Consider this thorny situation: You’re in a long-term relationship. It was great for a while, but your goals have changed. Do you have a respectful breakup, or just ghost your partner? This is the dilemma Beijing is facing with overseas investors worried that they will lose their shirts if China lets its troubled real estate developers unravel too quickly.
Beijing has good reasons to rein in the country’s property giants. They have accrued so much debt over the course of their breakneck expansion — $2.5 trillion among the top 50 or so listed companies — that even the Federal Reserve warned this week further fragility there could spread to the US Years of frenzied construction has resulted in a huge oversupply of apartment blocks, scattering effective ghost towns across China as demand for new housing has waned.
But developers also have served an important social purpose. In 1998, when China launched a program to encourage private home ownership, there was a severe shortage of apartments in urban areas, and what was available was often shabby. The government provided incentives, and the developers swooped in. At one point, China was adding about 15 housing units per 1,000 people, three times as many as in the US or Japan.
The construction boom helped fuel China’s rapid urbanization. By 2020, 64% of the population lived in cities, compared with only 36% in 2000.
With consent from the government, the likes of property giant China Evergrande Group fed the residential building boom through pre-sales, where buyers pay the full price of a home upfront, long before it has been completed. The practice allowed developers to expand at a faster pace than they otherwise could have. The most aggressive developers adopted a so-called “3691” model, vowing to break ground on new developments in three months, start pre-sales in six months, finish construction in nine months and return money to their investors in a year.
But the business model also sowed financial instability, as developers launched projects a lot faster than they could complete them. Evergrande has 1.6 million unfinished, pre-paid homes in its portfolio that it still needs to find money for to build and deliver. Meanwhile, with China’s birthrate hovering near a historic low, there is less need to bring new apartments to market every year. Over the next five years, only 6.9 million new households will be created each year, down significantly from eight million in the 2010s, estimates Goldman Sachs Group.
Those changing demographics mean that even if the real estate sector hadn’t run into trouble, residential property development would have gradually become a smaller share of the economy. But Beijing seems in a hurry to move on. With more than 400 measures this year aimed at restricting homebuilding, from tighter lending controls to curbs on pre-sales, developers that could have lasted a few more years are on the brink of collapse. The big question now is how China will deal with investors who loaned developers tens of billions of dollars and risk not being repaid.
The developers’ plight has drawn international attention in part because offshore investors make up the bulk of their bondholders. For instance, with about $12 billion dollar bonds outstanding, Shenzhen-based Kaisa Group Holdings Ltd. is the second-largest high-yield issuer after Evergrande. Domestic bank loans, by comparison, account for only 27% on the books. Investors are clearly pricing in a default: Kaisa’s $400 million note due this December is now trading at only 43 cents on the dollar.
Beijing would probably be very happy to have fewer real estate behemoths, and in particular to shrink Chinese banks’ exposure to the volatile sector. But what’s the impression that sends to the world? The next time China seeks funding to build up other capital-intensive businesses — think chip manufacturing, or electric vehicle parts — will global investors dare to venture in?
All companies risk failure, and China’s property sector badly overreached. But that isn’t a reason for Beijing to pressure companies out of existence, leaving investors holding the bag.
Bloomberg
