A significant downturn in the real estate sector in China
Understanding the risks associated with the Chinese economy has become paramount for investors, businesses, governments, and other stakeholders. China's rise as a global economic powerhouse that impacts international markets in every sector and industry, necessitates comprehensive ongoing risk assessment. Conducting accurate economic ‘risk assessments’ on China is notoriously challenging however due to difficulties in obtaining reliable data, vested and politicised viewpoints, and the inherent complexities of the Chinese political economy.
This series of George James Consulting (GJC) articles touches on a range of current and emerging risks to the Chinese economy that are worth watching through 2023 and beyond. It is recommended that this be used for informational purposes and that further research be undertaken as required on specific risk topics. The number of the topic # is not necessarily indicative of the likelihood or impact of the risk discussed.
#1 – A significant downturn in the real estate sector in China
The real estate sector in China has experienced a period of rapid growth over the last twenty years fueled by significant volumes of speculative investment. Millions of Chinese citizens have invested heavily in real estate as their primary source of household wealth. This arguably peaked around 2017 leaving major cities such as Beijing, Shanghai, Shenzhen, and Guangzhou with astronomical property prices.
In 2017, and in response to the clear risks emerging in the real estate market, the Chinese government implemented a number of measures to cool the market. This included purchase restrictions, increased down payment requirements, and tighter lending practices. By early 2019, there were initial signs of slowing demand for property in China. This occurred against the backdrop of a general economic slowdown across China.
The COVID-19 pandemic then emerged in 2020 resulting in the temporary halt in property transactions and construction activities across China. Real estate valuations began dropping and reporting surfaced about over leveraged Chinese households. It seemed evident that the Chinese real estate market had become overinflated and was slipping towards a bust cycle.
According to the Nomura Group, as of June 2021, the Chinese property development sector had accumulated RMB 33.5 trillion (US$5.2 trillion) in debt. A significant milestone was news that Evergrande Group, one of China's largest property developers, was at risk of defaulting on its $300 billion of liabilities. The Evergrande case attracted considerable media attention and sparked fears of wider contagion in the Chinese real estate market and Chinese economy.
Other companies such as Sinic, E-House, Kaisa Group, Central China Real Estate, Xinyuan, Shimao, R & F Properties, China Vanke were also found to be alarmingly exposed and subsequently lost between 30 – 90% of their share value. Other cases such the Fantasia Holdings Group highlighted the existence of large private bond markets in China circumnavigating regulation.
In 2022, the Chinese government reiterated its ongoing concerns with the sector and the need for further support and regulation. This included the People's Bank of China (PBOC) and the China Banking and Insurance Regulatory Commission’s (CBIRC) notice to support failing property companies and strengthened borrowing requirements to reduce excessive debt and speculation. Despite these efforts to rescue the sector and achieve a ‘soft landing’, there appears to be increasing recognition within the Chinese government of the inevitably of defaults and consequently the need to ‘manage the risks’ rather than achieve ‘stability’.
It is anticipated that the Chinese government will revisit the issue in 2023 and introduce more support packages for the Chinese real estate industry. That said, it also seems likely that there will be a greater level of tolerance for the failure of some real estate developers. In real terms may mean the complete collapse of some developers in the broader attempt to create a more sustainable Chinese real estate sector going forward.
What to watch in 2023:
How companies such as China Evergrande Group, Country Garden Holdings, and Sunac China Holdings manage their debt and if they default;
The Chinese government response at the city, State, and central government levels. The extent intervention is undertaken and the unintended consequences that emerge;
The underlying quality and safety of property developments to emerge as a concern with marginally viable developers taking short cuts as they are left out of government support packages (and indebted householders still acquiring these assets despite risks);
Social unrest occurring in China relating to real estate issues. This could include young Chinese workers who cannot afford houses, elderly individuals and families who have lost wealth through speculative real estate investment, corruption by local government becoming exposed, quality and safety issues in developments, and the exclusion of particular demographics from the real estate market (i.e. age, rural migrants);
The impact of a significant downturn of the domestic Chinese real estate market on Chinese investment holdings internationally and whether this generates capital flight inwards or outwards.
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In late January 2024, A Hong Kong court directed the liquidation of property developer China Evergrande Group. Justice Linda Chan decided to liquidate the developer who have accumulated over $300 billion of total liabilities. Chan noted that Evergrande had been unable to provide a credible restructuring plan more than two years after defaulting on its offshore debt.