How to tell if China’s property crackdown has peaked
China’s real estate sector grew rapidly as the country’s economy became more market-oriented, in part because the emerging middle class saw buying a home as one of the few safe investments available. House prices have soared, fueling speculation and increased demand. The authorities have encouraged development, which has helped to achieve the country’s ambitious gross domestic product targets. Debt piled up as Chinese automakers continued to refinance. For years, China has tried to defuse the growing debt bombshell, fearing it could trigger a disastrous financial collapse. In 2020, it tightened funding rules for private developers in a bid to reduce reckless borrowing. But many developers don’t have enough free cash to cover their debts. Soon, a liquidity crunch at one of the largest groups, China Evergrande Group, led to defaults and fears of contagion that rippled through the entire industry and the wider economy.
2. What is the government doing?
The government’s efforts suggest that state-owned companies will dominate the market and that the days of heady debt-fueled expansion by private developers are over. A key solution to the liquidity problems of private developers, for example, is the acquisition of assets by larger public companies. Agile Group Holdings Ltd. and Shimao Group Holdings Ltd. both announced this year the sale of stakes in companies to public companies to raise funds. Broadening the influence of the state would bring greater stability and limit the risk of financial fallout. At the same time, China has sought to rein in steadily rising prices as part of President Xi Jinping’s “common prosperity” campaign to address the country’s persistent wealth gap. The idea of imposing a nationwide property tax was revived to deter speculators and plans were announced to build millions of low-cost rental units by 2025 as it sought sustainable alternatives to the collapse of the real estate market.
Why could China be serious about a property tax now?
3. Are there other ways to raise funds?
China plans to issue nationwide guidelines to make it easier to extract money from escrow accounts from door-to-door presales, Chinese media including the 21st Century Business Herald and Securities Daily reported in February. The developers could use some of this revenue after setting aside the required amount for the construction of the project, according to reports. The standardized regulations would replace legions of local rules, some of which are considered too restrictive. This could significantly increase liquidity at a time when developers are collapsing under funding pressure.
4. Why might this be a game changer?
Facilitating access to stranded cash would free up a significant amount of capital that developers could use to service their debts. Homebuyer presale proceeds are the largest source of cash for real estate companies, accounting for about 37% of their funding. Restrictions on these funds mean that cash from project-level sales cannot be transferred to other parts of its business, and implementation of these rules is stricter in some cities. Limited access to this funding channel has already played a key role in the debt crises at Fantasia Holdings Group Co. and Kaisa Group Holdings Ltd., which subsequently defaulted on their bonds.
5. What about monetary policy?
China’s central bank already cut three of its key rates in January, although at 10 basis points the cuts were small. Banks also lowered the five-year prime lending rate that serves as the basis for mortgages. This cut was even narrower at just 5 basis points, disappointing investors at the time. Most analysts and economists agree that further monetary easing is needed, especially if falling house prices weigh on already fragile consumer sentiment. Property comprises up to 40% of household assets by some estimates.
6. How do I know if it works?
• China’s property sales slump deepened in February, with the 100 largest companies in China’s debt-ridden real estate sector posting a 47% drop in sales from a year earlier. Proceeds from home sales, including pre-sales, typically account for more than half of developer cash inflows, according to calculations based on official data. Long-term household loans, a key indicator of mortgage lending, rose by the slowest amount since February 2020.
• The offshore market remains largely closed, with the yield on Chinese junk bonds being prohibitive at 19%. Only one of China’s top 20 developers by sales, Greentown China Holdings Ltd., sold a dollar bond in January, down from at least seven in the previous period last year, according to data compiled by Bloomberg. Dollar ticket sales in the second half of 2021 fell 49% to $14.7 billion from a year earlier as concerns about contagion from Evergrande erupted.
Why Chinese Developers Have So Much Dollar Debt: QuickTake
• The onshore market does not present a much better image for private developers. Last year, sales of local bonds by these firms fell 39% to 190 billion yuan ($29.9 billion). The situation is very different for public promoters. They sold 315 billion yuan of local bonds, up 12% from a year earlier, to outpace their private counterparts for the first time in seven years.
• In December, the authorities eased the borrowing limits of large real estate companies used to finance mergers and acquisitions, which could facilitate the acquisition by state companies of assets sold by weaker developers. Regional lender Shanghai Pudong Development Bank Co. sold a bond to help fund loans for mergers and acquisitions in the sector, and at least three other banks and three developers have planned or sold similar bonds this year.
What China’s Three Red Lines Mean for Real Estate Businesses: QuickTake
• Real estate companies have $40 billion in local and offshore debt maturing in the first half. But concerns have grown over the transparency of some struggling developers. Evergrande, Agile, Kaisa Group Holdings Ltd. and Fantasia Holdings Group were found to have opaque liabilities that may or may not be reflected in their balance sheets, making it difficult to assess true credit risks. Guangzhou R&F Properties Co. was downgraded to restricted default by Fitch Ratings in January after completing what Fitch considered a distressed debt swap.
Why hidden debt is a big problem for Chinese developers: QuickTake
• More and more promoters are turning to the stock market as an alternative channel to raise funds this year, but the result usually triggers a sell-off. Developer valuations remain low in the equity market, trading at less than 0.3 times book value and around 2.3 times earnings on average. Since new shares are usually sold at a discount to the market, low multiples mean that developers would have to sell a lot of new shares to raise a significant amount of money.
• While bank loans remain available to some developers, lenders have become much more selective in trying to limit their exposure to the real estate sector. Their preference for public borrowers makes it difficult for weaker private developers to access lines of credit.
• The shadow banking sector, including the $3 trillion fiduciary industry, had offered an alternative to lenders that banks avoided. But it has declined in recent years amid government efforts to reduce hidden debt. Net financing of the real estate sector by trusts was negative 236.9 billion yuan last year, according to a report by CICC. Moody’s expects outflows to continue this year as authorities maintain tight regulatory oversight.
A Guide to China’s $10 Trillion Shadow Banking Maze: QuickTake
• More QuickTake explanations of why China’s defaults are more alarming, why developers have so much dollar debt, and what the three red lines are.
• Bloomberg’s Matthew Brooker Opinion on Chinese bulls’ torturous wait for policy easing
• A Bloomberg FFM examines Evergrande and other developers testing the limits