The long booming and now starving real estate market in China is growing into a crisis. The construction companies lack money to continue construction, while buyers are waiting for their apartments. But the bursting of the real estate bubble has come at the worst possible time for President Xi Jingping, too.
The 120-kilometer train journey between the cities of Luoyang and Zhengzhou is a prime example of economic malaise and broken dreams. During the one-hour drive, new, half-finished residential towers keep passing in front of the windows. A number of buildings appear to be almost complete; others are already used as family homes. Work on many other unfinished skeleton structures has long since stopped. The real estate companies lack the money for wages and procurement of materials; Construction projects come to a standstill and families get nothing.
A train journey through the heart of the Chinese countryside highlights arguably the biggest crisis the country has seen in recent memory: the public’s dwindling confidence in the economic model being pursued by the government. For decades, the real estate sector has stood as a symbol of China’s unstoppable growth. Private entrepreneurs made huge profits. The average person’s equity has skyrocketed as real estate values have tripled. Local governments filled their coffers by selling huge plots of land to construction companies. An unbelievable 70 percent of Chinese private wealth is now invested in real estate.
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Anyone who questions their trust in the system shakes the foundations of the Chinese economic miracle. A loss of trust on many fronts can also be observed in the course of the extensive corona lockdowns and strict regulations for private companies. Nowhere, however, is it more apparent than in the real estate sector, which accounts for an estimated 25 percent of gross domestic product.
New construction projects fell 45 percent year-on-year in July, home sales fell 33 percent and real estate investment fell 12 percent. The entire economy is affected by the consequences – from furniture manufacturers to steel workers. For China’s head of state Xi Jinping, who is expected to announce his third term at the party conference in October, the loss of confidence comes at a critical time.
The key for Xi and the Communist Party is to restore confidence in the system. So far, the government has been uncharacteristically haphazard and slow – it seems that the complex issue is overwhelming those responsible. In order to instill more confidence in the housing market, the public needs to see the completion of disused developments and a rise in prices.
The construction companies and their workers also need to be compensated, while the domestic and foreign investors need repayment of the fixed-income products. When all of these measures are implemented, the already unsustainable debt bubble on the real estate market must not continue to grow.
Two main causes are responsible for the housing crisis. The first is the government’s crackdown on excesses in the real estate industry. Under a rule known as the “three red lines,” authorities have imposed limits on contractors’ liability-to-asset, net-debt-to-equity, and cash-to-current-liability ratios since August 2020. This has forced many firms to stop raising new loans and divest assets, restricting the construction and sale of new projects.
China’s zero-Covid policy is another cause. The Chinese central government has forced dozens of cities to implement house arrests for days to weeks on confirmed cases of Covid. At the time of reporting, the megacities of Chengdu and Shenzhen are completely or partially sealed off. There were no viewings or property purchases due to the lockdowns.
The restrictions have also made themselves felt in consumer behavior. Some entrepreneurs fear sudden business closures. Workers fear layoffs. This is not conducive to buying a property.
The result is a bottleneck. China’s construction companies rely heavily on the sale of real estate long before it is built to ensure liquidity. Last year, 90 percent of residential properties were sold in advance. Now that access to bonds and credit is lacking – banks have reduced their exposure to the real estate sector – and new sales are declining, a real Ponzi scheme is emerging in the real estate market.
The world’s most indebted construction company, Evergrande, defaulted on its payments in December. The restructuring of its offshore debt, intended as a model solution, missed the end of July deadline. At least 28 other real estate companies have defaulted on repayments to investors or are in the process of restructuring.
According to research firm Gavekal, 30 Hong Kong-listed construction companies, which account for 10 percent of the market by revenue, have had their trading frozen. By early August, half of China’s listed real estate companies were trading at a price-to-earnings ratio of less than 0.5 – the level of Evergrande four months before it defaulted, according to Song Houze of MacroPolo, a Chicago-based think tank.
Companies that thought they were safe just a few months ago are now struggling. One example is China’s top-selling real estate group, Country Garden. At the beginning of the year, most analysts rejected concerns about the company’s difficulties. Bond buying continued. On Aug. 30, Country Garden reported a nearly 100 percent drop in profits for the first half of the year.
The real estate markets had “rapidly slipped into a severe depression,” it said in the balance sheet. The tense situation at Country Garden shows that the problems no longer only affect individual providers, but are now endangering the entire industry.
Potential customers have left the real estate market. However, the situation is much more serious for millions of people, who often have to wait years for the property they have already bought. Only 60% of the residential properties pre-sold between 2013 and 2020 have been handed over so far.
Mr. Liu, who wishes to be known by his family name, bought an apartment in Zhengzhou in 2014 with a down payment of 250,000 yuan. The house should be finished in 2017. However, that day never came. Instead, he rented an apartment before finally buying another apartment in an old building without a lift. This was not how he had imagined his life to be. Liu never started paying off his mortgage and has been in endless discussions with the real estate company to get the deposit back. “It’s pointless,” he says.
Analysts have known about these issues for years but believed the Chinese government would not allow affected buyers to protest. A report by accounting firm PwC, released two years ago, found that even when housing projects stall, “hundreds or thousands of disjointed households typically have little leverage.”
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This calculation is now upside down. A small but influential movement is collecting and publishing information about mortgage refusals – an unexpected development for the authorities. On July 12, anonymous volunteers began sharing data about mortgage boycotts on social media. About 350 of them have been identified so far; Analysts assume that the number of unreported cases is much higher. State censorship has done its best to remove references to the sensitive information, but knowledge of the protests appears to be spreading. Others are also tricked into postponing purchases or suspending mortgage payments.
Investors and potential homebuyers are currently watching with unease how the state is reacting at both central and local levels. For more than a decade, Chinese cities have had a plethora of rules and incentives regulating local real estate markets. These usually served to curb speculation and slow down the rapid rise in prices. These included, for example, control over the granting of mortgages or regulations on who is entitled to buy how much property.
In the meantime, the cities have relaxed their rules. As reported by the Chinese investment bank CICC, the city governments announced 304 individual measures to restore confidence between May and July. Zhengzhou, the focus of the mortgage boycott, set a good example. In March, the city announced 18 measures to boost demand. It was u. a. about facilitating access to mortgages and allowing families with older members to buy housing in the city.
These purchase incentives have attracted a lot of attention – not because they have stimulated demand, but because they appear to go against central government policy. In a video circulating on China’s social media in August, a local Communist Party official in Hunan province called on people to buy as much property as possible: “Have you bought a third property yet? Then buy a fourth.” The message contradicts Xi’s own statement, which emphasized “Houses are for living in” and not for speculation.
Regulators and officials have encouraged local governments to set up bailout funds to invest in uncompleted housing projects to help frustrated buyers find housing. The city of Zhengzhou has allocated 80 billion yuan (about 12 billion euros) for this purpose. It is believed that local funds are better adapted to local circumstances.
Possibly the most offensive local agenda is currently being tested in Zhengzhou. A city government directive states that all stalled construction projects must resume by October 6. Insolvent companies that are unable to do so must submit a restructuring application for new investments. These should also be used to reimburse real estate buyers like Liu for the advance payments they have made. If this does not happen, the developers face investigations into embezzlement and other serious crimes.
For their part, the responsible politicians have repeatedly lowered mortgage interest rates since mid-May. In order to maintain the housing supply, the central government has started to fully guarantee the new issues of some private developers, thereby shifting the risk to the state. Troubled real estate firm Longfor issued a 1.5 billion yuan bond issue on Aug. 26 at an interest rate of 3.3 percent, well below market prices.
This was only possible because the bond was fully secured by the state organization China Bond Insurance. More issuance of this type is planned to support those construction companies that the government deems to be of higher quality. A project to select winners has started.
Further government support comes in the form of direct liquidity. The Central Bank and Ministry of Finance announced on August 22 that they will provide special loans through state-owned banks for the completion of properties that have already been sold. The scope of the program is being kept quiet, but according to the Bloomberg news agency, 200 billion yuan is available.
Public spending of this kind is a double-edged sword. On the one hand, they help to get mortgage payments going again by handing over properties to their rightful owners, thus taking the pressure off the banks.
At the same time, however, the money also plugs financial gaps that have arisen as a result of poor local government and dubious real estate companies. “This is simply money that cannot be spent on other incentives,” said Alex Wolf of US bank JPMorgan Chase.
Zhengzhou City’s efforts to attract new customers since March have failed. On the contrary, conditions have continued to deteriorate, suggesting that changing local politics alone is not enough. The local bailout funds also seem flimsy. Although several cities have lavish budgets on paper, they are dependent on the municipal financing companies, which are short of funds themselves.
The city of Zhengzhou’s attempt to resume all construction projects in just one month is being closely watched by analysts. For the most part, however, the question arises as to whether the necessary funds are available at all for such a short-term solution. The deal risks triggering a wave of bankruptcies among smaller builders, creating panic and financial turmoil.
Investors’ hopes for the central government are growing, but so far their measures have not matched the magnitude of the crisis. The 200 billion yuan loan scheme is expected to cover just 10 percent of the needs needed to complete all of the country’s unfinished properties. About $5 trillion in residential properties have been presold since 2020, MacroPolo’s Song estimates, making even a fraction of those properties expensive to save.
The central government still has a number of options for action. Investment bank Macquarie’s Larry Hu notes that several measures are within the realm of possibility. These include a temporary easing of the “three red lines” or a pledge to act as lender of last resort for all standstill housing projects. The latter option may be expensive, but it is well within the financial capacity of the state.
The focus of the debate is no longer how far the central government can restore its confidence, but how far it is willing to go. The aim of the original action against lending was to punish highly indebted companies. A larger bailout will now encourage more builders to apply for additional assistance to complete homes. This would in turn prompt the government to further subsidize the real estate sector, writes Allen Feng of the US research institute Rhodium: “the complete opposite of the intentions of the ‘three red lines'”.
With the anti-debt campaign, the real estate sector should also be adapted more closely to demand in the next decade. Officials have long acknowledged excessive property trading by construction companies. About 70 percent of the properties sold since 2018 have been purchased by people who already own a home, according to JPMorgan estimates. The debt brake, on the other hand, was intended to induce companies to adapt to actual demand.
With China’s population slowing, this demand is likely to decrease. Residential property sales reached 1.57 billion square meters in 2021, more than double the 2007 figure. However, Chen Long of the Plenum Research Institute expects the actual annual demand to increase in the next ten consecutive years of the demographic change and the slowdown in urbanization will fall to 0.88 to 1.36 billion square meters. Restarting the market means supporting the bubble.
The state tightrope act is fraught with risks. In mid-October, the party congress will take place while the big cities are in lockdown. The mortgage boycott will continue and possibly expand. Public confidence in China’s economic fundamentals may already be so shaken that it will be difficult to recover. These are not the best starting conditions for Xi’s third term.
The article first appeared in The Economist under the title “China’s ponzi-like property market is eroding faith in the state” and was translated by Cornelia Zink.
The article “The ‘Ponzi Scheme’ is emerging in China’s real estate market” comes from The Economist.
