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10/11/21, 6:02 PMBeyond Evergrande, China’s Property Market Faces a $5 Trillion Reckoning - WSJ
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Beyond Evergrande, China’s Property Market Faces a $5Trillion ReckoningDevelopers have run up huge debts. Now home sales are down, Beijing is imposing borrowing curbs and buyers are balking at high prices.
China Evergrande Group, the embattled property developer, is the firsthigh-profile real-estate company to run into serious trouble in Beijing’scampaign to tame a roaring property market.
It might not be the last.
As China enters what many economists say is the final stage of one ofthe largest real-estate booms in history, it is confronting a staggeringbill: More than $5 trillion in debt that developers took on when timeswere good, according to economists at Nomura Holdings Inc.
That debt is nearly double what it was at the end of 2016 and is morethan the entire economic output of Japan, the world’s third-largesteconomy, last year.
Global markets are braced for a possible wave of defaults, with warningsigns flashing over the debt of about two-fifths of developmentcompanies that have borrowed from international bond investors.
Chinese leaders are getting serious about addressing the debt, with aseries of moves meant to curb excessive borrowing. But doing sowithout torpedoing the property market, crippling more developersand derailing the country’s economy is quickly turning into one of thebiggest economic challenges Chinese leaders have faced in years, andone that could reverberate globally if mismanaged.
Luxury developer Fantasia Holdings Group Co. failed to repay $206million in dollar bonds that matured Oct. 4. In late September,Evergrande, which has more than $300 billion in obligations, missedtwo interest-payment deadlines for bonds.
Asia’s junk-bond markets suffered a wave of selling last week. OnFriday, bonds from 24 of the 59 Chinese development companies in anICE BofA index of Asian corporate dollar bonds were trading at yields ofabove 20%, levels that indicate high risk of default.
By and
Oct. 10, 2021 12:07 pm ETQuentin Webb Stella Yifan Xie
10/11/21, 6:02 PMBeyond Evergrande, China’s Property Market Faces a $5 Trillion Reckoning - WSJ
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Some prospective home buyers are balking, forcing the companies tocut prices to raise cash, and potentially accelerating their slide if thetrend continues.
Total sales among China’s 100 largest developers were down by 36% inSeptember from a year earlier, according to data from CRIC, a researchunit of property services firm e-House (China) Enterprise Holdings Ltd.It showed that the 10 biggest developers, including China Evergrande,Country Garden Holdings Co. and China Vanke Co. , saw sales down 44%from a year ago.
Economists say that most Chinese developers remain relatively healthy.Beijing also has the firepower and tight control of the financial systemneeded to prevent a so-called Lehman moment in which a corporatecollapse snowballs into a financial crisis, they say.
In late September, The Wall Street Journal reported that China hadasked local governments to prepare for problems potentiallyintensifying at Evergrande.
But many economists, investors and analysts agree that even forhealthy ventures, the underlying business model—in which developersuse debt to fund a steady churn of new construction despitedemographics becoming less favorable for new housing—is likely tochange. Some developers might not survive the transition, they say.
Of particular concern is some developers’ practice of relying heavily on“presales,” in which buyers pay in advance for still-uncompletedapartments.
The practice, more common in China than the U.S., means developersare in effect borrowing interest-free from millions of households,making it easier to continue expanding but potentially leaving buyerswithout finished apartments should the developers fail.
The Evergrande Fairyland complex in Lu'An, China, with towers under construction. Evergrande recently missed two bond-interestdeadlines.PHOTO: RAUL ARIANO FOR THE WALL STREET JOURNAL
10/11/21, 6:02 PMBeyond Evergrande, China’s Property Market Faces a $5 Trillion Reckoning - WSJ
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Presales and similar deals were the sector’s biggest funding source thisyear through August, according to the National Bureau of Statistics ofChina.
“There is no return to the previous growth model for China’s real-estatemarket,” said Houze Song, a research fellow at the Paulson Institute, aChicago think tank focused on U.S.-China relations. He said China islikely to keep in place a set of limits on corporate borrowing it imposedlast year, known as the “three red lines,” which helped trigger therecent distress at some developers, though he said China might easesome other curbs.
While Beijing has avoided clear public statements on its plans fordealing with the most indebted developers, many economists believeleaders have no choice but to keep the pressure on them.
Policy makers appear determined to revamp a model driven by debt andspeculation as part of President Xi Jinping’s broader efforts to defusehidden risks that could destabilize society, especially ahead ofimportant Communist Party meetings next year. Mr. Xi is widelyexpected then to break with precedent and extend his rule into a thirdterm.
Beijing is worried that after years of rapid home-price gains, somepeople may be unable to get on the housing ladder, potentially fuelingsocial discontent as wealth gaps widen, economists say. Young couplesin large cities are beginning to get priced out, making it harder for themto start families. The median apartment in Beijing or Shenzhen nowcosts more than 40 times the median family annual disposable income,according to J.P. Morgan Asset Management.
Authorities have said they are worried about the property marketposing risks to the financial system. Reining in the developers’ business
A model of a residential compound by China Vanke, a large developer, at its showroom in Dongguan,China.PHOTO: CHINA STRINGER NETWORK/REUTERS
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models and limiting debt, however, is almost certain to slowinvestment and cause at least some downturn in the property market,which is one of the biggest drivers of China’s growth.
The real-estate and construction industries account for a large part ofChina’s economy. A 2020 paper by researchers Kenneth S. Rogoff andYuanchen Yang estimated that the industries, broadly construed,accounted for 29% of China’s economic activity, far more than in manyother countries. Slower growth in housing could spill into other partsof the economy, affecting consumer spending and employment.
Government statistics show about 1.6 million acres of residential floorspace was under construction at the end of last year. That was equal toabout 21,000 towers with the floor area of the Burj Khalifa in Dubai, theworld’s tallest building.
As restrictions on borrowing imposed last year kicked in, housingconstruction tumbled in August to 13.6% below its pre-pandemic level,calculations by Oxford Economics show.
The revenue local governments earn by selling land to developers fellby 17.5% in August from a year earlier. Local governments, which arealso heavily indebted, count on land sales for much of their revenue.
A further slowdown also would risk exposing banks to more bad loans.Outstanding property loans—primarily mortgages, but also loans todevelopers—accounted for 27% of China’s total $28.8 trillion in bankloans at the end of June, according to Moody’s Analytics.
As pressure on housing mounts, several research houses and bankshave cut China’s growth outlook. Oxford Economics on Wednesdaylowered its forecast for China’s third quarter year-on-year grossdomestic product growth to 3.6% from 5% previously. It trimmed its2022 growth forecast for China to 5.4% from 5.8%.
The Luwan 68 development by Fantasia Holdings Group in Shanghai. The luxury developer failed torepay $206 million of dollar bonds that matured on Oct. 4.PHOTO: QILAI SHEN/BLOOMBERG NEWS
10/11/21, 6:02 PMBeyond Evergrande, China’s Property Market Faces a $5 Trillion Reckoning - WSJ
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As recently as the 1990s, most of China’s city residents lived in drabdwellings provided by state-owned employers. When market reformsstarted transforming the country and more people moved to cities,China needed a massive new supply of higher-quality apartments.Private developers stepped in.
Over the years, they addedmillions of new units inmodern, well-maintainedhigh-rises. In 2019, newhomes made up more thanthree-quarters of home salesin China, versus less than 12%in the U.S., according to datacited by Chinese propertybroker KE Holdings Inc. in alisting prospectus last year.
In the process, the developersbecame much bigger thananything seen in the U.S. Thelargest U.S. home builder byrevenue, D.R. Horton Inc.,
reported $21.8 billion of assets at the end of June. Evergrande had some$369 billion. Its assets included vast land reserves and 345,000 unsoldparking spaces.
For much of the boom, the developers were filling a need. In morerecent years, policy makers and economists began to fret that much ofthe market was driven by speculation.
Chinese households are restricted from investing abroad, and domesticbank deposits offer low returns. Many people are wary of the country’sboom-and-bust stock markets. So some have poured money intohousing, in some cases buying three or four units without any intentionof living in them or renting them out.
As developers bought more locations to build on, land sales pumped upnational growth statistics. Dozens of entrepreneurs who had foundeddevelopment companies showed up in lists of Chinese billionaires. Tenof the 16 soccer clubs in the Chinese Super League are wholly or partlyowned by developers.
Floor space under construction in China
Source: National Bureau of Statistics via Refinitiv
'05 '10 '15 '201997 2000
0
0.5
1.0
1.5
2.0
2.5million acres
10/11/21, 6:02 PMBeyond Evergrande, China’s Property Market Faces a $5 Trillion Reckoning - WSJ
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The real-estate giants have borrowed not only from banks but also fromshadow-banking outfits known as trust companies and from individualswho put their savings into investments called wealth-managementproducts. Abroad, they became a mainstay of international junk-bondmarkets, offering juicy yields to get deals done.
One builder, Kaisa Group Holdings Ltd. , defaulted on its debt in 2015,yet was able to keep borrowing and expanding afterward. Two yearslater it spent the equivalent of $2.1 billion to buy 25 land parcels, and in2020 spent $7.3 billion for land. This summer, Kaisa sold $200 millionof short-term bonds yielding 8.65%.
Nomura estimated that as of June, Chinese developers had racked updebts of $5.2 trillion. It said the biggest share, 46%, was in bank loans.Bond markets accounted for about 10%, including the equivalent of$217 billion of dollar bonds, many of them junk-rated.
By last year, Chinese policy makers had had enough. In August 2020,they introduced the three-red-lines rules limiting how much borrowingdevelopers could do. Some companies with short-term obligations theycouldn’t pay without new funding had to start discounting apartmentsto raise money.
Authorities have tried to curb demand in some places by slowingmortgage lending. They have put caps on existing-home prices in abouta dozen cities to tame speculation, according to state media reports.
When old-fashioned funding sources like bank loans grew harder toaccess, developers became more reliant on presales of unfinishedapartments. These made up 26% of the debt in Nomura’s tally.
Presales are often recorded as contract liabilities, an item that showsup on the balance sheets of sector heavyweights such as Evergrande,Country Garden, China Vanke, Sunac China Holdings Ltd. and China
Residential skyscrapers being built in Shanghai, in November 2016.PHOTO: JOHANNES EISELE/AFP VIA GETTY IMAGES
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Resources Land Ltd. For these five combined, contract liabilities havejumped 42% in the past three years to the equivalent of $341 billion asof the end of June, FactSet data show.
Developers have also made more use of other liabilities that, likepresales, don’t strictly count as debt, such as borrowing more frombusiness partners by taking longer to pay contractors or suppliers.
Goldman Sachs Group Inc. analysts recently estimated Evergrande hadthe equivalent of $156 billion of off-balance-sheet debt and contingentliabilities, including mortgage guarantees to help home buyers getloans.
The other problem fordevelopers, and for China’sproperty market overall, is theway some of the trends thatfueled the boom are reversing.
China’s population is aging.Its workforce has been
shrinking since 2012, and official forecasts last year predicted the totalpopulation would peak in 2027.
Homeownership is already over 90% for urban households in China,among the highest in the world, according to Mr. Rogoff and Ms. Yang.They cited earlier Chinese research saying that as of late 2018, 87% ofhome purchases were by buyers who already had at least one dwelling.
Julian Evans-Pritchard, an economist at Capital Economics, said hisfirm has looked at developers’ ability to meet their obligations fromcash holdings and doesn’t think most are on the brink of default. But,citing changing demographics and reduced internal migration, he said“we’re now at a turning point where actually demand for new urban
The construction site of a Vanke residential building in Dalian, China, in 2019.PHOTO: REUTERS
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housing is going to decline over the coming decade. So they’re going tobe fighting over a shrinking pie.”
Deng Lin, a 33-year-old lawyer in Shanghai, planned to sell twoproperties she owns to buy a bigger one after she gave birth to twinsthis summer. The government’s clampdown on debt risks derailing herplan of upgrading to a three-bedroom, which she estimates could costup to $1.86 million.
Tightened mortgage rules means she would have to pay 80% upfront.Banks have been slow to approve her loan application.
“There’s simply too much uncertainty in the market,” she said.
—Anniek Bao contributed to this article.
Write to Quentin Webb at [email protected] and Stella Yifan Xieat [email protected]
Appeared in the October 11, 2021, print edition as 'China’s Property Market Faces a $5
Trillion Reckoning.'
