Previous warnings of a real estate crash in China were never confirmed; The real estate sector has always managed to get ahead. But unless the government takes concerted action to address developers’ deteriorating finances, things may be different this time.
PEKING. In the two decades since China’s State Council classified real estate as a “pillar industry,” the sector has seen rapid development, boosted GDP growth and inspired millions of Chinese to dream of owning their own homes. But today the sector is beset by problems ranging from high prices to huge debt, threatening to undermine growth at a time when China cannot afford to.
Although there is no private ownership of land in China, households aspire to own their own houses to improve their living conditions and accumulate wealth. The Chinese cannot easily buy foreign assets due to capital controls, and China’s stock markets have not performed very well. China does not tax residential real estate, capital gains or inheritance and promises significant appreciation. As a result, real estate has become the most attractive asset to own.
From 2005 to 2021, China’s real residential property price index increased by 28.5%, from 87.95 to 112.99. While the price index has occasionally dipped over the years, it has always rebounded solidly, giving the Chinese people the impression that when it comes to accumulating wealth, home ownership is virtually a sure thing.
But as expectations of rising property prices and speculation cause real prices to rise much faster than the growth in household disposable income, housing is increasingly unaffordable for young Chinese, and even more so for migrant workers who do not have the same rights. as permanent residents of cities. In some top-tier cities, housing units cost more than forty times the median income.
The Chinese government has repeatedly attempted to curb housing prices, such as limiting the number of property purchases a household can make and even imposing administrative controls on housing prices. However, these measures have often proved to be ineffective and sometimes even counterproductive. While this is partly due to buyers and sellers looking for ways to avoid restrictions, the underlying reason is that the real estate sector has effectively hijacked China’s economy.
The real estate sector has a very long value chain, so what happens there has far-reaching implications, both upstream and downstream. Slower growth in real estate prices leads to slower growth in real estate investment. Since this type of investment and related activities account for a significant percentage of China’s GDP, averaging more than 10%, over the past 10 years, it hurts overall economic growth.
For years, whenever this situation arose, the Chinese government responded by relaxing or removing all measures that prevented price growth, paving the way for a strong recovery in both property investment and property prices. After the 2014-15 crisis, house prices rose and continued to rise for another six years, marking the longest (mostly) continuous rise in prices since 2003.
So in 2021, the Chinese government intervened again and introduced three “red lines” for real estate developers. If any developer had a debt-to-asset ratio greater than 70%, a net leverage ratio greater than 100%, or a cash-to-current debt ratio greater than 100%, they would lose access to the bank. credit. Not surprisingly, the real estate price index soon began to decline, followed by an increase in real estate investment.
The magnitude of the decline was surprising: in 2022, real estate investment fell by 10% year-on-year. And although the government soon greatly relaxed its restrictive policies, the family revival never materialized. On the contrary, in the first 10 months of 2023, the growth of investment in real estate decreased by another 9.3% year-on-year and the amount of unsold area increased by 18.3 percent.
Nowadays, more and more real estate developers are teetering on the brink of default due to a combination of a high ratio of liabilities to assets and a lack of liquidity. And some, notably Evergrande, China’s second-largest developer, have already failed. While Chinese regulators insist Evergrande’s failure is an isolated episode that will have little impact on the market, there is no denying the growing risks in the property sector. China has always managed to slip through the cracks in the past, but this time may be different.
Failure among real estate developers, even very large developers, is unlikely to cause a systemic financial crisis in China. At the end of the third quarter of this year, non-performing bank loans in China totaled 234.5 trillion yuan ($33 trillion), with mortgage loans at just 39 trillion yuan (16.6% of the total) and real estate developer loans at 13 trillion yuan (5.6% of the total). Due to high standards for borrowers and important down payment requirements, the quality of mortgage loans in China is high.
The problem facing banks today is not the prospect of widespread borrower defaults, but rather the growing desire among borrowers to pay off their mortgages quickly. While the NPL ratio of Chinese banks is currently very low, below 2%, it could rise sharply if the government does not address the deteriorating financial performance of developers (and their development and planning companies).
In addition to liquidating and restructuring failed developers, the Chinese government can limit financial risks by placing developers at risk of insolvency under greater government control, either through receivership or nationalization. It could also offer liquidity to solvent developers who need it and buy the assets (financial or physical) of developers who are under pressure to offer “liquidation sales”.
With a relatively strong fiscal position and a central bank with room to adopt a more expansionary monetary policy, China should be able to ease the real estate industry’s debt woes. Let’s hope the Chinese government can make another breakthrough.
Author
Former President of the Chinese Society of World Economics and Director of the Institute of World Economy and Politics of the Chinese Academy of Social Sciences. In addition, he served on the Monetary Policy Committee of the People’s Bank of China from 2004 to 2006.