Is China's Real Estate Bubble Reaching The End Game At Last?
One Plus One No Longer Equals Two For Chinese Real Estate
While the world is losing what little sanity it had over events in the Middle East, China is losing what little hope it had that its property markets might yet avoid cataclysmic collapse.
The reporting leaves little room for doubt on this point: China’s two premier developers, Evergrande and Country Garden, are sick, sinking, and spiraling down towards total collapse.
China's Country Garden (2007.HK) may announce a restructuring of its offshore debt soon, local media reported, while bondholders of embattled peer China Evergrande Group (3333.HK) raised concerns about a possible liquidation as its debt plans floundered.
After more than two years of drama, default, and dogged resistance to a sector-wide bailout by Beijing, the situation within China’s real estate market is building to yet another tipping point, and this one may be the final one, after which total collapse becomes inevitable.
The world’s largest real estate marketplace is continuing its slow-motion implosion.
When Country Garden speaks of “restructuring” its debt, it means it is about to default on its debt...again.
For the second time in just over two months, Country Garden has warned investors that it could default on its $190 billion debt in a reminder that China’s real estate crisis is far from over.
The company said it had not made a repayment of 470 million Hong Kong dollars ($60 million) due to overseas bondholders by Tuesday.
This is becoming familiar terrain for Country Garden, as it was in technical default just a few weeks ago.
We have seen this drama play out before. Flirt with debt default enough times and the flirtation devolves into a consumation. Country Garden is reaching that point. Whether it magically finds the cash at the last minute to stave off default “this time”, it will eventually be unable to pull a monetary rabbit of the proverbial hat. When that time comes, it will default, it will collapse, and it will be forced to liquidate.
Evergrande, the first developer to crater under the weight of its unsustainable debt load, is a walking confirmation of this inevitability. While the company has gamefully struggled to shoulder on, restructure its debt, and bring its unfinished properties to completion, it remains as it was two years ago: the poster child for all the ways China is still the “sick man of Asia.”
For months it has been attempting to complete a debt restructuring, meeting regularly with a committee of its creditors, to no avail. Recently, Evergrande cancelled a fresh debt offering that was the foundation of its debt restructuring, claiming Beijing blocked the offering.
Last month, Evergrande cancelled a $19 billion debt restructuring that had been in the works for years at the last minute, citing regulatory hurdles. In their letter, the investors said the deal must get done or else consequences could be dire.
"This will likely lead to the uncontrolled collapse of the group," the bond holders said of Evergrande's inability to get the restructuring done. Evergrande defaulted in 2021 and remains China's most indebted property developer. By June, it held roughly $332 billion in liabilities, which included thousands of unfinished homes it still had to deliver.
This effectively leaves Evergrande with no plan even in the works to repay bondholders at all, making liquidiation all but inevitable.
Regulatory hurdles might be the cited obstacle to Evergrande’s restructuring, but, as Country Garden’s woes indicate, the real problem is that China’s property markets have collapsed and are continuing to collapse.
Commercial real estate sales have been a fraction of what they were even a year ago, which were already dramatically reduced from 2021’s sales.
The commercial real estate market has been in full-blown retreat since July of 2021, with only the teeniest of respites earlier this spring, as the percent change in sales year on year illustrates.
Residential real estate has not been any better. In fact, it’s even worse, with the absolute decline beginning one month earlier, and with a slightly better spring of 2023.
The constant contraction in property sales can only mean one thing: the Chinese people are losing confidence in the property market. It is impossible to opt to purchase a new condo or house if one has no confidence the condo or house will actually be built to completion.
Nor is the crisis one that can be resolved quickly. In addition to a collapse country wide in property sales, property investment has also declined dramatically.
Total investment and total investment in residential real estate development is also a shadow of its formal self.
Investment is the prequisite for sales. Without real estate investment, new properties can be neither started nor completed in order to power new sales.
Complicating the problem is a singular quirk of Chinese real estate: homeowners almost always take out a mortgage on homes before they are built, and then pay on those mortgages while the property is being completed.
Real estate accounts for about 70% of personal wealth in China - and home buyers often pay upfront for unfinished projects.
These "pre-sales" make up 70%-80% of new home sales in China, Mr Evans-Pritchard said, adding that developers need that money because they use it to fund several projects at once.
As a direct consequence, the dire straits of Evergrande’s finances, and of Country Garden’s finances, means they do not have the capital with which to complete homes which have already been sold and for which the developer has already been paid.
The lack of investment means there will be structurally fewer sales in the future, and the lack of sales in the present already means neither Country Garden or Evergrande has the revenue stream with which to finish these properties.
Last summer, the housing market collapse threatened to reach a crisis point when mortgage holders began a collective protest in the form of a “mortgage boycott”—homeowners refused to pay on mortgages for homes that were not finished and were not likely to be finished.
"Construction stops, mortgage stops. Deliver homes and get repaid!"
That was one of the chants disgruntled apartment buyers in China used at a protest in June. But their ire over unfinished homes didn't stop at signs and chants.
Hundreds of them stopped paying their mortgages - a radical step for China, where dissent is not tolerated.
A young couple who moved to Zhengzhou in central China told the BBC that after receiving the down payment last year, the developer withdrew from the project and construction stalled.
Even now, the lack of finished properties is itself the contagion risk China must address. As the developers collapse and properties are left unfinished, the largest portion of personal wealth in China is undergoing inexorable destruction. The crisis is literally impovershing untold millions of Chinese homebuyers.
"I almost bought an apartment from Country Garden," said 31-year-old Zhang Min who also lives in Henan.
She told the BBC that she and her fiancée had planned to buy the place as their marital home. Her parents' house had been built by Country Garden, and the young couple had been told they could buy a discounted property in August. But they changed their mind when they heard the firm was on the brink of a default.
"We're certainly not postponing our wedding because we didn't buy a new home. I will just have to give up pursuing the idea of 'newlyweds living in a new house'," says Ms Zhang.
"My parents' generation have seen two decades of China's housing market only going up. These days people around me are all worried about house price depreciation."
Contagion also is taking the form of fears over the health of Chinese banks, whose exposure to property developer debts is large but neither well nor transparently disclosed. Just recently, officials had to act to quell a nascent run on a regional bank in Hebei province, when fears began to spread that the Bank of Cangzhou was facing a liquidity crunch because of overexposure to Evergrande debs.
Fears that Evergrande’s debt woes are spreading into the wider financial industry have sparked a run on a regional bank in northern China, multiple state media outlets have reported.
Depositors lined up at the bank in Cangzhou, in Hebei province, to withdraw their money, according to photos and videos circulated online this week, prompting an appeal for calm by officials.
Police in Cangzhou have arrested “many people” suspected of spreading rumors that the bank was suffering a cash crunch because of its exposure to Evergrande, Yicai, a state-owned media outlet, reported on Wednesday, citing an officer deployed at the bank.
Posts on Chinese social media reviewed by CNN claimed that the Bank of Cangzhou had lent billions of yuan in loans to Evergrande, the indebted property giant that defaulted on its debt in 2021 and is struggling to survive.
As we have seen here in the United States, once a bank run begins no bank can long survive the rapid outflows of funds.
There is no government bailout program that can save a bank once the bank run begins and gathers momentum. A tipping point gets reached and the bank simply runs out of cash, after which it has no choice but to collapse.
China’s developers have reached that unavoidable inflection point where they have run out of their customers’ money. Evergrande and Country Garden’s woes are ultimately quite simple to understand: they do not have the funds needed to complete the homes they have already sold.
A major portion of Chinese developers do not have the funds needed to complete the homes they have already sold.
Homes which are already sold are not homes the developers can leverage for any more cash, which means Evergrande and Country Garden must find the means to both pay off their creditors and finish homes that have already been purchased, when their available cash is already inadequate to either objective and dwindling rapidly.
When one plus one no longer equals two for any business, that business has no option but bankruptcy. For Evergrande, for Country Garden, and perhaps ultimately for China, one plus one has not equalled two for a very long time.
Collapse is coming, and contagion is following.