Talking Point

The big bust?

A top official predicts the bankruptcy of 64,000 Chinese property firms

Easy-Home-1-w

Shaky foundations: almost 275 real estate developers have gone bust so far this year

Simon Yam is arguably Hong Kong’s most prolific actor. With credits in 234 movies, the 64 year-old has starred in a wide range of roles spanning mafia boss, police inspector and serial killer.

Some of these parts have seen his character injured or killed on the big screen. Of course, he would never have expected to be stabbed onstage in real life.

Yam was guest of honour at a promotional event for home furnishing chain Easyhome in Zhongshan in Guangdong last month. As he handed out gifts to guests, an assailant rushed to the stage, stabbing him in the stomach and slashing his arm before security intervened.

Yam suffered minor injuries, with doctors suggesting that his belly fat had protected him from worse damage. Local police later said the 53 year-old attacker had been diagnosed with schizophrenia. But many of those who watched footage of the incident on social media didn’t buy the official explanation. Another suggestion was that the assailant runs a small construction business that was going under due to unpaid bills from a property developer, and that he mounted the attack as a misguided way of generating pressure to get his money.

Easyhome put out a statement denying the speculation. But the episode has attracted attention to a harsh truth: a series of small and medium-sized enterprises are in dire financial stress following a wave of bankruptcies in the property sector.

How bad is the situation?

A photo taken of the notice board at the People’s Court in Beijing also went viral at the end of last month. It detailed a list of property firms that have filed for bankruptcy. According to the announcement, which spanned 18 pages, 274 real estate developers have gone under so far this year, about 50% more than the total in 2018.

Most of the failed firms are little-known names from third- or fourth-tier cities, Beijing News said, but also on the list was Yinyi Group, which ranks 215th among the top 500 property firms in China.

Yinyi’s boss Xiong Xuqiang had been dubbed Ningbo’s richest man but his firm filed for bankruptcy restructuring in June after failing to repay Rmb300 million ($43.48 million) in loans issued three years ago (see WiC458).

If a tycoon from one of China’s most entrepreneurial cities finds the going too tough, it’s less wonder that smaller real estate firms have been struggling to survive.

“The consolidation has just begun and it may well continue for a considerable period of time,” Beijing News warned.

Why is the property sector suffering?

Huang Qifan, deputy chairman of the financial and economic affairs committee at the National Peoples’ Congress, was similarly bearish last month, telling a real estate conference that as many as two-thirds of property firms could vanish as the sector consolidates.

The remarks carry more weight because of Huang’s lengthy tenure as Chongqing mayor (see WiC378), where he was successful in containing home prices in one of China’s most densely populated cities.

However, his latest warning was a particularly bleak one, implying more than 64,000 property bankruptcies to come. Part of the problem is oversupply. There were close to 97,000 registered property developers at the end of 2018, he noted in his remarks, compared with less than 500 in the United States.

Securities Times wonders if that number is misleading, however. It pointed out last week that the five biggest developers have “several hundred” subsidiaries and “subsidiaries of subsidiaries” registered in different provinces. The market is heavily concentrated around the bigger players, the newspaper added. In fact, the top 15% account for as much as 85% of the gross floor area in development.

The larger companies also capture the lion’s share of the sales. Up to 30 developers topped Rmb100 billion in sales last year, with the top three – Country Garden, China Evergrande and Vanke – all surpassing Rmb500 billion in revenues.

A much larger number of the nearly 100,000 property firms are inactive commercially. “They stay in their shells when the market is down. But in more frantic times they raise funds relentlessly and speculate on property prices,” the newspaper said.

This was exactly what happened in the first half of this year. Many smaller firms sprang back into life after Rmb5.81 trillion worth of new loans, a record amount, was pumped into the economy by local banks.

The lending spree was designed to offset the impact of the Sino-US trade war and refuel the economy (the rate of GDP growth slowed to a 27-year low of 6.2% in the second quarter). But regulators soon began sounding warnings about runaway real estate prices. They started with the Ministry of Housing and Urban-Rural Development, which put out alerts in April that six cities were in danger of seeing home prices overheat.

A starker warning was sent a month later to the four major cities of Suzhou, Dalian, Foshan and Nanning. “Houses are for living in, not for speculation,” the housing ministry reiterated, rehashing a policy directive from Xi Jinping, the Chinese president, back in 2016, and requiring the local governments to take measures to contain property prices.

Other regulators have stepped in to constrain lending to the real estate sector. In May the China Banking and Insurance Regulatory Commission (CBIRC) banned banks from lending to developers that have not secured necessary approvals to start construction. The ban has since been extended to indirect financing through wealth management schemes and bond offerings.

The CBIRC’s data suggests that up to 95 property firms raised funds in the domestic bond market in the first six months of 2019 at an average cost of 4.97%. However, all of these were larger players with relatively healthy balance sheets.

According to CBN, a newspaper, most of the bankruptcy-threatened property firms have less than Rmb3 billion in assets. To stay afloat, they have to accept financing costs of as much as 30%. Others have turned offshore for funding, like Tahoe Group, a mid-sized developer that has been mired in a corruption scandal in Shenzhen (see WiC450). It earned more unwanted attention last month by announcing a $400 million bond offering in Hong Kong with a coupon rate of 15% (its profit margin is less than 13%).

But even this costly overseas fundraising channel has now been blocked. In a move that has effectively prevented developers from using offshore debt to finance projects at home, the National Development and Reform Commission has instructed that any new bonds sold internationally by real estate firms can only be used to roll over existing offshore debt maturing within a one-year time period.

While the biggest developers have relied on their lower cost of funds to increase their land banks, medium and smaller-sized companies have been forced to reassess their portfolios.

“Many developers are feeling chilly in this hot summer,” CBN noted, adding that many are “severing their arms for survival” by selling off their better projects to bigger rivals.

Is it just another boom-and-bust cycle?

China’s property market often looks volatile because of the speed at which sentiment both soars and sours. Constant intervention from policymakers also means that conditions can vary across different cities, with booms in some locations, and busts in others.

But according to Huang Qifan, the afore-mentioned former mayor of Chongqing, a series of deeper trends in the sector have supported a bull market that has lasted for 20 years.

There wasn’t a private residential market in China before 1998 and just 100 million square metres (sqm) of residential floor area changed hands in 1999, Huang said last month. Annual transaction levels had surged to nearly 600 million sqm by 2008 and then doubled to 1.2 billion by 2012. Last year, the total had reached 1.7 billion sqm in sales. So the market grew 17 times in 20 years – a phenomenal rate of expansion.

“What is the way forward for the next 10 years? Will residential transactions stay at 1.7 billion sqm a year? Or will they climb another two-fold to top 3.4 billion sqm?” Huang asked. “My forecast is that sales will dwindle gradually each year to be-low 1 billion sqm a year.”

In this line of reasoning, a bull market of two decades in the real estate sector have been fuelled by three significant forces: steadily improving incomes; the need to improve China’s existing housing stock; and a surge in demand for downtown apartments from a rapidly urbanising nation.

Huang believes these trends won’t have the same impact in the 10 years ahead. He points out, for example, that older residential buildings weren’t built to last for much more than 30 years before the 1980s but in 2012 the government started to demand new standards of construction for buildings meaning they’d last at least 70 years. These higher standards should see reduced demand for brand new blocks of ‘replacement’ housing in the years ahead.

Huang isn’t predicting that two-thirds of the country’s current property firms will go under overnight, mind you. His forecast is based on trends that he thinks will last for more than a decade, including an end to a long period in which prices have persistently risen. In the 20 years to 2018, the average per square metre price for new homes climbed from Rmb2,000 to about Rmb8,800, he said.

In hot spots such as Shenzhen and Shanghai the acceleration has been much more rapid – prices in some of these cities have jumped ten-fold. But Huang doesn’t expect the same trajectory to be repeated in the next decade.

“Home prices will stabilise. They won’t climb too much and they won’t drop too much either. The rise in average home price is likely to be lower than GDP growth,” he predicts.

Doesn’t it depend on what policymakers decide?

The government is accustomed to using the property market as a policy tool to regulate the broader economy. With the rate of economic growth slowing to a three-decade low, investors have been waiting to see if Beijing will revert to the tested formula once again.

The country’s leaders provided an answer of sorts this week after a meeting of the ruling Politburo, which comprises the 25 most senior members of the Chinese Communist Party. In a statement published by Xinhua, the Politburo said it would take steps to boost demand and support the economy. However it stressed for the first time that policymakers won’t be using the property market as a form of “short-term economic stimulus”. Instead, a “long-term management mechanism” for the sector will be implemented.

“The Politburo’s meeting has sent a strong signal to the market that our country would stick to the principle that ‘houses are used for living, not for speculation’, and won’t compromise this principle for short-term growth,” Xinhua said in a separate op-ed.

“It is not that Beijing is unwilling to use this tool but it is unable to use it given the economic condition,” Yang Xianling, founder of Beijing-based consultancy Kongbai Institute, told the South China Morning Post. “The home price to income ratio and leverage ratio has reached such a level that the risk of loosening property [policies] far outweighs the benefits.”

Prior to the Politburo meeting, hopes were high that city officials would be allowed more leeway to ease some of the restrictions on home buying, such as relaxing curbs on purchases from non-local buyers. Maybe that will come up for consideration again if the economy slows further. But the directive from the Politburo has all but dashed such a prospect, CBN thinks, at least for the third quarter…


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