Inside the collapse of China property giants and its far-reaching economic impact

In the heart of China's urban landscape, a nuanced story unfolds with the dawn. Amidst the vibrant cityscape, a sombre reality looms—a deepening property market crisis casts a shadow over the nation's economic vitality.

From abandoned malls to sparsely occupied buildings and desolate construction sites, the scene paints a poignant picture of the challenges gripping China's economic landscape.

What’s wrong with China’s real estate sector?

Vanke, China’s largest property developer, has managed to survive the property downturn till now, but escaping the long-term real estate crisis seems questionable. While the stock has slumped over 35% so far this year, global credit rating agency S&P Global Ratings slashed the company’s rating by three notches in April. This was followed by Moody’s Ratings downgrading the stock. Vanke responded to this move by stating that it could 'mislead the market and exacerbate unnecessary panic’.

“The next step for the company is repaying a $600 million bond that comes due in June,” the Wall Street Journal wrote in its ‘Even a State-Linked Giant Can’t Escape China’s Real-Estate Crisis’. It added that the company has another $5 billion of dollar-bond debt to repay before the end of 2029.

Similar to many other companies, Vanke heavily relies on pre-sales, a practice where apartments are purchased before construction is completed. As of September, it reported approximately 408 billion yuan in contract liabilities, primarily consisting of deposits paid by consumers for homes still under construction. Considering this, Vanke's financial liquidity may be less robust than it appears.

Vanke's shake-up could be the curveball that throws China's plans off balance!

"For real estate companies that are seriously insolvent and have lost the ability to operate, those that must go bankrupt should go bankrupt, or be restructured, in accordance with the law and market principles," Ni Hong, China’s Minister of Housing and Urban-Rural Development, said at a press conference recently.

According to CNBC, he added, “Those who commit acts that harm the interests of the masses will be resolutely investigated and punished in accordance with the law.”

“They will be made to pay the due price!”

Since the establishment of a nationwide housing market in 1998, the property market has played a vital role in China's economy. Real estate contributes almost 30% of the country's GDP. China's economy, valued at $18 trillion according to the World Bank, represents nearly 18% of global GDP, positioning it as the world's second-largest economy behind the United States, which contributes approximately 25% to global GDP.

Dexter Roberts, the author of ‘The Myth of Chinese Capitalism: The Worker, the Factory, and the Future of the World’, highlights the fundamental issues of the country's real estate sector in National Public Radio’s article titled ‘Here's what to know about the collapse of China's Evergrande property developer’.

"China has known for a long time that their economy was imbalanced and too reliant on debt, with the real estate sector (being) the most indebted industry of all and Evergrande the poster child for the most indebted company in that sector,” he mentioned.

In January 2024, a court in Hong Kong ordered the liquidation of China Evergrande, the real estate developer with the world's highest debt burden, after its failed attempt to restructure $300 billion in debt owed to bondholders and financial institutions. Evergrande initially defaulted in 2021, just over a year after Beijing restricted lending to property developers to curb a property market bubble.

Next in line was Country Garden, which did not surprise the market as much as it should have.

While the company's total liabilities of 1.4 trillion yuan ($191.7 billion) are significantly smaller than those of Evergrande, Country Garden's extensive portfolio of over 3,100 projects across all provinces of China stands out. This is approximately four times the number of projects owned by Evergrande, which has around 800 projects.

The default by Country Garden disrupted the real estate supply chain, affecting suppliers, and contractors, and leading to a ripple effect in construction and home delivery. This came amidst already declining buyer confidence, impacting broader economic activity.

How did they get here?

“The COVID-19 pandemic and regulatory crackdown impacted the housing market in 2020 and 2021. Property sales growth dwindled, liquidity constricted, and financial distress coupled with defaults among developers created a negative credit cycle,” wrote Knight Frank in its report titled ‘Unravelling the impending tremors in China's property market’.

According to the report, Chinese property developers relied on high leverage and numerous financing channels. The government's clampdowns on financing methods like trust financing and bond issuance have restricted developers’ access to the funds. “This, coupled with the high debt-to-equity ratio of the industry, has created liquidity pressures and distress among non-state-owned developers.”

Policies like "three red lines" introduced a financial regulation that put a cap on borrowing property developers can do. In December 2020, the Central Bank of China implemented a regulation aimed at limiting property loans provided by banks, to manage real estate investment and mitigate speculation-driven increases in housing prices. This regulation divides banks into five categories, each subject to varying caps on loan issuance, and provides a grace period of four years for banks to comply with the new regulatory requirements.

“Chinese economic behaviour began shifting in 2015 when the state extended its control: since then, household savings as a share of GDP have risen by an enormous 50% and are staying at that high level," wrote Foreign Affairs in its ‘The End of China’s Economic Miracle’.

It added that private investment is even weaker, down by a historic two-thirds since the first quarter of 2015, including a decrease of 25% since the pandemic started. And both of these key forms of private-sector investment continue to trend further downward.

Another burgeoning problem for the country is its retiree population. This demographic challenge is expected to reduce its workforce and cause strain on healthcare and social safety nets. “In 2022, 12.8% of China's labour force, or 94 million people, were over 60, up from 8.8% in 2020,"  according to  Knight Frank’s report. The percentage is expected to rise as 300 million more Chinese people reach 60 in the next decade.

What’s the way forward?

In its report titled, ‘Thoughts from the road: China’ (published in April 2024), KKR explains that housing corrections typically stabilise when both the prices of houses and the volume of transactions collapse. However, in China, the housing market has mostly seen a decline in sales volume rather than in prices. The housing liabilities span across the private and public sectors, as well as local and central government levels. “Therefore, there is no quick fix," it mentioned.

According to the report, in China, traditional economic drivers such as real estate and consumption are likely to remain challenged in the near term.

“The health of a country's residential market is always a major bellwether for its overall economic outlook," said Anuj Puri, Chairman of ANAROCK Group.

The escalating crisis in its housing market, first heralded by the collapse of Evergrande Group, stands in stark contrast to the scenario in the thriving Indian residential market, according to him. “There appear to be some green shoots of recovery, but this space bears close watching,” he said.