Evergrande, property and construction crisis in China – what investors should know
According to Goldman Sachs Investment Research, China’s residential property market might be the world’s largest, with a total asset value of $62 trillion, with a T, compared to $34 trillion for the US property market.
According to estimates provided by the Wall Street Journal, Chinese property developers such as Evergrande have a total debt of $5.2 trillion with a T. Of the $5.2 trillion in debt, 46 percent is in the form of bank loans, amounting to around $2.4 trillion in bank loans to property developers alone.
Bonds account for 10% of the total, or $520 billion; this includes $271 billion in the dollar nominated bonds, which are now in default, whose values have crashed, and whose yields have skyrocketed to record highs. However, these dollar bonds account for just 5% of the overall debt owing by property developers; 26% of the $5.2 trillion owed by property developers, or approximately $1.4 trillion, is owed to apartment buyers who purchased unfinished flats in presales. This $1.4 trillion is effectively interest-free loans made to developers by tens of millions of people; property developers also borrowed from shadow banks known as trust firms, as well as individuals, who bought so-called wealth-management products.
Many property developers’ dollar bonds have fallen below 20 or 25 cents on the dollar. And the whole market for junk-rated dollar bonds in China has taken a tremendous hit, with yields skyrocketing to pre-crisis levels in recent days.
Urbanization and demographics challenges:
- In recent years, 25 million people per year were relocating to cities – a trend that is unlikely to continue at this level.
- China’s population growth is relatively low and is anticipated to continue declining, with a negative trend expected until 2050.
- Housing is transformed into a financialized, highly leveraged asset class.
- People who already owned at least one property accounted for 87 percent of home purchases in 2018.
- According to official figures published by the Wall Street Journal, there were around 1.6 million acres of residential floor area under development by the end of 2020. (which according to different estimates stands for around 110 million apartments under construction).
- Because so few of these units were rented out, apartments have become financial investment products acquired for capital gains rather than income.
- Around 25% of Chinese apartments remain empty, amounting to around 60 million units.
- According to the Wall Street Journal, total sales among China’s 100 top property developers fell 36% year on year in September. Sales of the top 10 developers, including Evergrande, plummeted 44%.
Regardless of what the government is going to do with Evergrande and other developers, it will probably try to prevent a chaotic collapse of them. Some creditors, especially foreign creditors, can suffer large losses. Other creditors, such as households that have invested in pre-sale apartments and wealth management products, can be bailed out. Larger developers can be handled methodically, as the government has been doing with its large conglomerates for several years. The debt-driven real estate speculation growth model has probably ended. The model created the housing bubble mired in massive debt. This bladder is now emptying. The government is trying to make sure it doesn’t get out of control.
Risks to watch:
* Credit locking up in the property development sector – different scenarios:
no meaningful measures mean then we are looking at a full-blown financial crisis;
steps will be implemented to help the better companies but not let up on over-indebted companies – likely;
and finally China could over-egg the response, opening up the credit taps.
* Property buyer confidence – China has some of the most expensive housing in the world relative to income. Should buyers lose faith in the value of properties, then a house price crash could result.
* House price wealth effects – high property prices increase inequality, reduce economic growth and damage productivity. All of those are longer-term problems. The short term effect of rising prices is to increase spending and consumer confidence. Politicians love short term gains at the expense of long term losses.
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The views expressed in this document do not constitute research, are not investment or commercial advice, and do not necessarily reflect the views of all management teams. They change over time.