The real estate sector and the economic slowdown in China (II)
Jorge Costa Oliveira
Rising real estate prices and underlying speculation, leveraged in bank financing and intertwined with land allocated by local governments, have driven the real estate sector into an unsustainable situation. This has forced the Chinese government to take measures to prevent an implosion and inevitable spillover into the banking sector. These measures caused a significant slowdown in the growth of the real estate sector, which has in turn led to a slowdown of the Chinese economy in the second half of 2021 and early this year. Supply in the real estate sector, which had already shrunk by 2.9% in Q4 2021, shrank again by 2% in Q1 2022.
The enforcement of the “three red lines” for real estate developers has posed complex challenges for some of the major real estate developers such as Evergrande, which has an estimated total debt of over $300 billion and has defaulted on bond payments.
The same is true for several other major real estate developers. According to the Financial Times, by October 2021, about half of China’s 30 largest property developers violated at least one of the “three red lines.” At the end of the third quarter of 2021, the Global Times reported that the number of bond defaults by real estate developers in 2021 stood at 39, which is an increase of 25 from 2020. These defaults have amounted to a cumulative value of $7.2 billion, which is an increase of 159% year-on-year.
Some analysts’ outlook for real estate in 2022 indicates a 14% drop in demand for real estate in the first half of the year and a 7.5% decrease in annual sales. According to Moody’s Investors Service, the value of property sales in China will fall by 2022, but the decline will gradually taper off during the year. However, on May 16th Reuters, using data from the National Bureau of Statistics, reported that new home sales were down 46.6% in April from a year earlier, while prices in 70 cities fell for the eighth consecutive month. As of March 25th, developers in 2022 had issued only $5.2 billion and $1.8 billion worth of bonds in the onshore and offshore markets respectively. This is a reduction from the $9.7 billion and $14.6 billion worth of bonds issued over the same period in 2021.
Moreover, as one-third of the credit provided by large Chinese banks is for real estate, many of these developers face significant exposure to default.
Some analysts believe that large developers will always find ways to raise funds. This includes by lowering property selling prices, dispersing or increasing share capital, selling non-core areas of the group or putting them on the Hong Kong stock exchange, and issuing [more] offshore bonds. Others believe that, given the size and relevance of these large real estate developers to the Chinese economy, the Chinese government will never allow them to go bankrupt. But if the Chinese government chooses to make an example of some of these developers, the consequences for the Chinese – and global – economy will be tremendous.
It seems clear that, as a result of the measures imposed by the Chinese government on a restructuring property sector, along with adjustments in prices and supply volumes, the slowdown in China’s economic growth will continue.
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