The problems with China’s real estate are getting worse. Prospective homeowners are delaying purchases, which is causing lacklustre sales and highlighting the urgent need for politicians to provide industry assistance.
Following double-digit increases earlier in the year, new house sales for the top 100 developers decreased by nearly a third in June and July from a year earlier, according to Edward Chan, a director at S&P Global Ratings. Weak new house sales will certainly cause serious cash flow concerns for developers because most flats in China are sold before they are finished.
“We think the situation is probably getting a little bit worse because of this Country Garden incident,” Chan said CNBC in a phone interview on Thursday. He noted that thus far, he hasn’t noticed any improvement in new home sales.
This lack of improvement, along with Country Garden’s impending default, is making it increasingly challenging for real estate developers to acquire money at a time when a wealth of statistics point to a fast weakening economy.
Evergrande, the world’s most indebted real estate developer, filed for bankruptcy protection late Thursday in the United States, further shattering investor trust.
The second-largest economy in the world is under more stress as a result of the worsening confidence problem.
Up to a quarter of economic activity on the Chinese mainland is thought to be generated directly or indirectly by the real estate industry. JPMorgan increased its projection for corporate high-yield defaults in emerging markets on Tuesday, partly as a result of growing concerns about contagion in China’s real estate market from a potential Country Garden catastrophe.
Country Garden, the largest non-state-owned developer in China by sales, has fewer than 30 days to pay the $22.5 million worth of two dollar bond coupons that were due on August 7 but were not.
The property developer warned it expected to have a half-year annualised loss of up to 55 billion yuan ($7.5 billion) and froze trade in 11 domestic bonds last week.
Since Beijing clamped down in 2020 on mainland real estate developers’ debt levels, the Chinese property market has been in free fall.
Years of rapid growth resulted in the creation of ghost towns as developers tried to cash in on the desire for home ownership and real estate investment.
These regulations, also referred to as China’s “three red lines” policy, identify three distinct balance sheet requirements that developers must satisfy in order to take on further debt.
The regulations compel developers to keep their debt levels in check with their cash flow, assets, and capital levels; Evergrande, a developer with a heavy debt load, experienced its first notable default in late 2021.
The overall amount of defaults for the Chinese real estate market to date in 2023 might reach $17 billion if Country Garden defaults, according to a report from JPMorgan dated Aug. 15. A default by Country Garden could bring the year-to-date total for global developing markets high-yield corporate defaults to $9.9 billion.
China property is anticipated to make up over 40% of all emerging market default volumes in 2023, according to a U.S. investment bank.
A large portion of Country Garden’s issues stem from its excessive exposure to lower-tier cities in less developed regions of China. According to the company’s 2022 annual report, these lower-tiered cities, where there is an excess of housing supply compared to demand, are home to about 61% of developments.
S&P Global’s Chan stated that “Country Garden sales performance has been somewhat disastrous,” noting that sales in June and July decreased by almost 50% year over year.
According to Chan, sales started to weaken in lower-tier cities in May while they started to get worse in higher-tier cities in the following months.
Chan stated that it is “becoming more and more challenging” for China’s overall real estate sales to reach S&P’s base case of 12 trillion to 13 trillion yuan this year as a result of Country Garden’s problems.
He suggested that it might be a descending staircase rather than an L-shape.
Chan stated that S&P’s bear case for the Chinese real estate market calls for sales of 11 trillion yuan this year and 10 trillion yuan in 2024.
According to data Chan provided, that still represents less than half of the country’s real estate market’s peak 2021 sales, which totaled 18 trillion yuan.
China’s top leaders promised to “adjust and optimise policies in a timely manner” for the country’s troubled real estate market at their mid-year economic review conference in July.
They still haven’t made it clear how they intend to adjust to “major changes” in the dynamics of supply and demand in the real estate market.
In a note dated Aug. 11, head economist at Oxford Economics Louise Loo stated, “The debt issues at Country Garden and the uncertainty of government support are feeding into wider unease in the Chinese housing market.”
State-owned developers are better positioned to thrive than non-state ones as China’s real estate market consolidates in the face of the debt and credit crisis.
According to data from Natixis Corporate and Investment Banking, state-owned developers saw contractual sales increase by 48% in the first seven months of this year compared to the same period last year, while non-state-owned developers saw sales decline by 19%.
As a result, state-owned developers are better able to acquire land from local governments because strong home sales are increasing their cash flow.
“How do you expect [privately owned enterprises] to grow further when [state-owned enterprises] currently account for 87% of the land purchases?” In a phone interview on Tuesday, senior economist at Natixis Gary Ng stated.
According to Natixis data, state-owned developers purchased 87% of the value of land from January through July this year. This is similar to last year. The study showed that there is a considerable increase from 59% in 2021.
Ng anticipates that in the future, state-owned developers will hold a larger share of the market for real estate in China. However, he noted that while non-state-owned developers have occasionally experienced issues with leverage, the prevalence of state-owned developers in the market may make it more challenging to predict true demand.
Although fairly resilient and untapped, the underlying housing demand in first-tier cities may be unleashed once there is more policy clarity.
According to Chan from S&P Global, “timely policy in stabilising the demand and sales in the higher-tier cities would be very important.”
If that were possible, the stabilisation might eventually spread to the less developed cities. However, that will require much more time.