How China’s Real Estate market grew?
In China, land is primarily owned by Govt. In 1988, the government changed the constitution to allow rights to use land – not to own, to use – to be bought and sold under long term leases.
Residential = 70 years Lease; commercial = 50 years Lease
In 1998, the government introduced urban housing reforms that removed the obligation of employers to provide housing, which boosted the demand and private company’s participations. This model was based on the success of Hong Kong real estate. This model is prevalent in India also for example if you buy a apartment in NOIDA, you get leasehold rights on the land, the ownership still lies with development authority (North Okhla Industrial Development Authority)
The question arises why China did this? The plane answer is : During eighties, under the leadership of Mao Zedong, China changed itself as a socialist capitalist country from pureplay socialist country and for that to happen funds were required hence they monetised land following suit in the lines of Hong Kong , which led to development of Shanghai as a city parallel to HK.
One chart that proves that the rise of RE was state sponsored:
Whenever there was a drop in newly built home price you can see a CRR (cash Reserve ratio ) cut meaning liquidity injection by banks. No prizes for guessing that Chinese banks cumulative Real estate exposure is ~30% .
The other factor which is at the core of rise of RE in China is cultural. Chinese investors put very little wealth into equities and nearly 70% in real estate. There’s a cultural basis for this as it’s a historical custom that men in China should own a home before they are married, hence the country boasts an impressive 90% homeownership rate.
Nevertheless , the private participation was required so that led to rise of property developers such as Evergrande !
Complete Story of Evergrande
The Evergrande Group is China’s second-largest real estate company in terms of total sales and employs over 200,000 employees. Its core business deals with buying large amounts of land, developing them into houses, restaurants and so on and selling them to interested buyers
Evergrande was listed, at the end of 2009. It was the biggest residential real estate developer of them all. At the end of the year, it had a total land reserve of 55 million square metres, giving it years of runway compared with the 5.6 million square metres of gross floor area (GFA) it sold that year. One of the bankers on the deal called Evergrande the ” McDonald’s of the Chinese residential property market”
Mad Asset Growth
The year after IPO, it grew its land bank by 75%, investing in a pipeline of developments across 62 cities, up from 25 the previous year. It took scale to a new level, building mini-cities rather than just apartment blocks that could accommodate as many as 65,000 people on a single site.
it diversified into other businesses. It’s had a football team since 2010 which has gained success under famous coaches. It operates theme parks, is involved in grain, dairy and mineral water businesses and has a cultural entertainment division. Its electric vehicle business is now worth $26 billion.
The company uses large amounts of debt from banks and investors as well as short-term loans extended by suppliers and property buyers to fund its business. It has total liabilities worth over $300 billion and has to pay around $37 billion in interest and maturing debt over the next one year. The company’s bonds have been downgraded by rating agencies such as Fitch and S&P and have traded well below 25 cents on the Dollar, given the company’s precarious financial position.
In the last decade, the company’s debt level has gone up almost 60 times. As its debt burden grew to 153% net gearing ratio , so did its interest payments on that debt. With over $7.4 billion of bond payments due in 2022, and large interest payouts looming as close as this week, the crisis is imminent.
The reason for the Collapse
Last year, Beijing started cracking down on RE developers by introducing 348 new regulations to bring order in the economy as most of the RE was bank funded. Also Govt implemented its “three red lines” policy, the number referring to three strict caps placed on the ratio of debt a property developer can hold in relation to its assets, equity and cash on hand. Under this combination of new rules, Evergrande could not sell enough apartments fast enough to pay back its debts at the pace mandated by regulators.
To meet its ever growing obligations, Evergrande began tapping into “creative financing strategies” in the form of short-term loans from its employees, but missed out on repayments.
Is it too Big to fail?
My answer is no ! I see 3 possible outcomes from here:
- Bailout by Govt (Almost rejected by govt)
- Controlled Detonation (restructuring of debt, change in ownership of Evergrande)
- Complete Liquidation (highly unlikely , as it will destabilise the economy by job losses, buyers’ resent)
Next Lehman Crisis?
Out of USD 300 bn debt only USD 19 bn is dollar denominated debt which tantamounts to ~6% of the overall debt, so in case of debt crisis also the impact to outside world investor would be very limited.
Impact on Metal
China’s property sector consumes around 32% of steel produced in the country, so the ripples might be felt across Steel/copper sectors in short term, however, the steel prices are not expected to drop suddenly as construction activities in China shall not go on standstill.
Watch a small cap hidden gem :