China Real Estate Market: Explained: Why China’s crumbling real estate sector has the world on edge

Home buyers in China are running out of patience now that the country’s real estate crisis is getting out of hand. Hundreds of thousands of home buyers have launched a “mortgage boycott” refusing to pay their mortgages for unfinished or stalled housing projects.

On July 18, home buyers in 80 cities and 200 projects threatened to cut mortgage payments.

Total mortgages amid stalled Chinese developments, according to analysts at GF Securities Co. and Deutsche Bank AG 2 trillion yuan (296 billion dollars).

Home sales are down nearly 60% from a year ago, and the current 11-month steady decline in sales is seen as the worst in China’s history.

Analysts expect real estate sales to fall 25% from January to June amid China’s “Zero Covid Cases” strategy. Numerous developments in China have been halted as project developers run out of capital to complete construction.

All over China, real estate developers are getting desperate – they are trying to sell houses in every possible way, going as far as accepting down payments in wheat, garlic, watermelons and peaches to serve the farmers.

House of cards

What started as problems with the Evergrande Group is snowballing into a crisis that risks engulfing some of the largest developers in the country, its lenders and a middle class that has attached significant wealth to the real estate market.

About 70% of the country’s family wealth is stored in real estate, along with 30-40% of bank loans, 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 accounted for 29% of the country’s GDP – about $4 trillion out of $14 trillion.

Evergrande is not the only group in trouble. Several debt-laden developers such as Fantasia Holdings, Sinic Holdings Group and Modern Land have defaulted or are heading for default. Also at Sunac, China’s third-largest developer, credit ratings have been slashed amid concerns over debt repayment.

Three red lines

In August 2020, in an effort to better manage the heavily indebted sector, Chinese regulators introduced rules called the “three red lines” to limit lending from real estate companies. The three red lines developers maintain:

  • A debt-to-asset ratio of 70% or lower,
  • A limit of 100% on net debt to equity,
  • Enough cash on hand to meet short-term loans, debts and obligations.

Each crossed red line reduced a company’s ability to take on additional debt. If all three lines are crossed, a company can no longer incur debt.

However, a Reuters report found that companies used various tactics to keep debt and projects off-balance, or debt disguised as equity, to comply with the “three red lines” policy.

By the end of 2020, China’s national debt stood at $4 trillion. Goldman Sachs estimates “hidden” or “shadow” debt at a staggering $8 trillion, more than half of the country’s GDP.

Global Precipitation

A collapsing real estate market in China has set alarm bells ringing worldwide. It is still the manufacturing center of the world and if the economy falters, countries around the world would suffer from slower and more expensive exports.

Contract electronics and semiconductor manufacturing, where China is a global leader, had already brought several sectors to a standstill such as automotive, consumer electronics and more due to Covid-induced supply bottlenecks. This would only increase in an economic crisis.

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

The Xi government has sponsored numerous projects under the Belt and Road Initiative. Currently, B&RI projects are valued at over $1 trillion in 139 countries around the world. These construction sites, highways, power plants and so on can be left unfinished.

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