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China’s real estate crisis threatens global economy

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China’s property boom has been a huge driver of the country’s economic growth -- the sector is responsible for around one-quarter of GDP

Hundreds of thousands of Chinese people have sent angry messages to China’s developers, banks and local governments that have reverberated in Beijing’s halls of power. “You stop construction, I stop paying my mortgage,” says one letter, sent on behalf of 7,200 households that bought deeds in the same property development in Chongqing. “You hand over the apartment, I will start paying.”

Similar threats have been made — and in some cases carried out — across 328 property developments in nearly 100 cities. Some of the messages have appeared briefly on Chinese social media platforms before being scrubbed by censors. But their echoes remain — the letters have been preserved on a crowdsourced website titled WeNeedHome — as does the fury. The mortgage boycotts are posing a fresh challenge for the government in a country where widespread dissent is uncommon and other economic troubles loom large.

What prompted people to speak out?

The short answer is that construction has stalled at apartment complexes across the country — apartments that have eaten up many people’s life savings. The long answer traces to deep-seated problems in China’s real estate sector that have been brewing for decades and laid bare over the past two years.

China’s property boom has been a huge driver of the country’s economic growth — the sector is responsible for around one-quarter of GDP. But now a pair of factors has brought developers to their knees: China’s economic headwinds — due primarily to its strict ‘zero-COVID’ policy that has locked down entire cities — and a government effort to rein in the real estate industry’s soaring debt.

“We are in the midst of a slow-motion crisis. I would view the property sector’s distress as absolutely central to China’s current economic slowdown,” Logan Wright, a partner at Rhodium Group who leads the firm’s China markets research said.

Roots of the crisis

Logan Wright says that the ‘slow-motion crisis’ has many roots. To some extent, it was planned: The government explicitly wanted to cool down the red-hot property sector. For years, apartment buildings shot up across China as people moved from the countryside to cities and developers had easy access to credit. But it soon became clear that real estate investors — not actual home buyers — were the ones driving up demand in a speculative frenzy that left vast expanses of apartments empty. Property prices soared, and home ownership became increasingly unaffordable for China’s middle class. At the same time, another problem was brewing: The developers who were benefiting from those high prices amassed a mountain of debt to keep building at a breakneck pace.

“They have taken on too many loans to build too many buildings that no one really wants to live in,” Jeremy Wallace, an associate professor at Cornell University who has studied urbanization in China said.

In recent years, government officials have begun to see the underbelly of risk in that property-fueled economic growth model. President Xi Jinping has taken to repeating the exhortation that ‘houses are built to be inhabited, not for speculation.

In August 2020, the Chinese government decided to intervene to deflate the housing bubble before it burst. The housing ministry and the People’s Bank of China announced a ‘three red lines’ policy, laying out three benchmarks to evaluate the level of debt developers had taken on. If regulators found that a developer had exceeded any of the benchmarks, they would place limits on the developer’s ability to borrow further.

It turned out that many of China’s biggest developers had blown past the thresholds — and all of them now had to start re-balancing their lopsided balance sheets. That left these companies short on cash needed to complete the apartments they would promise to people all over the country. The early seeds of the boycott movement were planted.

“It is no surprise if you have this extensive distress that you are seeing within the property sector, that eventually, this issue would have come to a head,” Jeremy Wallace said.

Real estate bombshell

In the wake of the ‘three red lines’ policy, China appeared to come close to its own Lehman Brothers moment last year. As in a moment when one company’s troubles nearly cratered the country’s economy. Evergrande is the poster child for China’s real estate craze. It is a privately owned company that became China’s largest real estate developer, and as it grew, it took on an enormous amount of debt: more than $300 billion as of last year.

Even before the three red lines policy, Evergrande was facing pressure as China’s economic growth slowed, cooling demand for the company’s often lavish properties. But the new policy pushed it over the edge. Because it could no longer borrow as easily under the new government rules, Evergrande had to begin rapidly selling off pieces of its diverse business empire. But it still couldn’t keep up with its debt payment schedule. In December 2021, Evergrande failed to make payments to international bondholders, thereby officially crossing over into default territory.

Evergrande’s fall immediately set off concerns that China’s whole real estate sector would collapse. But instead, Evergrande’s troubles and China’s response have been a part of that slow-motion crisis. The government decided to intervene and has worked with Evergrande to develop a plan to restore the company to solvency. For now, a full collapse has been averted, but Evergrande’s path forward remains uncertain. It recently missed a July deadline to release a plan for restructuring its debts.

Meanwhile, the same story has played out for other large developers in China. The new rules have hit their ability to borrow from banks, and Evergrande’s high-profile struggles have made it harder for all these companies to access capital from foreign markets.

Experts say that some of this fallout from the red line policy was inevitable, but it was made worse because of a “perfect storm” of other economic factors.

“I think they were trying to do something that was very difficult — to deflate something in its real estate sector that looked very bubble-ish. To do this in 2020, 2021, it seemed reasonable that maybe they would be able to pull it off, but with zero-COVID really destroying other economic activity, it’s really made things a lot more difficult,” said Jeremy Wallace.

Summer wave of mortgage protests

The downfall of Evergrande and other behemoth developers leads back to all those angry mortgage holders. Evergrande is now the target of the largest number of mortgage boycotts. According to WeNeedHome, of the 328 developments where homeowners are threatening to withhold their mortgage payments, 52 are Evergrande properties.

Government policy certainly contributed to the problems, but they are magnified by China’s unusual, and problematic, property sales model. China’s real estate developers typically use a “presales” tactic in which buyers — or the banks that hold their mortgages — must pay in full for homes that have yet to be built. So even before many Chinese people move into their apartments, they are already making mortgage payments.

That model worked well enough while developers were able to build at a rapid pace and hand over apartments, but the recent setbacks have thrown wrenches into that process. In the past, developers were able to illegally tap into the cash they collected from presales to build other projects in their portfolios. But with zero-COVID hitting the economy, people have been less willing to buy apartments, so these sales have fallen. That in turn has left developers short on cash for construction.

Meanwhile, the three red lines policy has prevented the developers from borrowing more to compensate. All this has produced a vicious cycle, as Michael Pettis, a professor of finance at Peking University, wrote in a recent blog. The news about the liquidity crisis has also scared people off from buying presale apartments because they fear developers won’t be able to complete them. That, in turn, cuts further into developers’ cash.

“What you’re seeing is the unwinding of confidence that developers are still going to have sufficient resources to complete houses out there. It’s a significant change in credit conditions more broadly for developers,” said Logan Wright.

With no money in hand, developers started to push the pause button on their construction projects, leaving hundreds of thousands of people paying mortgages with no idea when they will actually move into their apartments. That’s why so many mortgage holders have banded together and threatened to stop paying.

What comes next?

Chinese government officials are working hard to contain the boycotts and keep the property market from going farther off the rails. It’s a delicate balancing act; the government wanted to reduce debt in the sector, but it’s now being forced to intervene to stop the crisis from spreading into other parts of the economy.

So far, authorities have largely allowed the boycotters to pause their payments without penalty. And the government isn’t leaving developers entirely in the lurch. Central government officials are trying to help speed the completion of projects, initially by appointing local governments to oversee the work. Chinese financial outlet Caixin reported that local state-owned companies might even be tasked with purchasing stalled developments and completing them on their own.

But local governments alone can’t fix the problem, in part because they are already highly indebted from implementing the costly zero-COVID policy, and the central government seems to realize as much. Bloomberg reported that the central bank will provide nearly $30 billion in special loans to developers to help them finish the delayed projects.

Even that is likely to be far from sufficient. Given how much revenue the sector is currently losing, the $30 billion “doesn’t seem large enough to help developers significantly at all,” said Logan Wright.

One thing is clear, from Jeremy Wallace’s perspective: Given the political sensitivities, the mortgage boycotters won’t be left to bear the full cost. “It’s a very compelling population. The family that has saved up in order to buy something that they never get because of some billionaire developer — that is a political fight that they will always win. And I think that’s really a dangerous potential problem that the government won’t let or can’t let sit forever,” he ad

Meanwhile, even if the government ultimately manages to get developers to deliver most of the apartments to the boycotters, the broader distress in the property sector still threatens the country. Sales across China’s top hundred property developers dropped by half in the first six months of the year, according to the New York Times. Home prices have also been falling, and more developers are still expected to default this year. In some ways, this is what the government was aiming for, but the real estate sector has plunged too quickly due to zero-COVID. Where will this downward spiral leave China? It is likely to stick to a path of reining in the property sector to a large extent, even if it continues to come at an economic cost.

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