Explainer: Why China's crumbling real estate sector is putting the world on edge

Explainer: Why China’s crumbling real estate sector is putting the world on edge

Homebuyers in China have run out of patience as the country’s real estate crisis threatens to spiral out of control. Hundreds of thousands of homebuyers have started a “mortgage boycott”, refusing to pay their mortgage for unfinished or stalled housing projects.

As of July 18, homebuyers in 80 cities and 200 projects have threatened to halt mortgage payments.

Mortgages on stalled Chinese projects total 2 trillion yuan ($296 billion), according to analysts at GF Securities Co and Deutsche Bank AG.

Home sales have collapsed nearly 60% compared to last year, and the current continuous drop in sales (11 months) is the worst in China’s history.

Analysts expect property sales to fall 25% in the January-June period, amid China’s “Zero Covid Cases” strategy. Many developments in China have stalled as property developers ran out of capital to finish construction.

Across China, real estate developers are getting desperate – trying to sell homes by any means possible, even going so far as to accept down payments in wheat, garlic, melons and peaches to meet farmers’ needs.

paper house

What started as a problem with the Evergrande Group is the crisis worsening into a crisis that threatens to engulf some of the country’s largest developers, lenders and the middle class with significant wealth tied to the real estate market.

About 70% of the nation’s household wealth is stored in property, along with 30-40% of bank loan books, while land sales account for 30-40% of local government revenue, according to Pantheon Macroeconomics.

A working paper published by the National Bureau of Economic Research in 2020 estimated that China’s real estate sector accounts for 29% of the country’s GDP – about $4 trillion out of $14 trillion.

Evergrande isn’t the only group in trouble. Many debt-laden developers such as Fantasia Holdings, Sinic Holdings Group and Modern Land have defaulted or are heading towards default. Sunac, China’s third-largest real estate developer, has also sharply downgraded its credit ratings, as debt repayment concerns surfaced.

Three red lines

In August 2020, in an effort to significantly improve the management of the leveraged sector, Chinese regulators introduced rules dubbed the “three red lines” to limit the borrowing of real estate firms. The three red lines require that developers maintain the following:

  • Debt to assets ratio of 70% or less,
  • At a 100% cap on net debt to equity,
  • Enough cash on hand to meet short-term borrowing, debts and liabilities.

Each red cross line reduced the company’s ability to take on additional debt. If all three lines are crossed, the company will not be able to take on debt.

However, a Reuters report revealed that companies were using various methods to take off-balance sheet debt and projects, or debt disguised as equity, to comply with the “three red line” policy.

By the end of 2020, China’s local government debt has reached $4 trillion. Goldman Sachs estimates that “hidden” or “shadow” debt is $8 trillion, more than half of the country’s GDP.

global repercussions

The collapse of the real estate market in China has raised alarm bells around the world. It is still the manufacturing center of the world, and if its economy falters, countries around the world will suffer from slower and more expensive exports.

Contract electronics and semiconductor manufacturing, where China is the world leader, has already halted various sectors such as automobiles, consumer electronics and more due to supply bottlenecks caused by the Covid virus. This would rise further in an economic crisis.

China is also the global creditor of the developing world. Developing countries that depend on China for infrastructure projects will be hit hard.

Xi’s government has sponsored many projects under the Belt and Road Initiative. Currently, B&RI projects are valued at more than $1 trillion in 139 countries around the world. Construction sites, highways, power plants, etc. can be left unfinished.

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