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How China’s property suppliers are ‘dragged to death’ in real estate crisis
Indebted Chinese property developers such as Evergrande and Country Garden owe millions to small companies and their workers, showing how far-reaching the debt crisis has become in the real estate sector.
www.scmp.com
- Indebted property developers such as Evergrande and Country Garden owe millions to small companies and their workers, showing how far-reaching the impact has become
- Millions of homebuyers who pre-bought property have little recourse but to wait for a turnaround, and industry insiders say the onus is on Beijing to act
But the ramifications of this month’s revelation, he said, could be devastating to both market confidence and in terms of debt repayments from the nation’s major developers to suppliers like himself who are bleeding cash amid China’s property crisis.
For the past two years, the owner of a relatively small piling company says he has been trying to collect more than 200 million yuan owed by the world’s most indebted property developer – China Evergrande Group. All the while, his own unpaid workers, investors and suppliers are angrily clamouring for tens of millions owed to them – showing how the crisis has trickled down and hit the entire industry.
“It could get worse. It’s one thing after another,” he told friends, asking for their advice on what he should do.
It wasn’t too long ago that times were great. Ye, now in his early forties, started the piling company in southern China in 2010 and was able to capitalise on China’s post-financial-crisis construction boom – when it turned to massive infrastructure investment to lift the economy. Piling is a technique that sets deep foundations for any form of construction work, including buildings.
Back then, all of the players – including local governments, developers, suppliers and buyers – engaged in frenetic land purchases, construction and property trading. And for Ye, the future looked especially bright in 2017, when he scored a partnership with property giant Evergrande.
But the good times would not last. Also in 2017, President Xi Jinping famously declared that “ houses are for living in, not for speculation”. Beijing would go on to support that sentiment by tightening credit rules against property speculation. And eventually, Evergrande was the first domino to fall when it defaulted in late 2021.
“A huge number of suppliers for developers, like me, have been deeply trapped by the crisis,” Ye said, lamenting that the vast majority of his wealth has been wiped out in just two years.
Hundreds of thousands of victims have been sucked into the Evergrande black hole, which reported 812 billion yuan in combined loss for 2021-22, and nearly 2.39 trillion yuan worth of liabilities as of June 30.
Unlike local government financing vehicles, which are largely owned by governments at different levels – with their debt owed to state-owned banks and middle-class investors through a variety of wealth-management products – the crisis in the property sector is particularly urgent because it involves so many households nationwide.
In early 2022, Evergrande chairman Xu Jiayin released a target of delivering 600,000 homes that year – “equivalent to nearly 50 per cent of its pre-sold housing projects”. But according to the latest update by the firm on August 25, Evergrande delivered only about 301,000 homes in 2022.
Unlike developed markets where second-hand homes dominate the market and properties are largely sold upon completion, a vast majority of new Chinese properties are sold often before construction starts.
Fears have spread that pre-sold homes might not be completed, due to the slow progress. China Business News, a state-backed newspaper in Shanghai, reported that only a third of unfinished pre-sold homes identified in September 2022 had been completed as of May this year.
Breaking it down geographically, the proportion of deliveries was 56 per cent in southern China, 40 per cent in the east, 15 per cent in the southwest, and 16 per cent in central China.
And with no light seen at the end of the tunnel two years after Evergrande’s debt crisis unfolded, analysts warn that Beijing needs to take immediate actions – or perhaps a different approach entirely – to prevent contagion and spillover fears.
“Ensuring the delivery of unfinished property units is [one of] Beijing’s measures to protect consumers, i.e. homebuyers, to prevent this from turning into a mass social problem,” said Raymond Yeung, chief Greater China economist with ANZ Bank.
Beijing has taken some steps to maintain social stability and prevent a banking crisis. In June, the central bank extended 200 billion yuan worth of relending quotas to ensure completion of unfinished property units and to allow commercial banks to roll over maturing loans after the Evergrande crisis, extending the policies until the end of next year. Policy changes are also meant to increase bank loans. And special teams have been dispatched by Beijing and local authorities to oversee the process.
This approach is distinctly different from that seen in the US, which chose in 2008 to bail out Fannie Mae and Freddie Mac, two of the largest mortgage loan providers, by injecting funding and market-oriented restructuring.
“The [Chinese] government needs to follow laws and regulations and conduct a cost-benefit analysis to measure the actual impact on jobs and the national economy,” Yeung said.
The current downturn in China’s real estate sector is caused by government policies, not by the real estate sector itself, said Yao Yang, a Chinese economist and dean of Peking University’s National School of Development, while speaking at a public forum in Shenzhen last week.
He called on authorities to abandon restrictive measures on real estate credit. Secondly, bankruptcy proceedings and reorganisations should be carried out for developers with capital-outflow problems.
“Now the debts are hanging in the air. Some big companies are too big to fail, but it’s leading to their suppliers being dragged to death.” Yao was quoted as saying.
Thirdly, the authorities must resolutely stop intervening in the market’s trades and falling home prices, Yao added.
In a research report on Thursday, Gavekal Dragonomics said: “In the financial sector, moral-hazard constraints explain why regulators have not bailed out struggling developers, and will probably not fully compensate investor losses on high-risk investment products, following years of warnings.”
Fitch Rating says the outlook for Chinese developers is “deteriorating”, citing a lack of improvement in private developers’ funding access and weak homebuyer sentiment. However, it says the outlook for many state-owned developers is stable.
“Sales of most distressed developers are unlikely to stabilise in the next few years, while pressure on overall sales may persist without an aggressive policy response,” analysts Lan Wang and Duncan Innes-Ker wrote in a credit brief last week.
Peter Berezin, a global investment strategist at BCA Research in Canada, warned that the Chinese housing market looks even worse than Japan’s market in the early 1990s.
“In terms of leverage associated with the property developers, China looks worse. In terms of the prospect of a demographic decline, China looks abysmal,” he said. “And so, the question then is what does China do to fill that hole in spending that the housing market occupied? It was the same question that Japan faced in the early 1990s, and they didn’t have a good answer.”
In the first seven months after China ended its strict Covid restriction, Country Garden’s sales fell by 35 per cent, year on year, and the operating cash flow dried up.
Behind the private giants are dozens or even hundreds of smaller private firms that have also been dragged into the debt crisis. But local authorities cannot provide additional funding because of their sluggish fiscal revenue seen during the pandemic.
“It is actually even more difficult for us to get the arrears,” said Raymond Zheng, another supplier, “because many of the contracts signed with Evergrande are overturned and disapproved by local governments.”
Despite Beijing having vowed to ensure timely payments to small and private firms, those payments owed by Evergrande have been made exceptions, after the government stepped in to solve its crisis.
Zheng, who is also in the piling business, has similarly seen his fortune plunge amid the property crisis.
To make matters worse, his credit standing took a hit because he defaulted on payments to third parties, meaning he is now restricted from borrowing money, using a credit card or even buying an air ticket, according to China’s social credit system.
“I used to be a successful, private entrepreneur,” Zheng said. “But now I’m making preparations for the worst – going bankrupt personally and corporately.”
Meanwhile, as many homebuyers remain anxious about the delivery of their pre-bought properties, Beijing’s actions in ensuring prompt delivery times seem to be paying off.
In the first half of this year, the top-50 Chinese developers completed and delivered more than 2.02 million pre-sold homes, state media reported last month.
Country Garden said that the firm delivered 700,000 pre-sold housing units last year and planned to complete another 700,000 units this year. It delivered 278,000 units in the first half of the year, according to its statement in July.
But the two piling entrepreneurs, Zheng and Ye, expressed doubts that the newly introduced policies will have a practical effect, and they were concerned that enforcement and governance are fraught with arbitrariness on the ground.
“So, how can the authorities bring certainty to investors and the market,” Ye asked.
They fear that, if the Country Garden crisis deepens, it could strike a big blow to market confidence and debt chains among the country’s developers and their suppliers.
“There is a serious surplus of houses, especially in fourth- and fifth-tier cities. Besides, everything is unknowable ahead, like how much property prices will fall, in which direction policies will change, and whether the business environment for private companies will continue to deteriorate,” Ye said.
China Real Estate News, a newspaper afflicted with the Ministry of Housing and Urban-Rural Development, ran an op-ed piece on August 20 saying that local stimulus measures had failed to yield obvious results because core issues concerning supply and demand had not been addressed.
“The financing environment of private developers has not substantially improved. A large number of those who already reported defaults are now still struggling, while many others are also gradually slipping to the edge of risk due to the market deterioration,” it warned.
Meanwhile, the state-run publication warned that market expectations are unstable – with household consumption weakening while restrictions in purchases, loans, and prices in some cities remain strict.
“The policy support should start with ensuring the cash flow of developers and their deliveries of pre-sold units; the relaxation of administrative interventions; and the lowering of home-buying costs, including down payments, taxes and sales prices,” it added.
