by Historical_Lie5701
TL;DR: China’s property developers move collaterals, take debts from banks, and issue off-shore bonds to acquire new lands and sell off-plan units, in order to pay off constructions on the older development. When new developments stop selling, everything goes burst, including those off-plan sold units which are under construction.
As it is no more news by now, China’s property crisis is happening at full speed. Two biggest property developers Evergrande and Country Garden, one just filed chapter 15 bankruptcy, and the other one is in the grace period of paying off its US Bond and will almost certainly to default.
There were an article pointing out that Chinese real estate development is more of a Ponzi scheme than a bubble, let me explain more in detail why this is the case. Article link: www.theguardian.com/business/2022/sep/25/china-property-bubble-evergrande-group
The real estate development cycles work like this in China:
- First, the government will start an auction for real estate development land. Various property development companies like Evergrande and Country Garden will bid for the development land, the winner gets the right to develop and sell the apartment units and collect HOA afterward.
- The winner can sell off-plan apartment units before they even start building, but they need to put down collateral for all the expenses that require building the apartments.
- After all the units are finished and sold, they will have the profit = price of total sold units- (development-related expense + the bid for acquiring the land)
This system is designed nothing out of order. However, almost all real estate developers, instead of having the collateral sitting on their balance sheet doing nothing, they move the collateral, borrow money from banks, and issue bonds simultaneously to bid on more lands and construct new developments. This put on huge leverage on those companies.
In earlier years, many lands that they took on are good areas in first and second-tier cities (like Shanghai, Beijing, Shenzhen, Hangzhou, etc) The apartment units built on those land were almost sold out immediately. When the housing price goes up and the economy is doing well, those leverages pay off greatly, because the later developed units are always sold out, leaving enough money for finishing off earlier developments, paying off the debt they took from banks and a fat profit. The profit goes to the owner of those real estate developers as a form of stock dividends, and those owners move the money offshore through their charities in Hong Kong.
This process encouraged the property developers to take on bigger leverage to acquire more new lands and speed up the property development cycles. After good lands are all developed, the property developer aims to lower-tier cities that have less population and economic activities. However, things changed after Covid hit. What happens to Evergrande and Country Garden is that, after a huge slowdown in China’s economy, along with the cooldown in the property market, average Chinese citizens don’t have any more money to buy new apartments unit which are under development, especially in lower tier cities. Once the new developments stop selling, what is left with those real estate developers are huge debt they took through banks and bonds, and unfinished construction in those lower-tier cities.
Finally, let’s look at the stats for Evergande and Country Garden:
Evergande:
Debt: $340 billion Asset: $256 billion
Country Garden:
Debt: $195 billion Asset: $252 billion (most of it are iliquid)
Edit: the reasoning behind those real estate developers is that housing price only goes up in China basically non-stop for the past 20 year before Covid. That’s literately how China’s central bank stimulate economy after 08 when exports drop significantly. The money from auctioning lands is the major source of income in many low-tier cities as well, on a different topic, most of local government in China have huge city development debt as well, they are leveraged to the tits.
Evergrande and Country Garden are not state-backed, the debt Evergrande has is roughly 2% of China’s annual GDP, the China central government will watch them fail
Backgrounds on Country Garden in case anyone does not know: www.reuters.com/markets/asia/country-garden-how-bad-is-chinas-property-crisis-2023-08-17/
China does not have personal bankruptcy law so if a citizen defaults, then his/her apartment will be auctioned off and still own banks tons of money, basically getting life ruined. In terms of those unfinished developments, one scenario is that local government loan money to third party or another company to possibly finish the construction. However, most of local governments don’t have money. The biggest issue is that this will crush the confidence on anyone who attempt to buy new home, dragging down the home price even more.