World

Chaos in China’s property market

China’s property market is in trouble. House prices are falling, and many Chinese property developers are in severe financial distress.

To understand the problems in the Chinese property market, you must turn back the clock to the nineties when China started experiencing a huge migration to cities.

The rural population’s move to urban cities resulted from strong industrial growth in the country.

People could earn far more in factories than on farms, and most people followed the money.

In 1990, almost 75% of the Chinese population lived in rural areas. By 2000, this figure dropped to 65%; today, only 37% of the Chinese population lives in rural areas.

The enormous inflow of people into Chinese cities was the largest urbanisation in history.

As urban populations soared, housing demand soared. A big opportunity was presented to property developers to ramp up large-scale apartment construction to meet demand.

Property developers would take pre-paid initial deposits from homeowners to secure an apartment in a new development.

Homeowners would start paying their mortgage instalments as construction began, and once buildings were completed, they could take occupation of their apartments.

The high demand for property caused a rapid expansion in construction, and property developers took on substantial debt to keep up with this demand.

The business model worked well during the big migration period. However, demand for property started to fall as the growth rate of the urban population slowed.

The pre-sold model created another problem – property developers used the initial deposits to fund other developments.

Easy access to finance also made developers use new loans to pay off existing loans.

It created a Ponzi scheme of sorts where property developers operated with unprecedented leverage.

To address these problems, the Chinese government implemented the “Three Red Lines” policy in August 2020.

The policy prohibited property developers from getting access to additional financing unless they met three requirements.

  • Had a Total liabilities/Total assets ratio of less than 70%
  • Had a net gearing ratio of less than 100%
  • Had cash to short-term liabilities greater than 1

This policy brought a large property market segment to an immediate standstill as half of all Chinese developers could not meet the three requirements.

These developers were heavily dependent on continuous debt to continue their operations.

On top of this, the Chinese government advised banks to aggressively pull back on their issuance of mortgage loans to customers.

Massive cities of buildings under construction suddenly came to a halt, and many Chinese citizens were outraged for not receiving their apartments.

A ghost city in China

A risk to the global economy

China’s rapidly expanding property market bolstered its gross domestic product, contributing between 20% and 30% to its total GDP.

With the Chinese economy contributing almost 20% to the global GDP, the effect of China’s property collapse on the global economy could be significant.

The Financial Times reported that there are about 90 million empty and unfinished houses in Chinese cities.

Evergrande property was at the heart of this expansion. Many Chinese pension funds and offshore bondholders are deeply invested in the company.

In September 2021, Evergrande missed payments to Chinese wealth management products and shortly thereafter missed its first coupon payment on offshore bonds.

It greatly impacted the Chinese property industry as offshore investors lost trust in the market.

Local Chinese governments are also under pressure as 40% of their revenue comes from land sales to property developers.

The new “Three Red Lines” policy put a dampener on developments, which means these local departments no longer receive lots of money from selling land.

Local government financing vehicles (LGFV) were the main financers of property developers through municipal bonds. Their municipal debt stood at $7.8 trillion at the end of 2021.

If LGFV starts to default on these bonds, the Chinese government may need to take on this debt, which would ultimately increase the burden on Chinese citizens.

Many economists now fear that the Chinese property market created an investment bubble that has ended.

The impact of this bubble bursting remains to be seen.

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