If there is a key moment in the evolution of the real estate market in China, it is that of the “three red lines”. The turning point in the trajectory of the developer Evergrande and the entire real estate industry in China. The point at which, in August last year, the Chinese government imposed three parameters to limit the huge debt in the sector and cool a market that had been red-hot for two decades. It had become one of the least affordable in the world in cities like Beijing, Shanghai or Shenzhen. Not surprisingly, prices have doubled in a decade. It was a necessary long-term measure. But in the short term it has unleashed a storm that threatens to bankrupt the most indebted developer in the world and spread its clouds to the entire sector and even to the growth of Chinese GDP.
It is difficult to overstate the importance of the real estate sector in China. It represents, directly or indirectly, a quarter of the national GDP – more than the brick in Spain before the bubble burst. One and a half million families in the real estate limbo of Evergrande, a proportion that rises to 80% in the large metropolises: for cultural and economic reasons, the purchase of a house is by far the preferred investment of the vast majority of the citizens. Its value accumulated last year 52 trillion dollars, according to calculations by Goldman Sachs.
It is a sector where speculation has been very present: Goldman Sachs estimates that up to 20% of properties may be vacant. Families that can buy a second home as an investment, sometimes even a third. Or more. And speculation has helped drive prices up. In Beijing, the average price of a house is 55 times the average annual salary. In Shenzhen, the cost is 57 times more than the standard salary.
The debt is also huge. In a country where corporate debt represents 220% of GDP, according to Asia Nikkei magazine, loans in the real estate sector make up 30% of the total. For more than a decade, the Chinese government tolerated this spiral, as companies that incurred debt generated GDP growth at an unprecedented speed. Xu Jiayin, the peasant who became the brick king with Evergrande. But that permissiveness has come to an end. In the last year, the Communist Party has taken action to tackle capitalist excesses, real or perceived, in the system. The “common prosperity”, the new mantra of the authorities, seeks to reduce inequality, eliminate monopolistic practices and put the level of debt under control. And the real estate sector is one of those affected.
The “three red lines” imposed in August 2020 require a developer to have a debt-to-assets ratio of less than 70%, less than 100% to equity, and a ratio of more than 1 of liquidity to assets. to short-term debt. With accumulated liabilities in excess of $ 300 billion, Evergrande did not meet any of the three requirements. That has prevented it from accessing new debt.
Already last year this company, which employs 200,000 people and indirectly generates jobs for another 3.5 million, which has more than 1,300 projects in 280 cities in China, began to suffer difficulties. Since then, the snowball has not stopped growing and Evergrande threatens to go bankrupt. The group has tried to divest some of its subsidiaries and offer discounts on its flats to obtain liquidity. But it has not been able to pay part of its subcontractors and suppliers, so 60% of its ongoing works are stopped: 1.5 million homes. Faced with the succession of negative news – this week it has failed to pay about 48 million dollars in interest on a foreign bond – “potential buyers seem to have lost confidence in the developer and in the real estate market, amid an excess of construction and high prices, ”said Erik Nielsen, chief economist at Unicredit Bank in London, in a note. In August, the value of sales fell 20% compared to the same month in 2020. So far this year, the projects started to build have fallen by 1.7%.
Given that an uncontrolled bankruptcy The Evergrande earthquake will cause tremors outside China, and thus the economy, analysts agree that there may be some kind of intervention by the Chinese government to prevent a catastrophe, especially in a year in which President Xi Jinping is preparing to extend his term in 2022. “The goal [de las medidas del Gobierno] it is reducing risk, not triggering a crisis ”, recalls by videoconference Bo Zhuang, from the American investor Loomis Sayles in Singapore. It will not be a rescue, as Beijing wants the case to serve as an example for other businessmen and send the message that the era of excess – be it in profits, be it in debt, be it in dubious corporate practices – is over. But yes, Zhuang considers, probably “by sending working groups” to analyze a possible restructuring or through specific decisions by local governments.
There will not be a “Lehman Brothers moment” like the bank failure that precipitated the 2008 financial crisis. Evergrande is not as closely linked to the international financial system as that entity. But, “it seems clear that even in an orderly restructuring, China’s real estate sector is likely to face downward pressure,” Citibank analysts write in a note.
Bad news for the Chinese economy, which was already growing at a slower pace since before the pandemic. More than a year after Beijing took the coronavirus for granted, consumption continues without raising its head. “The debt-fueled housing market is likely to deal a second blow to growth and will weigh against investment, spending and confidence. And when housing bubbles burst, the consequences for the economy are typically material and long-lasting, ”Nielsen recalls. The agency Moody’s believes that China “will seek to avoid social and financial instability by solving the problems of Evergrande, but various sectors could incur economic losses.”