China’s Real Estate Crisis Threatens Broader Economy as Fallout Spreads

China Is on Edge as Fallout From Its Real Estate Crisis Spreads

August 20, 2023

China is facing a growing crisis in its real estate market as the fallout from debt-laden developers and sinking sales spreads to the broader economy. What started as a crackdown on risky business behavior by home builders three years ago has now escalated into a full-blown crisis that is threatening the confidence of consumers, businesses, and investors.

For the past three decades, China’s property sector has been the engine of its transforming economy, employing millions and providing a store for household savings. However, years of excessive borrowing and overbuilding have turned the once-lucrative sector into a liability. The property boom, which was sustained by borrowing more to pay off mounting debts, has come to an end, leaving China struggling to regain its economic footing.

The current property crisis is a problem of the government’s own making. Regulators allowed developers to accumulate massive amounts of debt to finance a growth-at-all-costs strategy. However, in 2020, they intervened to prevent a housing bubble, cutting off the flow of cheap money to real estate companies. As a result, many developers have crumbled under the weight of their debts, leading to defaults and missed payments.

The impact of the crisis is being felt across the economy. Chinese consumers are spending less due to a slump in housing prices, which has affected their savings tied up in property. Jobs tied to housing, such as construction and landscaping, are disappearing, and companies and small businesses are afraid to spend due to the uncertainty of the crisis. Local governments, which rely on land sales to developers for revenue, are also cutting back on services.

Despite calls for a major rescue package, Chinese policymakers have opted for modest gestures like relaxing mortgage requirements and cutting interest rates. They have tolerated the fallout of the real estate crackdown because even companies that can’t pay their bills have continued to build and deliver apartments. However, the recent shock to the housing market, with plummeting sales and defaults, has raised concerns among investors that a bigger crisis is looming.

The fears have spread to other markets as well. Confidence in Hong Kong, where many of China’s biggest companies are listed, has plummeted, leading to a bear market. Investors have also pulled billions of dollars out of Chinese stocks in the past two weeks.

The real estate troubles are also spreading to China’s shadow banking system, with financial trust companies facing losses from risky loans handed out to property firms. The recent failure of Zhongrong International Trust to pay what it owed to investors has sparked protests from angry Chinese investors.

While the Chinese government has taken some steps to address the crisis, such as relaxing mortgage requirements, it remains to be seen whether these measures will be enough to prevent a larger economic downturn. Investors and analysts are calling for more decisive action to stabilize the real estate market and restore confidence in the broader economy.China Is on Edge as Fallout From Its Real Estate Crisis Spreads

Beijing wanted to cool its housing market, but created a bigger problem, as the fallout from debt-laden developers and sinking sales spreads to the broader economy.

A model Chinese property developer in a sector replete with risk takers is teetering on the edge of default. Short of cash, one of China’s biggest asset managers has missed payments to investors. And billions of dollars have flowed out of the country’s stock markets.

In China, August has been a dizzying ride.

What started three years ago as a crackdown on risky business behavior by home builders, and then an ensuing housing slowdown, has spiraled rapidly this month. The broader economy has been threatened, and the confidence of consumers, businesses and investors undermined. So far, China’s typically hands-on policymakers have done little to ease anxieties and seem determined to reduce the country’s economic reliance on real estate.

“What is happening in the Chinese property market is really unprecedented,” said Charles Chang, who heads corporate credit ratings for Greater China at Standard & Poor’s.

For the last three decades, as China’s population surged and its people flocked to cities seeking economic opportunity, developers couldn’t build modern apartments fast enough, and the property sector became the engine of a transforming economy. Real estate employed millions and provided a store for household savings. Today, the property sector accounts for more than a quarter of all economic activity.

China’s dependence on real estate was lucrative during what seemed like a never-ending property boom, but it has become a liability after years of excessive borrowing and overbuilding. When China was growing faster, the excesses were papered over as developers borrowed more to pay off mounting debts. But now China is struggling to regain its footing after emerging from the paralyzing pandemic lockdowns its leaders imposed, and many of its economic problems are pointing back to real estate.

Chinese consumers are spending less, in part because a slump in housing prices has affected their savings, much of which are tied up in property. Jobs tied to housing that were once abundant — construction, landscaping, painting — are disappearing. And the uncertainty of how far the crisis might spread is leaving companies and small businesses afraid to spend.

Local governments, which rely on land sales to developers to pay for municipal programs, are cutting back on services.

Financial institutions known as trust companies, which invest billions of dollars on behalf of companies and rich individuals, are staring at losses from risky loans handed out to property firms, prompting protest from angry investors.

The current property crisis is a problem of the government’s own making. Regulators allowed developers to gorge themselves on debt to finance a growth-at-all-costs strategy for decades. Then they intervened suddenly and drastically in 2020 to prevent a housing bubble. They stopped the flow of cheap money to China’s biggest real estate companies, leaving many short on cash.

One after another, the companies began to crumble as they could not pay their bills. More than 50 Chinese property developers have defaulted or failed to make debt payments in the last three years, according to credit ratings agency Standard & Poor’s. The defaults have exposed a reality of China’s property boom: the borrow-to-build model works only as long as prices keep going up.

As the property crisis has worsened, Chinese policymakers have defied calls to step in with a major rescue package. They have opted instead for modest gestures like relaxing mortgage requirements and cutting interest rates.

In an editorial on Friday, the state-run Economic Daily said it would take time for recent policies to take effect: “We must be soberly aware that the process of defusing risk cannot be completed overnight, and the market must give it a certain amount of patience.”

Policymakers have tolerated the fallout of the real estate crackdown because even the companies that aren’t able to pay all their bills have continued to build and deliver apartments.

China Evergrande, for example, defaulted on $300 billion of debt in 2021 and yet managed to finish and deliver 300,000 apartments out of the more than 1 million that it had taken money for but not completed at the time of its collapse. Evergrande filed for bankruptcy protection in the United States on Thursday.

But a lot has changed in recent months. Households pulled back on big purchases, and apartment sales abruptly plummeted. That shock altered the fortunes of Country Garden, a real estate giant that was once put forward as a model by the government. The company is now anticipating a loss of as much as $7.6 billion in the first half of the year and says it is facing the biggest challenge to its business in its three-decade history.

Country Garden has just weeks to come up with the cash to make interest payments on some of its bonds, or join its peers in default. It also has hundreds of billions of dollars in unpaid bills.

These developments have spooked home buyers, who were already wary. In July, new home sales at China’s 100 biggest property developers fell 33 percent from a year earlier, according to data from the China Real Estate Information Corp. Sales also fell 28 percent in June.

Investors worry that policymakers are not acting quickly enough to prevent a bigger crisis.

“I don’t think they have yet found the right solution to solve the problems,” said Ting Lu, chief China economist for Nomura. He and his colleagues have warned that falling home sales and defaulting developers risk a chain reaction that threatens the broader economy.

The fears have spread to other markets. In Hong Kong, where many of China’s biggest companies are listed, confidence has plunged so drastically that stocks have fallen into a bear market, down 21 percent from their peak in January. Over the last two weeks, investors have pulled $7.5 billion out of Chinese stocks.

The real estate troubles are also spreading to China’s so-called shadow banking system of financial trust companies. These institutions offer investments with higher returns than standard bank deposits and often invest in real estate projects.

The latest troubles surfaced earlier this month. Two publicly traded Chinese companies warned that they had invested money with Zhongrong International Trust, which is managing about $85 billion in assets, and said that Zhongrong had failed to pay the companies what they were owed. While it was not clear that those investments were tied to real estate, Zhongrong had been a major shareholder in several property projects of developers in default, according to the South China Morning Post. Zhongrong did not respond to an email seeking comment.

A crowd of angry Chinese investors gathered outside the Beijing offices of Zhongrong demanding that the company “pay back the money” and calling for an explanation. It was not clear when the protest took place; videos of it were uploaded to Douyin, the Chinese version of TikTok, this month.

The demonstration was reminiscent of other acts of defiance in China rooted in the housing crisis. While such occurrences are rare, there are a few recent examples.

In February, thousands of retirees in Wuhan confronted officials to protest cuts in government-provided medical insurance for seniors. The cutbacks were a sign of the strain on local governments caused in part by the downturn in real estate that had hurt land sales, a reliable source of revenue.

Last year, hundreds of thousands of homeowners refused to pay mortgage loans on unfinished apartments. Some staged protest videos on social media, while collectives of homeowners tracked boycotts online.

Both protests drew notice, but the momentum petered out as the government intervened to limit discussion on social media, while adopting some steps to ease tensions. Last week, a new video outside of Zhongrong’s offices showed no demonstrations but police cars and vans were parked in and near the facility.

The fallout from China’s real estate crisis is spreading, and the government’s limited response has left consumers, businesses, and investors on edge. As the property market continues to deteriorate, concerns about the broader economy are growing. The government’s crackdown on risky business behavior and excessive borrowing has led to a wave of defaults and missed payments by developers, causing a slump in housing prices and affecting consumer savings. Jobs tied to housing are disappearing, and companies are hesitant to spend amid the uncertainty. Local governments are cutting back on services due to a decline in land sales, and trust companies are facing losses from risky loans to property firms. Despite calls for a major rescue package, policymakers have only implemented modest measures. Investors worry that the government is not acting quickly

How has the real estate crisis in China affected other markets, such as Hong Kong, and what are the implications for investors

The property market has become a major obstacle.

The root of the current crisis can be traced back to the Chinese government’s own policies. Regulators allowed developers to accumulate massive amounts of debt to fuel a growth-at-all-costs strategy. However, in 2020, as concerns of a housing bubble grew, they intervened to tighten regulations and cut off the flow of cheap money to real estate companies.

This crackdown has had significant consequences. Many developers, burdened by their debts, have collapsed, leading to defaults and missed payments. The downturn in the property market has also had a ripple effect on the broader economy. Housing prices have slumped, causing consumers to spend less and impacting their savings tied up in property. Jobs in industries related to housing, such as construction and landscaping, have disappeared. Companies and small businesses are hesitant to invest due to the uncertainty surrounding the crisis. Even local governments, heavily reliant on land sales for revenue, are cutting back on services.

In response to the crisis, Chinese policymakers have taken some measures, such as relaxing mortgage requirements and cutting interest rates. However, these actions have been seen as modest gestures and have not alleviated the concerns of investors and analysts. Calls for a major rescue package to stabilize the real estate market and restore confidence in the broader economy have been growing.

The fears surrounding the real estate crisis have also spread to other markets. Confidence in Hong Kong, where many of China’s biggest companies are listed, has plummeted, leading to a bear market. Investors have withdrawn billions of dollars from Chinese stocks in the past two weeks.

The fallout from the real estate crisis has even reached China’s shadow banking system, with financial trust companies facing losses from risky loans given to property firms. The recent failure of Zhongrong International Trust to pay its debts to investors has sparked protests from angry Chinese investors.

While the Chinese government has taken some steps to address the crisis, the severity of the situation and the potential for a larger economic downturn remain uncertain. Investors and analysts are calling for more decisive actions to stabilize the real estate market and restore confidence in the broader economy. The coming months will be crucial in determining whether China can effectively navigate through this real estate crisis and prevent further damage to its economy.