Weekly Brief: Chinese Real Estate Market in Turmoil
- Waseda Economics and Finance Forum
- Sep 28, 2021
- 3 min read
China Evergrande Crackdown
When Blackstone dropped the 3 billion USD acquisition deal on September 10 for Soho China as Chinese antitrust regulators dragged on, the market never knew that the Chinese real estate industry would be in turmoil. Last week, the fact that China Evergrande Group (3333. HK) is not ready for 83 million USD interest and offshore bond payment until the deadline of September 23 among 300 billion USD of liabilities surfaced, numerous players in global markets started to realize that something huge can happen. Compared to June 2020, which was their record high since the pandemic (25.668 HKD), Evergrande lost more than 20 times of share price (2.360 HKD September 27), and stakeholders of Evergrande and its subsidiaries are protesting for action.
From the impact of the Chinese real estate industry turmoil, S&P 500 plunged more than 2.8% in five trading days, performing a disastrous week for the global economy.
About China Evergrande Group
China Evergrande Group (3333. HK), founded in 1996, is the biggest operator in the real estate industry of China. It operates its business through four main sectors, which are property development, property investment, property management, and other businesses. ‘The other business’ includes insurance, consumer products, and even EV. Xu Jiayin, the founder of China Evergrande Group was listed as third on the list of Chinese billionaires.
Inside the real estate sweep of Chinese real estate development starting from the late 20th century, Evergrande Group differentiated their business operating strategy by focusing on developing outskirts, instead of main cities such as Beijing and Shanghai. Avoiding their plunging working capital and liquidity problems, they aggressively dominated the Chinese real estate market by composing high leverage.
Their liquidity problem surfaced rapidly in 2013, shortly after Xi Jinping said that China needs to shift its economic structure to manufacturing from real estate development. Also, their aggressive ‘pre-construction contract strategy’, which lets tenants repay the fee after their residence was made. As Chinese citizens are extraordinarily dependent on real estate for their assets – homeownership rate is around 90%, the depreciation of land & property and the rise of individual’s default since pandemic, put China Evergrande Group in a grueling situation. As a result, their net debt became 305 billion USD in September 2021, which is equivalent to around 2% of China’s GDP.
Why it could be ‘the next Lehman Brothers’
The plunge, especially of S&P 500 and Hang Seng index, was driven by the world’s anxiety of the ‘Chinese Version Lehman Brothers’. Investors and numerous players in global markets already witnessed two crackdowns in this industry – the 2008 Sub-prime mortgage-driven economic recession, and the Japanese real estate bubble bust two decades earlier than that. Through these two big incidents, a big learning – land bubbles are especially pernicious, is reflected in any kinds of movements of the players in global markets. We are now aware of the fact that the tragic end of land bubbles can destroy both the financial institutions and retails, which is why we are extremely sensitive to the possibilities of this incident becoming the next Lehman Brothers. As huge events such as the September FOMC meeting and tapering agendas were still on the board, the insolvency of China Evergrande Group made the market way more volatile than we expected.
The problem is highly related to Xi’s policies. We all know that Chinese banks are controlled by the government, so continuing to lend for cash-bleeding companies makes a big difference with 2008. However, as mentioned above, Xi is in the middle of shifting its economy from real estate to other businesses, more discussions among the leadership might be required of measuring the profit and loss of bailing out. And we know that if this real estate giant goes into default, it might be a new tragic history of capitalism.
Global economy is testing China’s ability to respond
This event might test China’s ability to respond to macroeconomics shocks. Since the pandemic, the impact of Chinese-related events grew on a big scale, regardless of whether or not it brought an alpha to their system. China relied on solutions such as the expedient of ordering banks to lend, regulations under the name of antitrust, and the protective instinct of maintaining their system. This differs from the countries that went through a housing crackdown as Japan and the U.S. use traditional monetary and fiscal policy to deal with macroeconomics shocks. As China avoids following the traditional solution but instead sticks to ‘the Chinese model’, the players in the market will test the ability of China to respond to this situation.
References
Noah Smith. (2021, September 25). Why China’s Evergrande Crisis Could Be Worse Than the U.S. Crash. Bloomberg. https://www.bloomberg.com/opinion/articles/2021-09-25/why-china-s-evergrande-crisis-could-be-worse-than-the-u-s-crash
Alexandra Stevenson, Lauren Hirsch, Cao Li. (2021, September 23). Uncertainty Swirls Around Evergrande as a Deadline Passes. The New York Times. https://www.nytimes.com/2021/09/23/business/china-evergrande-bond-payment.html
Vincent Ni. (2021, September 21). Evergrande: will it collapse and what would happen if it did?. The Guardian.
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