Introduction
China Real Estate Market Collapse: Understand the causes, consequences, and future outlook of this economic shift, including debt crises…
China’s real estate industry is collapsing in slow motion. These ghost cities, residential buildings without tenants, and construction that never finished have become visual metaphors for the ongoing crisis. This has really undermined the confidence among home buyers because they were now worried that developers might not deliver the apartment they had put a down payment on for.
Consequently, there has been a confidence crisis among consumers who weren’t able to trust developers to deliver the apartments they had paid for, at least in part. This lack of trust led to a decline in demand and, therefore, a downward adjustment of prices.
One of the issues for the property sector has been its rapid expansion, and in China’s financial world, there haven’t been as many regulatory constraints as you might have seen in other parts of the world that are more developed.
The total value of commercial real estate sales from things like offices and shopping centers skyrocketed in February 2021, with a month-over-month increase of 133%. However, this same value on those sales has now fallen negative to minus 1.5% from July to August of this year.
Part of the problem this summer and late July and early August was that the pace of the sales decline was accelerating. This was exacerbated by Country Garden running into default worries, from Evergrande’s default and eventual bankruptcy filing to Country Garden’s debt restructuring. Ripple effects are making waves throughout the entire economy and the Chinese stock market.
The Hang Seng Mainland Properties Index illustrates this tough time rather clearly, with a steep decline since the sector’s peak in January 2020.
This all comes as China’s overall economy struggles with its post-COVID recovery. Wall Street analysts are now cutting their forecasts for China. Barclays, for example, cut its estimate for China’s 2023 GDP from an astronomical 9% to 4.5%.
Official Chinese statistics state the real estate sector only accounts for 6 to 7% of the country’s overall GDP, but estimates from economists like Ken Rogoff suggest all real estate and supply chains make up a whopping 30% of China’s overall GDP.
Housing Sector Weakness
Back in 2014, the country’s sizzling housing market began to cool, with fewer sales, falling prices, and slowing development. Compared with the situation back in 2014, the current scenario is quite different. Back then, we didn’t have this kind of housing sector weakness.
Developers at that time just had a slowdown, not a huge wave of default of private developers, and there weren’t huge groups of austerity households already facing high leverage and lower income expectations. This time around, developers began to look to offshore international debt markets and local governments to finance new projects, anticipating continued growth.
They had seen huge growth in the last two decades, partly because they could buy land from local governments and then sell those properties they built on the land to people in China.
There was a lot of financing involved with that. As these companies began to grow with no restriction in sight, several auditors parted ways with the big real estate companies in China, sparking fears of underlying concerns. It’s a result of very deliberate policy by the government to prick the property bubble that was forming over the last decade or so.
The government stepped in and essentially curbed financing to developers, tightening household borrowing, for example, to reign in property prices. However, they got a bit more than they bargained for because, now, about a year and a half later, the property market is actually quite depressed.
Evergrande is one of the notable property developers that defaulted on its offshore debt payments in late 2021, meaning it failed to repay bills and even missed the grace period window to repay.
Country Garden was another privately owned Chinese property developer to catch investors’ attention after signaling pressure on their ability to pay down debt.
On October 18th, the company missed a $15 million payment. The company now rests with $11 billion in offshore bonds and even mentioned it expects to be unable to meet all of its offshore debt obligations.
One strategy the government adopted to reign in the frothy housing market was to curb the financing access of developers. Developers would borrow money in the market, build apartments, and sell these to consumers.
By cutting off developers from funding or at least restricting their access to funding, developers suddenly realized they didn’t have enough money to actually complete the projects they were working on. In total, 26 property developers encountered distress events in 2022, according to S&P Global Ratings.
S&P Global Ratings counts distress events as those where the developer reportedly restructured or outright failed to pay any of its offshore or domestic obligations. However, these defaults subsided in 2023 as several of these companies were able to push back their maturities to late 2024.
China’s shrinking real estate sector over the coming years will have a huge impact on heavy industry and commodity markets globally because there will be less steel demand, less cement being used, and less glass, for example. This impacts heavy industrial areas within China that produce these raw materials.
China has its own Rust Belt in the Northeast, similar to the U.S., where the economy shifts away to different sectors, leaving behind empty factories and declining employment. China has the equivalent, and all of this is spilling over into the global economy.
The International Monetary Fund just cut its global growth forecast for 2024 and called out China’s real estate crisis as a big reason why, in addition to citing rising inflation and interest rates. The IMF described China’s real estate crisis as a major problem facing policymakers going into 2024. The IMF said diminished consumer confidence and investment in China posed a significant risk for the global economy.
Since real estate was one of the biggest parts of China’s economy, real estate developers were growing significantly. It made a lot of investment sense at one point to buy these bonds, but that growth and that reliance on debt proved unsustainable.
It’s something that people have warned about in China’s economy for decades, and at some point, the government started to think about how they could reduce the level of debt in their system. This led to the central government’s decision to institute a three-red-line rule for property developers. This rule puts a cap on the ratios of debt to cash, debt to assets, and debt to equity that these companies can hold.
Government Intervention
From anecdotes I’ve heard, this policy was implemented pretty stringently, to the extent that everyone was so scared of giving any financing to the real estate developers that they were almost cut off.
This three-red lines policy was so steep that it doubled China’s default rate to 4.4% in 2021, and then the following year it doubled again to 8.2%, according to S&P Global Ratings. I think the Chinese government would try to let those private developers negotiate with creditors and get those things done to stabilize the situation instead of leveraging the central government to bail them out.
Fast forward to just a couple of months ago, when the central bank and government officials moved to boost home sales by lowering the minimum down payment for first-time home buyers to 20% and 30% for second-time purchasers. Officials also began encouraging lenders to lower rates on existing mortgages, all in an effort to boost property sales.
All these strategies are aimed at increasing home sales and raising demand for apartments. However, on both of these strategies, the government has only been partially successful so far. We’re still in the early days, but we’re not yet seeing a V-shaped recovery in housing demand. It’s been a bit of a slog in recent months to get consumer confidence back into the market and stabilize home demand.
A key difference between private sector developers and state-owned developers is that private sector developers funded themselves a bit more out of the international market.
They went to global investors and issued bonds to fund their expansion, whereas state-owned developers funded themselves more domestically. This exact phenomenon played out in 2021 and 2022, as privately owned enterprises or developers’ default amounts surged to $35.4 billion, while their state-owned counterparts fell to $190 million in a very rapid difference. It’s not to say that state-owned developers are entirely off the hook.
They too have faced increasing pressures due to declining demand and are facing a more difficult time raising funding, although not quite on the same level as private sector developers experienced over the past 18 months. The amount in offshore defaults for China’s property sector soared to a record rate in the last 10 years, from $4 billion in defaults in 2015 to $54 billion in 2022.
The rate at which companies defaulted tripled, according to S&P Global Ratings. You can see that bifurcation in how the property developers are doing. For example, Evergrande was more exposed to the lower-tier cities and not as much to the higher-tier cities.
It’s similar to how New York’s property market will almost always hold its value. It might go down, but after the pandemic, it comes back and is more expensive than ever because more people are always going to large cities for job opportunities, education, and healthcare services.
Cities and localities in China differ in their policy responses to the struggling property sector. For example, China’s central authorities announced that city-level governments could decide on their own the eligibility criteria for first-time home buyers.
These policies differ based on where you are in China. As of now, only Shanghai is still maintaining its momentum, while other tier-2 or even tier-1 cities have already slowed. This means that the effectiveness of these policies is quite different, and perhaps the booming economy and growth we’ve seen in the last couple of decades might not continue.
What’s Next?
People have expected that China’s growth overall is going to slow, but does that mean it will collapse and fall into a deep recession? There’s a lot of space between that scenario and what’s happening right now.
No one expects the property market to fully recover overnight. What could happen is more signs of stabilization, with the possibility of a slower, more gradual recovery that takes years rather than months. China’s housing market was once the main driver of its economy, with years of sizzling growth.
Over the years, property prices have risen sharply and even increased the net worth of many individuals, while the general public saw more positive economic effects. Today, the housing market has become one of the main challenges for China’s economic recovery and global stability.
In conclusion, the collapse of China’s real estate market is the result of a complex interplay of factors, including rapid expansion, excessive borrowing, policy shifts, and a lack of consumer confidence. The government’s interventions have been varied and only partially effective in stabilizing the market.
The future of China’s real estate sector will likely involve a slow and gradual recovery rather than an immediate rebound, with significant implications for both the Chinese and global economies.