FROM BOOM TO BUST

Rise of Real Estate in China 

• Under the leadership of Mao Zedong during the 1940s to 1970s, China followed a strict Communist ideology and  outlawed private property. Housing was state-controlled where the state planned and managed land ownership. The state also controlled the means of production of agricultural land and exerted greater control over the daily lives of the people. When housing sector reforms were initiated under Deng Xiaoping in 1988, there was a rapid shift towards private home ownership which increased the demand for constructing and investing in housing spaces. China’s New Developmental Strategy under Deng made space for a ‘socialist market economy’ and an increase in people’s wealth which they could invest in private enterprises such as buying their own land.

• With China’s accession to the World Trade Organisation (WTO) in 2001, it underwent rapid trade liberalisation to pursue market-oriented economic reforms. Economic and market stability came with a rising middle class and an increase in people’s purchasing power with many families buying private properties as investments giving them lucrative returns. This incentivised builders to construct huge apartment buildings in underdeveloped parts of the cities.

Defaulting Loans

• However, this led to massive overcapacity, declining property values, and a drop in potential buyers, which led to defaults by numerous real estate developers who had borrowed from overseas. With local government’s revenue declining from land sales and private developers taking on heavy borrowing to buy land at high prices, the real estate market contributed to China’s financial troubles.

• In 2020, China’s biggest private property developer Evergrande Group made headlines by accruing substantial debt due to borrowing in offshore and onshore bonds with no means to fund them back. Grappling with a liquidity shortage since mid-2022, Evergrande accumulated an offshore debt of $31.7 billion, encompassing bonds, collateral, and repurchase obligations. In fact, Evergrande’s financial turmoil is so huge that in August 2023, it filed Chapter 15 bankruptcy petitions in the US, marking it one of the largest debt restructurings globally.

• In a similar situation, Country Garden, the second significant player in the Chinese property sector had found itself saddled with debts amounting to approximately $196 billion by the end of 2022. Till today the company has consistently failed to meet its $15.4 million coupon repayment deadline intensifying concerns from Chinese property buyers and global investors. Even with a 30-day grace period the expectations of meeting payments seem improbable as the company struggles to meet its financial obligations.

• This crisis has also cascaded down to smaller firms creating a domino effect leading to firms like Kaisa, Shimao defaulting on offshore bonds and onshore debts, amounting to at least 18 billion dollars. Fallout of offshore bonds affect international investors and stability of the global financial market, whereas overdue onshore debts not only strain companies and domestic investments but also restrict cash flow within the economy, impacting overall market profitability.

Ghost Cities and Empty Houses

• China’s property landscape runs on the pre-sale model where buyers pay upfront for properties before their completion. This accounts for approximately 80% of new home purchases and based on these pre-sales, developers invest in new land parcels to generate more revenue. To build more homes, companies borrowed immensely without anticipating the decrease in demand for property. As a result, developers have accumulated substantial debt to finance news ventures with no buyers in sight who could invest in new properties. This is also because of low buyer trust in the market as previous buyers who made down payments and took mortgages are facing unfinished homes because private developers have failed to complete existing projects in a run to initiate new ones.

• The supply of property in China is also imbalanced in tier-two and tier-three cities. Private investors constructed properties in such cities where land was affordable and they were optimistic that these areas would evolve into thriving hubs over time. However, the anticipated demand has not yet materialized and smaller cities are now grappling with the consequences of ambitious but misguided urban projects earning the term of ghost cities - once hopeful ventures that now serve as symbols of speculative overreach. According to one former Chinese official, China has at least 65 million empty homes – enough to house the entire population of France. But with high buying prices, most of the population cannot afford these spaces creating a housing bubble and inflating the value of property.

China’s Housing Crisis and International Repercussions

• As the world’s second-largest economy, any downturn in China significantly impacts the global economic landscape. The World Bank recently revised China’s 2024 economic growth projection downward to 4.4 percent from the initial 4.8 percent estimate, marking the slowest growth since the 1960s. Barclays has also reduced China’s 2023 GDP growth forecast from 9% to 4.5%. These developments have potential global repercussions with the IMF predicting a global economic slowdown by growth rates dropping from 3.5 percent in 2022 to 2.9 percent in 2024.

• The international consequences of China’s housing bubble can affect heavy industrial sectors and businesses worldwide. The spillover effects are substantial impacting labour, private businesses, and construction industries such as cement and steel. Moreover, China’s housing has been built by private developers who reach out to global investors and issue bonds to finance their projects. China’s private sector loans have escalated from $4 billion in defaults in 2015 to an alarming $54 billion in 2022. Since offshore bonds are issued this is a cause for global concern as they impact foreign investors and the market of other countries.

Government Policies and Regulatory Measures

• In 2020, China introduced the ‘three red lines’ policy for property developers who had previously unrestricted amounts for borrowing from outside and in turn had incurred huge debts by not following any regulatory mechanism. The policy meant a cap on the rations of debt-to-cash, debt-to-assets and debt-to-equity that private companies hold. These initiatives included restricting financing for new projects and imposing stricter limits on borrowing. Officials encouraged lenders to decrease interest rates on existing mortgages to control escalating property prices and increase property sales. However, despite these efforts, the government’s strategies achieved only partial success with difficulty in regaining consumer trust and stabilizing home sales.

• In November 2022, the People's Bank of China issued a significant document outlining 16 wide-ranging measures to revive the property sector. Among these measures, two were prominent with the central government encouraging banks to provide financing to private developers and potentially taking over financially weaker banks. The other initiative was to extend the repayment period for current debts. With China easing COVID restrictions by February 2023, the market was predicted to show signs of recovery only to indicate a negative growth of property sales experiencing a year-on-year decline of 20.33% in September 2023. It is estimated that post-pandemic real estate investment declined by 9.3 percent, and officials acknowledged that the industry needs adjustment before it plunges into crisis.

• In a recently announced initiative by the Ministry of Housing and Urban-Rural Development, the Ministry of Finance, and the central bank, China plans to provide 200 billion yuan ($29 billion) in special loans to aid developers in completing halted housing projects. Further assessments and adjustments are necessary such as emphasizing supply-side reforms to address structural challenges and improving available fiscal and monetary options.  

Economic Recovery and Optimism in China

• Amidst the challenges posed by its housing bubble, China exhibits a resilient economic outlook, fostering optimism amidst global concerns. According to China's National Bureau of Statistics, the economy demonstrated significant growth, with a 4.5 percent expansion in the first quarter and a notable 6.3 percent growth in the second. Furthermore, there was a 0.8 percent increase in GDP from April to June. These figures signify a rebound, dispelling speculations of an economic downturn. Particularly there has been a surge in China's consumer demand witnessed in August, indicating an improvement in consumption.

• In response to external scrutiny of China’s housing crisis, Xi Jinping has reaffirmed the robustness of his economic model, characterized by ‘strong resilience, tremendous potential, and great vitality’. Mao Ning, the Minister of Foreign Affairs of China also remarked that, China’s economy has outlived all sorts of comments predicting its collapse and ‘what has collapsed is such rhetoric, not China’s economy.

• During the 19th National Congress of the Chinese Communist Party, President Xi Jinping emphasized the importance of housing for living, not for speculation. However, the message seems to fall flat with China facing unprecedented challenges with private property developers defaulting on huge loans and bonds, as well as angry citizens and investors who demand homes and lowering of property prices.

Conclusion

• China's housing crisis has created massive debts, bankruptcy declared by private property developers, and spillover economic effects to be faced by the international market. With major private sector stakeholders like Evergrande and Country Garden defaulting on their payments, the stage seems set for a housing bubble which might burst if not deflated by government’s regulatory measures. As the world sits back to see how China’s housing crisis unfolds and corrects its structural course, one can expect China’s economic policies to be based on addressing these vulnerabilities in its housing sector. Despite these challenges, China's resilience and considerable economic might is evident with a property market that stands as the largest asset globally at $50 trillion. Although corrections are necessary for China to burst its housing bubble, one can hold belief in the nation’s ability to maintain domestic and global stability as an economic powerhouse.