Slowing economy, credit crunch: What's ailing China's real estate sector?

On Thursday, one of the biggest Chinese real estate groups, Evergrande, filed for bankruptcy protection under Chapter 15 in New York

Housing, China's housing

Photo: Bloomberg

Raghav Aggarwal New Delhi
The story of the rapidly declining Chinese economy has been in the news for quite some time now. The developments of the world's second-largest economy falling into deflation, debt default by several companies and fertility rates at historic lows have been finding their mention in the World sections of media across the globe.

In this, perhaps the biggest crisis that China is facing is in its real estate sector.

On Thursday, one of the country's biggest realty groups, Evergrande, filed for bankruptcy protection under Chapter 15 in New York. According to Bloomberg, with the filing, the group is aiming to restructure its debt worth $32 billion. With this, reports have also stated that another real estate giant, Country Garden, may also be looking at default. 

But what's ailing the Chinese real estate sector? Here's a deeper look at the crisis

Migration, property boom and free debt

The boom in China's real estate sector started in the 1990s when people started migrating from the countryside to major cities. At the end of the 1990s, one-third of people in China lived in cities. According to the latest official data, now more people live in cities than in the countryside.

When the migration started in the early 1990s, the Chinese government provided the migrants with a government apartment, which they were later allowed to buy at heavy discounts. This demand for homes provided a golden opportunity for real estate companies. 

They had ready demand from the government and were also given cheap loans to construct these apartments. The boom, which most believe was the world's biggest in the real estate sector, allowed companies like the Evergrande Group to earn huge revenue.

It is also reflected in the company's accounts. From $0.2 billion in 2004, the company's revenue grew to a whopping $79.8 billion in 2020, clocking an annual growth rate of 44 per cent.

The holy real estate

With the rapid expansion of the real estate sector, the Chinese economy saw a period of rapid economic growth. Between 1990 and 2015, the Chinese economy grew at an annual rate between 7.5 to 14.2 per cent.

Led by high debt and easy money from domestic as well as international lenders, the real estate sector remained the main driver of the country's growth. In 2017, it accounted for 28.7 per cent of the total gross domestic product (GDP). It was much higher than 20 per cent in the UK and 17.3 per cent in the USA. 

Moreover, it also played an important role for companies from other sectors that used their properties as mortgages to get more loans.

Low economic growth, Covid-19 and falling demand

After the 2008 recession, lenders across the globe started stricter scrutiny of the real estate sector. They grew more cautious in lending money to developers. The inflow of cash, which was necessary to keep the projects running, gradually started drying up.

This led to a slower pace in the development of housing projects in China, and the homebuyers, in return, started putting less of their money into the sector due to the fear of losing their savings.

Led by skewed demography, China's economic growth also started to slow down after 2010. From 10.6 per cent in 2010, the annual GDP growth rate in China fell to 6 per cent in 2019.

The Covid-19 pandemic further hammered the Chinese economy, which saw the strictest lockdowns anywhere in the world. In 2020, the country reported a GDP growth of just 2.2 per cent. It was not particularly bad compared to the US or European countries but substantially slower than China's previous growth rate.

The slowing growth rate also came with another problem: low demand for homes.

The slowing economic growth led to lower disposable income for households. They started putting less money towards real estate. This impacted the developers as they took the money in advance and used it to develop the projects.

The final hammer came in the form of a policy that the Chinese government introduced in August 2020.

Three red lines policy

In 2020, when the Chinese economy started facing troubles due to the pandemic, its government realised it could not keep lending money to real estate companies with the same easy terms.

The "three red lines" policy was introduced with three fixed ratios property developers must follow to get access to more credit.

One, liability to asset ratio was to be less than 70 per cent. Second, the net gearing ratio or debt-to-equity ratio was to be less than 100 per cent. The third was the cash-to-short-term debt ratio, which was to be more than 1. These ratios indicated that the company had enough cash to support its business.

Interestingly, over half of China's top developers failed to meet the requirements. Now, they were disallowed from borrowing money from domestic banks as well. So, customers were unable to give money to these developers and banks were not allowed to provide them with credit. An era of trouble began for the country's property sector.

In 2021, Evergrande Group became the first major developer to show stress in their balance sheet. They started missing out on repayment obligations.

This further pushed foreign banks, which even now have huge exposure to the Chinese real estate sector, to tighten their lending via bonds and other instruments. The third and the last source of income for these companies was now also cut off.

In many ways, the Country Garden crisis is the fruit of this tightening.

Demographic concerns, slow growth rate and the problem of plenty

Now, the urban population growth rate in China has fallen. According to official statistics, from 4.1 per cent in 1996, it had fallen to 2.1 per cent in 2020. It is also struggling with a rise in the number of older people who cannot contribute much to the country's growth.

On top of it, the Chinese economy has failed to recover from strict lockdowns imposed by the Xi Jinping administration.

Despite a financial support policy announced in November 2022 and then in July this year, the sector has failed to recover.  

According to Chinese government data, economic growth slid to 0.8 per cent in the three months ending in June, down from 2.2 per cent in January-March. It is equivalent to a 3.2 per cent annual rate, among China's weakest in decades.

Moreover, the unemployment rate among urban workers aged 16 to 24 spiked to a record 21.3 per cent. The Chinese statistics bureau has now said that it would withhold updates while it "refined" its measurement.

This has culminated into a major problem for the developers. They cannot get access to money and thus cannot complete their ongoing projects. With most of their projects turning into "ghost" constructions, they are unable to repay their debt obligations, slowly staring into the mouth of bankruptcy.

Will the Chinese government bail out its critical real estate sector in the coming days? The answer, yes or no, will probably come in the coming weeks.

First Published: Aug 18 2023 | 3:15 PM IST

Explore News