Can China's real estate crisis crash the global economy?

“Houses are for living in, not for speculation,” Chinese President Xi Jinping has repeated this line quite often in the last six years. He had said this while addressing the 19th Party Congress in 2017. And now, as Xi is set to seek a nod for an unprecedented third term from 20th Party Congress in a few months from now, he is witnessing the unfolding of his worst fears -- a huge crisis in the country’s real estate sector.

A 20-year-long real estate boom, fuelled by proceeds from pre-sold homes and debt, has made Chinese property the biggest single asset class in the world, worth more than a staggering $50 trillion. 

In August 2020, China issued guidelines limiting how much developers could borrow, in order to force them to deleverage. The measures, called ‘three red lines’ shut off credit to some developers, setting in motion a series of defaults. 

Xi’s clampdown on skyrocketing property prices meant that top nine real estate tycoons have lost $79 billion of wealth since 2020. The erosion in their fortunes is symbolic of the crisis that has engulfed China’s real estate sector, an industry that represents about 70% of the country’s household wealth and makes up as much as 30% of its GDP.

China Evergrande Group is the world’s most indebted property developer

China’s Evergrande Group, which racked up $305 billion of liabilities to become the world's most indebted property developer, was the biggest casualty. Evergrande defaulted in December last year.

In the last one-and-a-half years, Chinese developers including top ones like Kaisa Group, Shimao Group and Sunac China have defaulted on at least $18 billion of offshore dollar bonds and $2.5 billion worth onshore debt.

China’s home prices and sales have fallen for record 11 months in a row as consumer confidence in the property market weakens. This has made it more difficult for developers to pay for construction given pre-sales make up to 90% of all property sales in China. What has exacerbated the crisis is the refusal of tens of thousands of homebuyers to pay mortgages for unfinished construction projects. 

According to Nomura, between 2013 and 2020, only about 60% of the homes that were pre-sold by developers were actually delivered. In a matter of only two months, the boycotts have spread to at least 320 projects in 99 cities, making it perhaps the largest mortgage protest in China’s history.  

  

Banks in China have about $9 trillion of exposure to the property sector, of which $5.3 trillion is in the form of mortgage loans. Analysts estimate that as much as $291 billion of loans could be impacted by the boycotts. However, contrary to the 2007 US subprime mortgage crisis, when money was loaned to high-risk borrowers who later defaulted, many in China are capable of paying but choose not to.

[Byte of Ananth Narayan, Associate Professor, SP Jain Institute of Management & Research]

China has meanwhile stepped in to help developers facing a cash crunch by offering $29 billion in special loans through policy banks. On Wednesday, China announced an economic stimulus package, which includes $44  billion that state policy banks can invest in infrastructure projects.

Research firm Capital Economics however estimates that developers need $444 billion to complete halted projects.

The stimulus packages provides relief to local governments, which are responsible for infrastructure spending.

As the housing crisis deepened, demand from developers to buy land has collapsed. As a result, local governments’ income from land sales, a key revenue source, plummeted 32% this year.

While a complete collapse of either China’s economy or its banking system looks unlikely, the property bubble popped by the government is unlikely to see a soft landing.