What's led to China's property-market woes and what does that mean for the world?

Concerns over China’s property sector persist as several of the country’s largest developers report staggering losses and struggle to cover their debt service.

Major developer Country Garden announced a loss of approximately $6.7 billion in the first half of 2023 and warned that they could default “if the financial performance of the group continues to deteriorate in the future”. It narrowly avoided missing the 30-day extension it had gotten on bond payments due in August and just paid the $22.5 million it owed on those US dollar bonds. This near-miss has underscored the challenges the company continues to face as it works to repay the $15 billion it owes over the next year. The company currently has $13.9 billion in cash and equivalents.

China Evergrande Group, a major rival of Country Garden, saw its shares plunge 79% when trading resumed on 28 August after being halted since March 2022. As of June, Evergrande had more than $326 billion in total liabilities, $19 billion of which was offshore debt. The company is working with creditors in what is likely one of the world’s biggest debt restructurings and formally filed for Chapter 15 bankruptcy in New York as part of a workout of the offshore debt.

The tide began to wash out in 2020 when China instituted its Three Red Lines policy to help measure and mitigate overleverage by setting out specific criteria around debt ratios. Evergrande failed to meet the three criteria, revealing its full debt burden. Many other major developers were also in violation, triggering the government to restrict their borrowing and spooking investors and consumers. As a result, access to financing via US dollar bonds dried up and pre-sales sunk.

Developers often depend on funding existing projects via pre-sales, where buyers pay for homes upfront before a project is completed. As fears of the companies’ insolvency spread, demand for pre-sales dropped, widening a funding gap that collided with restricted borrowing power. Many projects stalled, new projects were not initiated, and the ripple effect has spread to subcontractors and related businesses. Revenue has remained weak with new home sales for the top 100 developers falling by a third in June and July from the year prior.

Prior to the current downturn, residential development in China had boomed for several decades, leading to significant oversupply in certain markets and even ghost cities. The frenzy spurred developers to take on unsustainable amounts of debt and gave false confidence to homebuyers who poured their savings into home purchases up front thinking home prices would perpetually increase. It is estimated that 60-70% of China’s household wealth is concentrated in housing, reinforcing the potential ramifications of problems in the sector to the wider economy.

Second- and third-tier cities have seen sales fall the most, while first-tier cities have remained relatively resilient, though many experts question the accuracy of certain sales data. Country Garden and the other developers under scrutiny have had outsized exposure to these markets. Close to 61% of Country Garden’s developments are in lower-tiered cities. COVID-19 lockdowns exacerbated wider economic woes and stalled construction, further exacerbating the slowdown.

In July, Chinese leaders promised to “adjust and optimize policies in a timely manner”, but have not yet made sweeping changes. Beijing and Shanghai however announced that they would provide better mortgage rates for first-time buyers, despite their credit records, and reduce down-payment requirements. These measures follow those from Shenzhen and Guangzhou to ease policies in the hope of spurring both the housing market and general spending.

Investors remain uncertain as to whether the government will ultimately prop up the struggling developers, and a distinction between the health of state-owned developers and their non-state-owned counterparts has become starker. State-owned developers saw contracted sales grow 48% in the first seven months of the year, compared to non-state-owned companies, who saw contracted sales fall by 19%. State-owned developers can more easily acquire land now given their stronger cashflows. Eighty-seven per cent of current land purchases are by state-owned firms, which could potentially lead them to dominate the market and force out weaker entities.

While many experts have cited fears of contagion, the downturn seems fairly contained to the property sector and the domestic economy. But a downturn in the world’s second largest economy is still a significant factor for the global economy. Barclays, Citigroup and UBS all recently downgraded growth projections for China, and the MSCI China Index officially entered bear market territory, underscoring these domestic concerns. Annualized growth for China’s economy was just 3.2% in the second quarter, compared to estimates of close to 6% for the US economy. Spreads on Chinese company bonds outside of the property sector have been stable, and companies like Alibaba and Baidu have bonds with yields close to US corporate bonds, reflecting broader confidence from investors.

While fears over the impact on international financial institutions have been quelled, with real estate making up approximately 30% of China’s GDP (its single largest contributor), the world will be waiting eagerly for the industry to find more equilibrium.