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A major driver of China’s growth over the decades has been the property sector, but what was once a pillar of reliability and strength, is now a significant drag on the growth of the burgeoning nation. In Sept 2021, the cracks began to fissure when Evergande defaulted on its bonds. However, instead of a “Lehman Brothers” event, as many predicted, Evergande and the Chinese real estate market continue to tread water. This week, ABSI provides an update on the issues plaguing CCP officials in the Chinese real estate market. 

It is important to appreciate the growth of the Chinese property market since 1998, when housing reform ended employer-based accommodation and moved to a more traditional housing-finance system. Since then, the industry has prospered; generating sales in 2020 of 17 trillion yuan (US$2.5 trillion), according to data from Statista. The Chinese were selling the same dream as every other Western culture - “a home is your castle” - as such, property mortgages surpassed 40 trillion (US$5.9 trillion) in 2021. As a comparison, the US holds approx. US$10.3 trillion in mortgage debt, but has significantly higher median household income.

Given the debt burden, there are worrying times ahead for the entire Chinese economy if housing prices decline substantially; think 2008 GFC. The trend is starting with year-on-year prices of newly built housing contracting 0.1% in May 2022 and 0.5% in June. 

China Newly Built House Prices YoY Change

Source: Trading Economics

The repercussions of this decline are already being felt with over 100 highly leveraged developers, representing more than a third of developments, going through liquidity issues and halting construction on projects. This is having a domino effect in which homebuyers are boycotting mortgage payments and suppliers closing off trade finance. Unsurprisingly, the prices on Chinese real estate bonds have plummeted as investors, especially international funds, race to the exit and dispose of their exposure at a record pace. Currently, ~73% of Chinese high-yield property bonds are trading below 35 cents on the dollar. More importantly, the whole situation is having a contagion effect on the whole Chinese junk bond market with the proportion of Chinese junk bonds trading below 20 cents on the dollar surging over the past two months, according to data from Bloomberg.

Source: Bloomberg 

Contagion is the biggest issue and there is a real risk that the property woes will spread to the banking system and infect the whole economy. CCP policymakers are acutely aware of this fact and have already started to take steps in order to restabilise the industry. The biggest announcement came yesterday with the establishment of a real estate fund. Armed with 300 billion yuan (US$44 billion) war chest, the goal is to help at-risk developers from failing by providing much needed liquidity to meet ongoing debt coupons and finish developments for the Chinese people. 

Source: Google Finance

The sugar-rush from the announcement had its desired effect with the Hang Seng Mainland Properties index spiking during trade yesterday. However, given the scale of the industry this fund will be but one piece of a much larger pie designed to ease the markets and project an image of strength and financial nous on leader Xi Jinping as he attempts to win an unprecedented 3rd 5-year term in office later this year. 

Read the Conversation:

Jack Colreavy:  

“You may recall last year there was big news in the media around the most indebted property developer out of China Evergande. Defaulting on its debt repayments and the risks that there would be a Lehman Brothers type moment in China with the collapse of one of their biggest property developers.

Fortunately, that never came to pass, and even though the news has subsided, the Chinese real estate market continues to tread water and deteriorate somewhat slowly. In the last couple of months, housing prices have been going backwards, which isn't a good thing for the highly indebted nation, they've got about US dollars, 5.9 trillion in mortgage debt.

The market for Chinese real estate bonds is also getting hammered with the likelihood that a lot of these property developers will also default or already have defaulted on their payments and this contagion effect is in play with the whole China junk bond market absolutely cratering. In the last couple of months, a significant amount of bonds are now trading below 20 cents on the dollar.

Meaning you can buy a dollar worth of value for 20 cents, but there's no guarantee that that dollar will be paid. In response to this issue, the Chinese Communist Party has taken a number of steps, and there was a major one today with the launch of a real estate fund. So armed with 300 billion Yuan war chest, the goal is to help at-risk developers from failing by providing much needed liquidity. To learn more, please subscribe to ABSI by clicking the link in the description.”

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