China is caught in a continuous decline in the housing market. The only way out can be a relief to developers. Whose unfair practices contributed to distrust in real estate in the first place? So, let us see “What is all about China real estate crisis?”
China’s central bank cut interest rates in August to support lending. But the Covid lockdown and falling market confidence mean the move will have little effect. China’s banking system is becoming increasingly fragile, with about 4% of outstanding mortgages. Already affected by a growing payment boycott across the country. And slow growth in July shows that the crisis is already affecting the country’s overall economy.
Why does this matter beyond the obvious consequences of financial hardship for the Chinese people? China is the second largest economy in the world. 18.6% of US imports came from China in 2020, while exports to China were $124.5 billion. China is already reducing its holdings of US Treasuries, effectively pushing up US consumer interest rates. If China’s economy collapses, it will have devastating effects on the global economy.
Ingredients in China’s Real Estate Meltdown
A housing bubble created by government policy and cultural pressures China’s real estate market has been in freefall for almost a year. In the spring, desperate real estate firms began accepting garlic, melons, and other agricultural products as down payments. But things weren’t always so dire. Six years before the downturn, property values were rising rapidly. Citizens of China believed that real estate was the best way to increase. Their wealth and spent a large portion of their income on primary homes and investment properties. Government policies and societal pressures encouraged this behaviour.
Most of the problems have arisen because local governments are motivated to artificially increase the demand for housing and keep prices high. Municipal authorities derive 46% of their income from land transfer fees. To raise more money, these local governments increased property subsidies, encouraging more home buying. They even created demand by forcing people to sell country estates and buy more expensive units in urban housing complexes.
But relying on land sales for local income is not sustainable. Especially with the multitude of other factors affecting the market. One solution would be to raise property taxes to cool the housing market while preserving funding. For local governments, that idea has yet to catch on.
Meanwhile, there was a lot of cultural pressure on citizens to become homeowners, especially men who wanted to start a family. About 78% of household wealth in China is tied up in the real estate, long been considered a stable investment. In general, people save their income for years for the opportunity to buy a house. For this reason, demand suppression may have been difficult, even if local governments were willing to bear the loss.
Real Estate Developer Ponzi Schemes: China real estate crisis
In China, real estate developers have adopted a pre-sale model – essentially a Ponzi scheme – to finance their projects. Chinese home buyers were willing to buy properties that had not yet been built, and some developers used the money to complete projects they had already sold, allowing them to get more money from pre-sales. About 90% of the properties have been pre-sold. This strategy would be sustainable with continued demand, but once the housing market tanked, preparation was up.
Ironically, it was in part government policy responding to the potential risks of the situation that caused companies like Evergrande to default and leave Chinese noteholders paying mortgages on unfinished properties. This challenged real estate as a safe investment and caused demand to plummet. Now developers are having trouble raising the funds to complete these projects – it’s a vicious circle.
Government attempts to control excessive debt: China real estate crisis
In an effort to prevent the bursting of the real estate bubble, China introduced the “Three Red Lines Principle”, which set out three requirements for developers:
- Liabilities may not constitute more than 70% of assets
- Net debt cannot be more than 100% of the equity
- Must have at least 100% of short-term debt in cash reserves
Almost half of all developers in China failed to meet the requirements. This caused land acquisition to slow down and development projects to not be completed, as developers could not sell properties under construction or obtain financing. For example, by 2020, Evergrande had nearly $200 billion worth of projects under construction, but the company only managed to sell a fraction of that amount that year.
Zero Covid policy that crippled the economy: China real estate crisis
President Xi Jinping’s “Zero Covid Policy” prioritizes limiting the spread of Covid over maintaining a stable economy. Strict isolation measures have hurt consumer spending and led to higher unemployment. As an example of the dramatic response, just a few infections in Beijing last month meant 21 million people had to be tested every three days to be allowed into corner shops.
As a result of this policy, migrant workers and young people are unemployed in large numbers. Economists believe China’s detachment from the rest of the world is gathering pace as investors, tourists, foreign students and ex-pats lose interest in the country.
Large-scale boycotts of mortgage repayments for unfinished projects
That’s enough for Chinese homeowners. They are tired of foreclosures and tired of waiting for developers to finish the houses they are already paying mortgages on. Due to the weakening economy, affordability is also an issue for many. What started as a small group of homeowners boycotting their mortgage payments in 2021 has grown into a movement affecting hundreds of billions of dollars in loans. Hundreds of thousands of Chinese middle-class homeowners refuse to make monthly payments until their homes are built.
A protest of this scale is rare in China. We are all familiar with the famous picture of “Tank Man” in Tiananmen Square standing in front of a line of Chinese tanks in 1989. But the government is usually quick to quell dissent. This time, however, they have not yet managed to control the spread of the protest on social networks. Meanwhile, developers can’t respond to homeowners’ demands because they don’t have access to financing.
How the Chinese government is responding
Economists say these signals suggest China needs to move away from a growth model that is too dependent on assets. Economic policy should focus on raising wages. But instead, the People’s Bank of China cut interest rates to encourage even more people to buy more properties. Most experts agree that it won’t do any good. Source: Definitive Guide