The real estate sector and the economic slowdown in China (I)
Jorge Costa Oliveira
Although China’s gross domestic profit (GDP) growth reached 8.1% in 2021, in the second half of the year, China’s GDP grew by only 4.9% in the third quarter and 3.9% in the fourth quarter. For 2022, the International Monetary Fund has revised China’s GDP growth downward to 4.4%. There are several reasons for this economic slowdown, mainly measures related to the real estate sector. According to a 2020 World Bank report, the share of housing-related activities in both fixed assets investment and GDP in China today greatly exceeds levels in the US at the height of its real estate boom in 2006.
Real estate accounts for 30% of the country’s GDP. Housing prices in urban China have tripled over the past 20 years, with the ratio of house prices to annual income hovering around 43.15 in Shenzhen, 42.47 in Beijing and 33.36 in Shanghai, compared to 13.37 in London and 8.76 in New York. Speculation is also relevant here, mainly because alternatives for investing the savings of families and companies — in the financial markets and banking system — have always offered very low rates of return. This is why, at the 19th National Congress of the Communist Party of China, Chinese President Xi Jinping said that “houses are for living in, not for speculation.”
In order to stabilize housing prices, force real estate developers to reduce bank debt and reduce commercial banks’ exposure to the sector, the Chinese government introduced three important measures in late 2020. The first was the imposition of “three red lines” for real estate developers: some large developers cannot have a debt-to-asset ratio of more than 70%, a net debt-to-equity ratio of more than 100% or a cash-to-short-term-debt ratio of ≥ 1. Regulators will impose tighter debt limits on developers that cross these red lines.
China has also introduced new limits on banks’ exposure to real estate. For large state-owned commercial banks, real estate loans cannot exceed 40% of the total, and mortgage loans are limited to 32.5%. Ultimately, China has revised the way in which local governments can dispose of real estate rights. As a result, the cumulative growth rate of real estate financing dropped from 54.2% in January 2021 to 4.2% in December of the same year. Over the same period, the cumulative growth rate of total home sales dropped from 133.4% to 4.8% in terms of square feet and from 104.9% to 1.9% in terms of value.
As a result, China’s cumulative real estate development investment growth rate fell from 38.3% to 4.4%. Highlighting the relevance of real estate investment, China’s total 2021 investment growth fell from 35% in January to 4.9% in December. To offset this fall, infrastructure investment could have been increased, but it grew by a mere 0.4% in 2021. The Chinese government still has leeway to adopt fiscal and monetary policies to stimulate growth. It hesitated to do so when there was no inflation, and now it be more difficult.
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