August8 , 2022

China Real Estate Market: Explained: Why China’s crumbling real estate sector has the world on edge

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China’s homebuyers are running out of patience as the country’s real estate crisis threatens to spiral out of control. Hundreds of thousands of homebuyers have begun a “mortgage boycott”, refusing to pay their mortgage for unfinished or stalled housing projects.

As of July 18, homebuyers in 80 cities and 200 projects had threatened to stop mortgage payments.

Total mortgages at stalled Chinese developments amount to 2 trillion yuan ($296 billion), according to analysts at GF Securities Co. and Deutsche Bank AG.

Home sales have collapsed by nearly 60% compared to a year ago, and the current constant decline of sales (11 months) is pegged to be the worst in China’s history.

Analysts expect property sales to have dropped 25% from January to June, amidst China’s “Zero Covid Cases” strategy. Numerous developments in China have halted as property developers have run out of capital to finish construction.

Across China, real estate developers are getting desperate – attempting to sell homes by whatever means possible, even going as far as accepting down-payments in wheat, garlic, watermelons and peaches to cater to farmers.

House of cards

What started as trouble with the Evergrande Group is snowballing into a crisis that risks engulfing some of the biggest developers in the country, its lenders and a middle class that has significant wealth tied to the property market.

About 70% of the country’s household wealth is stored in property, along with 30-40% of bank loan books, while land sales account for 30-40% of local government revenue, according to Pantheon Macroeconomics.

A working paper published by the National Bureau of Economic Research in 2020 estimated China’s real estate sector accounted for 29% of the country’s GDP – about $4 trillion out of $14 trillion.

Evergrande isn’t the only group in trouble. Several debt-laden developers such as Fantasia Holdings, Sinic Holdings Group, Modern Land have defaulted or are heading towards default. Sunac, China’s third-biggest developer, has also had its credit ratings cut sharply, as concerns about debt repayment have arisen.

Three red lines

In August 2020, in an effort to better manage the heavily leveraged sector, Chinese regulators introduced rules dubbed the “three red lines” to limit borrowing of real estate firms. The three red lines mandate that developers maintain:

  • A debt-to-asset ratio of 70% or lower,
  • A 100% cap on net debt to equity,
  • Enough cash on hand to satisfy short-term borrowing, debts, and liabilities.

Each crossed red line reduced a firm’s capability to take on additional debt. If all three lines were crossed, a firm could no longer take on debt.

However, a Reuters report revealed that firms were using various tactics to take debts and projects off-balance-sheet, or disguised debt as equity, to comply with the “three red line” policy.

By the end of 2020, China’s local government debt stood at $4 trillion. Goldman Sachs estimates “hidden” or “shadow” debt to be as high as $8 trillion, more than half the country’s GDP.

Global fallout

A collapsing property market in China has triggered alarm bells across the world. It is still the manufacturing hub of the world and if its economy falters, countries around the globe would suffer from slower and more expensive exports.

Contract electronics and semiconductor manufacturing, where China is a global leader, had already stalled various sectors such as auto, consumer electronics and more due to Covid-induced supply bottlenecks. This would only go up further in an economic crisis.

China is also the global creditor of the developing world. Developing countries dependent on China for infrastructure projects, would be hard-hit.

The Xi-government has sponsored numerous projects under the Belt and Road Initiative. Currently, B&RI projects are valued at over $1 trillion across 139 countries around the globe. These building sites, highways, power generation plants and so on could be left unfinished.

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