisis. Developers are facing a cash-flow crunch that has sent some major companies into default, plus a slump in sales and a mortgage boycott by people angry that the homes they paid for in advance aren’t finished. So far, the state’s intervention has held off a disorderly collapse of the property market. The stakes are high, as such a crash could undermine the financial system and jolt the world economy too. 

1. What sparked the crisis? 

As an emerging middle class flocked to property as one of the few safe investments available, home prices skyrocketed -- surging sixfold over the past 15 years. 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. In response, Chinese officials ratcheted up steps to reduce the risk of a bubble and temper the inequality that unaffordable housing can create. That touched off the cash-flow crisis for developers. Then a sales slump that began during the pandemic was deepened by aggressive measures to contain Covid-19. 

2. What had fueled the real estate boom?

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 expanded rapidly to keep up. Boom cities such as Shenzhen became less affordable based on price-to-income ratios than London or New York. 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 all Chinese borrowers. Additional, opaque liabilities make it hard to assess true credit risks.

3. What did the government do?

It has for years tried to defuse the debt bomb amid fears an explosion 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 threat, 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.

4. What happened to the developers?

Those that didn’t have enough cash on hand to cover their liabilities found themselves in a bind. At least 18 defaulted on offshore bonds after 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 complete 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.

5. Where does this leave the industry?

In a deep slump. Combined sales at the top 100 developers halved in the first four months of this year compared with 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. The ramifications are significant given that China’s 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.  

6. How bad could it get?

Across China millions of square feet of unfinished apartments have been left to gather dust as a result of developers facing cash-flow problems. Economists at Nomura International HK Ltd estimated in mid-July that Chinese developers have delivered only about 60% of the homes they pre-sold from 2013 to 2020. The mortgage protests hit just as the market was showing signs of stabilizing, with sales picking up in June. A full-bore 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.) Home prices began to fall last September for the first time in six years. Fire sales would further pummel the market, squeezing other developers and rippling through related industries and suppliers. Because more than 70% of urban China’s wealth is stored in housing, the risk of popular unrest 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. 

7. How serious are the mortgage protests?

The wildcat boycotts spread at one point in mid-July to over 300 housing projects in about 90 cities, with loans of as much as 2 trillion yuan ($295 billion) under threat. (Tracking the extent grew more difficult after China began censoring crowd-sourced online tallies in mid-July.) While the protests affect only a sliver of the lenders’ combined mortgage portfolios, the speed at which they grew took many by surprise. In a scenario analysis released July 22, Bloomberg Intelligence estimated between 1.8% and 6.5% of China’s total mortgages could be exposed. The boycotts are politically sensitive in a year when the ruling Communist Party wants stability ahead of the all-important party congress later this year where Xi is expected to get anointed for a third term. They also pose a risk to the broader housing market by keeping potential buyers on the sidelines.

8. How has the government intervened in the crisis?

The mortgage boycotts prompted authorities to promise stricter regulation of pre-sales -- a popular way to buy a home or apartment in China, in which buyers have to start repaying their loans even on projects that are still under construction. A grace period on payments for some homebuyers was said to be under consideration. In the biggest financial commitment yet from Beijing to contain the crisis, the government is offering 200 billion yuan ($29.3 billion) in special loans to ensure stalled housing projects are delivered to buyers. 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. Chinese lenders have 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 ahead of the party congress. That political necessity most likely means the government will try to contain the crisis, at least for the near term. 

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