For the second largest economy in the world, real estate is one of the most important sectors as well as one of the biggest concerns. The real estate sector of the Chinese Economy accounts for up to 29 per cent of the total gross domestic product, and nearly 70 per cent of the household wealth in China is stored in real estate. As the Chinese economy is struggling with the burden of a faltering real estate sector, Chinese developers in debt have been forced into a major crisis.
During the initial period of what was known as ‘Reform and Opening up’ (the late 1970s until late 2000s), China’s underlying growth rate was delivered by the private economy consisting mainly of exports, business investments, and consumption. Bridging the gap between the GDP growth target and the aforementioned factors was not a point of concern for the Chinese Economy as the real estate sector in China was grossly underinvested in infrastructure development, property, and manufacturing capacity; therefore, the investment required to achieve the GDP growth target was productive, for the most part.
To bring about a reform in the real estate sector as well as boost the already-booming economy of China, the country started investing heavily in infrastructural projects. The government started allocating land and earmarking it for massive infrastructure projects to facilitate economic growth. At the same time, the developers were offered massive amounts of debt for carrying out the construction. By opting for such an aggressive urban development model and after massive quantities of debt-fueled construction, the country is now home to many uninhabited buildings and “ghost cities”, leaving the developers in insurmountable debt.
While some of these “ghost neighbourhoods” found occupants later on. Still, in some cases, the newly-built beautiful urban areas struggled to find inhabitants or even obtain funding to complete the project. To fund the construction, developers tend to sell the units years before the completion of the project to utilise the pre-sale revenues. Followed by the outflow of population, slowing economic growth, and oversupply of land, the demand eventually drops, resulting in a cash crunch for the developers that might force them into abandoning their projects.
Analysts issued a warning that the government has adopted a “Build, Pause, Demolish, Repeat” policy as a measure to limit supply, prevent the drop in property prices, and increase economic activity through more construction. In order to revive the stalling real estate market, the government is halting projects under construction and demolishing buildings, skyscrapers, and housing projects which could accommodate over 75 million people (more than the entire population of the United Kingdom).
A significant incident w.r.t. the crisis and the implementation of the policy took place in Kunming, the capital city of Yunnan on August 27, 2021, where a group of 15 high-rise buildings that have been under construction for seven years was torn down in less than 45 seconds. The development of the complex called ‘Sunshine City II’ in Kunming began early in 2011, although the work on the project was halted in 2013 after the developer ran out of money and was taken over by a new company. Sitting idle since then, another company acquired the project’s developer in 2020 along with its debt. By stating the unfinished buildings’ quality defects, the new developer filed for the demolition of the structures to make land available for new, low-rise apartments.
In 2020, the Chinese government put the ‘Three Red Lines’ policy into effect, which states that if any company (especially construction developers) had a debt-to-asset ratio of 70% or more, they would be prohibited from obtaining further loans from the banks. The policy also mentioned that the companies are obligated to maintain a 100% cap on net debt-to-equity and should possess enough monetary assets to satisfy the conditions for obtaining short-term borrowings and debt.
An example depicting the gravity of the situation was when the Evergrande Group announced that it would default on its debt obligations in 2021. One of the country’s largest real estate developers with over a quarter of a million employees and constructed approximately 2% of all the buildings currently in the country, it had outstanding debt worth over 300 billion USD. With the enforcement of the policy, the company failed to get additional funding from the banks. It could not deliver the promised homes to approximately 1 million homeowners out of the 1.5 million who had pre-booked units with Evergrande as of September 2021.
Similarly, several major real estate companies like Sinic Holdings Group, Sunac Developers (3rd largest), and Fantasia Holdings failed to deliver their projects which were followed by a mortgage payment ‘boycott’ by the homeowners since they were not getting their promised homes. The crisis has led to a downfall in demand for new houses and a contraction of real estate prices. Although the measures taken by the Chinese government could be considered a step up, the problem could take a long time to resolve.
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- Carnegie Endowment for International Peace (2022). China’s Overextended Real Estate Sector Is a Systemic Problem [online]. Available at: https://carnegieendowment.org/chinafinancialmarkets/87751 [Accessed 3 December 2022]
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