The real estate sector moves close to one-third of China’s economy…and is in deep trouble.
With another term secured under his belt, President Xi Jinping, earlier this week, announced a sixteen-point plan to rescue the real estate sector.
For the last few years now, the entire real estate in China has been close to collapse with soaring prices even with falling demand, defaulting real estate groups, starting with Evergrande, local governments losing out on land sales and revenues, and ghost cities.
Not anything Lehman Brothers, however, China’s real estate finds itself in decline after a decade of booming growth.
The sixteen-point agenda includes more property development loans for developers, easing the home-buying requirements for borrowers, ensuring fundraising and financing for construction companies, and allowing a moratorium on the loan payments for developers.
Further, the plan includes support for the issuing of bonds, special loans for pending projects with a priority on residential properties, negotiating with homebuyers if they default on their mortgage payments, and ensuring long-term funding for even the rental properties.
Together, close to $590 billion can be attributed to unfinished real estate projects in China. The concerns are not limited to the developers alone, for bankers and promoters behind these projects, many of them local, are also facing the possibility of a run on their deposits, triggering another crisis.
Given a lot of the buyers make 100 per cent payments before the houses are delivered, the consumption economy also suffers. What shocked the authorities in Beijing was the protest by several buyers against mortgage payments.
China’s real estate crisis emerged only in the last few years. Since 2008, it had been the recipient of free money from the state.
Three factors were critical in the decade-long boom. One, is the economic stimulus that almost all major economies ushered after the slowdown of 2008.
Two, the growing urbanisation and anticipation of housing demand in cities, and finally, the generous capital that was available to developers at throwaway interest rates, thanks to the backing of the state. Then came the problem of excesses.
Post-2015, the ‘Ghost City’ phenomenon started becoming common. Houses with no residents, commercial estates with no offices, and localities with no communities. The consequences of the ‘Ghost City’ phenomenon led to low returns for the developers and local governments while they were taking on more debt.
Eventually, to service the previous debt, these developers, and provincial and local administrations took more loans, thus getting trapped in a debt loop. Beijing now wants to ensure more free loans for real estate developers.
Another fallout of the real estate crisis was the ability of developers to raise money through dollar bonds. In March 2022, some of these bonds were paying a 32 per cent yield, higher than what was in 2008.
In the last few quarters, the quantum of dollar bonds issued has also come down significantly, compared to 2018 and 2019.
For Q1, 2022, the issuance was down by 97 per cent compared to Q1, 2021, thus triggering another crisis for the developers. In August, investors were estimating bond losses in excess of $130 billion.
As a result, Beijing had to bail out several local administrations too. Xi’s government had to deploy LGFVs or Local Government Financing Vehicles to buy out lands from provincial governments at inflated prices.
For H1 2022, the LGFV purchases were $57 billion, 70 per cent more than H1 2021. In July 2022, the year-on-year change in revenues from land sales for local authorities was down by over 30 per cent.
Beijing now wants to ease the regulatory burden on developers as well. In August 2021 introduced the ‘three red lines’ system under which the financial health of a real estate group was evaluated.
The parameters included the ratio of liabilities to assets, net debt to equity, and cash to short-term borrowings. Over a dozen big property developers were in violations of these regulations.
Most developers had a liability to assets ratio in excess of 70 per cent. The cash to short-term debt ratio was as low was 0.55 for some developers.
Beyond the 30 per cent contribution to the annual growth which includes several sectors, China’s real estate is also linked to its demographic fortunes.
Seen as the primary deterrent against having more children after education cost, apartment prices, in cities, were regulated by Beijing last year when they allowed families to have three children.
In some cases, the excessive supply of apartments was dealt by demolishing them altogether, and in some cases, an offer was made for one-plus-one.
While the markets have responded optimistically to the agenda, estimated to cost around $180-odd billion, the sentiment continues to remain divided, and for the right reasons.
Ease of credit to build or buy homes is no guarantee of demand, and beyond finishing incomplete projects, the Chinese economy no longer has the appetite for a state-backed building boom as was the case between 2008 and 2018. Further, will the investors on dollar bonds come back with the same vigour?
The real estate ‘ghosts’ will continue to haunt Xi, even with all his political leverage.
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