China’s real estate sector is of massive scale. According to Goldman Sachs Group Inc., its total value reached $52 trillion in 2019, which is double the size of the US residential housing market. Remarkably, this sector contributes to nearly one-third of China’s gross domestic product (GDP).
Property accounts for 70% of China’s household wealth, and real estate has generated the highest number of billionaires in the country.
Subpar building standards in China don’t appear to deter most investors. Regardless of the construction quality of a building in China, it almost guarantees an increase in value over time. At least until recently.
In contrast to the Western approach, where purchasing an apartment complex typically involves renting out units to keep them occupied, in China, investors who acquire apartments often don’t intend to live in them or even rent them out.
These poorly constructed and seemingly unoccupied structures in China, often referred to as “ghost cities,” have been a subject of fascination for nearly a decade. Currently, there are enough vacant houses in China to accommodate the entire population of France.
China has experienced remarkable economic growth in recent years, with property prices continually rising, and investors heavily participating in the real estate sector’s success.
But similar to the devastating market crash Japan experienced in the 1990s, China’s economy is on the brink of undergoing the largest crash in history, one that will take decades to bounce back from.
Last week, China’s Evergrande Group, formerly the nation’s second-largest property developer, submitted a bankruptcy filing in New York. The troubled company had taken on substantial debt and experienced default in 2021, triggering a significant property crisis in the Chinese economy, the repercussions of which are still being experienced.
Following the downfall of Evergrande, numerous other prominent Chinese developers, such as Kasia, Fantasia, and Shimao Group, have also experienced debt defaults.
Country Garden has long been China’s biggest real estate developer, specializing in residential property. In August the company rattled markets by failing to pay U.S.$22.5 million in interest due on debt securities with a total value of $1 billion.
“Prices of the two bonds, which were scheduled to mature in 2026 and 2030, plunged to less than 8 cents on the dollar, according to Tradeweb,” said one report. “Such levels indicate that investors are expecting the company to default.”
Country Garden was given a 30-day grace period which was due to expire this week, and eventually made two overdue bond-coupon payments shortly before the end of the grace period, averting an international debt default that many investors saw as inevitable.
The company stated that it faces an imminent obligation to repay nearly $15 billion in debt over the next 12 months, encompassing bonds, notes, as well as loans and other borrowings. Country Garden’s near-term debt surpasses its existing cash and cash equivalents, which currently amount to $13.9 billion.
Country Garden recently recorded a net loss of approximately $7.10 billion for the six months of the year the company said in an announcement to the Hong Kong Stock Exchange.
The expected loss compares to a $265m profit for the same time last year.
Country Garden’s financial difficulties, as the last remaining big developer in China following the default of many of its counterparts, have deeply unsettled the troubled housing sector and financial markets in the country.
Concerns regarding major Chinese banks being adversely affected by the collapse of several developers have generally been dismissed. But, there are other potential risks that cannot be overlooked.
If the property market continues to weaken, there is a possibility that the government may request banks to extend more loans to the industry. This move could reduce returns and result in an inefficient allocation of credit, particularly at a time when China’s economy is facing challenges.
Nevertheless, the most pressing concern for officials remains threats to social stability. If Country Garden, for instance, has to reduce prices to stimulate sales, it could trigger competition and prompt quicker price declines across the entire industry. This, in turn, might encourage prospective buyers to postpone their home purchases, hoping for further price reductions. In past downturns, those who bought homes early, missing out on discounts, have protested and demanded price reductions to match the new lower rates.
Allowing Country Garden to collapse could trigger broader panic, exacerbate economic hardships, and potentially lead to additional defaults, raising the risk of contagion and social unrest. On the other hand, intervening with a rescue plan would entail officials being responsible for numerous additional bailouts and sustaining an industry that is fundamentally unsustainable.
Official figures in August showed China had slipped into deflation for the first time in more than two years. Exports have also fallen sharply, while youth unemployment is at a record high.
The Federal Reserve said in its financial stability report from 2021, that China’s real estate troubles could spill over to the U.S.
“Stresses in China’s real estate sector could strain the Chinese financial system, with possible spillovers to the United States.”
The Federal Reserve also said that given the size of China’s economy and financial system as well as its extensive trade linkages with the rest of the world, financial stresses in China could strain global financial markets through a deterioration of risk sentiment. They say that it could also dramatically pose risks to global economic growth and affect the United States.
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