China’s real estate market is facing increasing troubles as prospective home buyers hold back on making purchases, leading to weak sales and cash flow issues for developers. New home sales for the top 100 developers dropped by about a third in June and July compared to the previous year. Edward Chan, a director at S&P Global Ratings, stated that the situation is likely getting worse due to the recent Country Garden incident, and there has been no improvement in new home sales so far.
The Chinese property sector has been struggling since 2020 when Beijing implemented measures to crack down on the debt levels of mainland property developers. These measures, known as China’s “three red lines” policy, require developers to limit their debt in relation to the company’s cash flow, assets, and capital levels. The highly indebted developer Evergrande was the first to default in late 2021.
Country Garden, one of China’s largest property developers, is facing significant troubles, with sales dropping by about 50% year-on-year in June and July. The company has a large exposure to lower-tier cities where housing supply exceeds demand. A default by Country Garden could add $9.9 billion to the global emerging markets high-yield corporate default tally for 2023, according to JPMorgan.
The uncertainty surrounding government support and the debt troubles at Country Garden are contributing to broader unease in the Chinese housing market. The deepening crisis of confidence is adding pressure to the world’s second-largest economy. China’s top leaders have vowed to adjust and optimize policies for the property sector, but their plan to adapt to the changing demand-supply dynamics is yet to be clearly demonstrated.
As the property sector consolidates amid the debt and credit malaise, state-owned developers are better positioned to grow compared to non-state ones. State-owned developers saw contracted sales grow by 48% in the first seven months of this year, while non-state developers saw sales fall by 19%. This trend is enhancing state-owned developers’ ability to buy land from local governments, as robust home sales boost their cash flow.
However, the increasing dominance of state-owned developers in the industry may make it more difficult to forecast actual demand. Despite the challenges, underlying housing demand in first-tier cities remains somewhat resilient and untapped, and could be unleashed with greater policy clarity. Timely policy measures to stabilize demand and sales in higher-tier cities would be crucial for the overall stability of the Chinese housing market.
How has the “three red lines” policy impacted the cash flow of developers in the Chinese real estate market?
Well as their liabilities and assets. The policy aims to prevent excessive borrowing and speculative practices in the real estate market.
The impact of the “three red lines” policy became evident in the declining home sales numbers for the top 100 developers in June and July. Prospective home buyers are now holding back on making purchases due to the uncertainties surrounding the market. This decline in sales has led to cash flow issues for developers, further exacerbating the challenges faced by the real estate sector.
Edward Chan, a director at S&P Global Ratings, believes that the situation is set to worsen, especially in light of the recent Country Garden incident. This incident, which involved the delay in property deliveries by the major developer, has shaken buyer confidence and raised concerns about the reliability of developers in delivering on their promises.
Despite these challenges, there have been no signs of improvement in new home sales. Prospective buyers remain cautious, waiting for clearer signals of stability in the market before making their investment decisions.
The struggles in the Chinese real estate market have been ongoing since 2020, when Beijing implemented measures to address the high levels of debt among mainland property developers. These measures were aimed at reining in the speculative practices that had driven up property prices and created a potential bubble in the market.
The “three red lines” policy requires developers to control their debt levels and ensure a healthy balance sheet. Developers must maintain a “red line” on three key indicators: the ratio of total liabilities to total assets, the ratio of net debt to equity, and the ratio of cash to short-term debt. This policy is intended to promote financial stability and prevent excessive borrowing by developers.
While the policy has had some success in reducing debt levels and curbing speculative activity, it has also created challenges for developers in terms of their cash flow and ability to fund new projects. With homebuyers now holding back on purchases, developers face an uphill battle to maintain sales and ensure their financial sustainability.
The future of the Chinese real estate market remains uncertain, as it depends on various factors such as government policies, economic conditions, and buyer sentiment. However, it is clear that the sector is currently facing increasing troubles, and developers need to adapt and find innovative solutions to navigate these challenges.
