Opinion: It is dangerous to underestimate China’s property crisis

Since China’s economic boom started, there has been a common saying that glamorous Tier-1 cities only make up a small part of the Chinese narrative, and that the real China secretly unfolds itself in smaller Tier-3 cities and even villages in the countryside.

So, when angry Chinese homebuyers across hundreds of cities stopped their mortgage repayment on stalled presold units in July, or when a fresh group of savers started cashing in their wealth management products to pay off mortgages, the implications about China’s property market were clear.

Their reaction is part of an ongoing crisis where property developers, banks, and the whole financial system could be in trouble.

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A recent chat with a restructuring expert on Chinese enterprises revealed the complexity of China’s current property crisis.

To grasp the lifeline of China’s housing market, he looks at second-hand home prices and the affordability of each city.

“These developers are huge. They have thousands of projects around China. So, every market is different. It’s not just a Chinese market. You have to go market by market to see what the affordability, supply and demand, and the inventory is in that city,” the Hong Kong-based managing director of a restructuring consulting firm told AsianInvestor.

This is echoed by Nomura, which believes that contract sales data from developers are of much higher quality than selective data such as the Wind 30-city data, which over-represent large cities.

Recent data released by the firm on Sep 1 showed that the top 100 developers in China reported 15 consecutive months of contraction in contract sales in August, as new home sales growth in volume and value terms remained deeply negative at -36.6% y-o-y and -32.9%, respectively, albeit up from -47.9% and -39.7% in July, with the improvement mainly being derived from a low base.

The property sector has long been one of the most important growth engines for China.

For the average Chinese household, as much as 80% of their wealth is built around their homes. So, the impaired sentiment and declines in home prices imply a decrease in Chinese people’s wealth.

The central government has stated that they will take all measures necessary to resolve the crisis, but questions remain on whether those measures will be enough, seeing that the true cost of the crisis is still unclear.

On Aug 19, China’s housing ministry, Finance Ministry and the People’s Bank of China issued a joint statement that they will offer special loans through policy banks to ensure unfinished property projects can be delivered to homebuyers, although it did not specify details.

Days after that, a Bloomberg report citing anonymous sources said the loan is worth Rmb200 billion ($28.7 billion), in line with Nomura’s estimate that the funding would need to be something from Rmb200 to 300 billion to be an effective initial rescue plan.

But the restructuring expert thinks the amount, if it is the official number, is “pretty small” compared with the problem. And the question mark remains on how the special loan will work, how banks are involved, and whether it can really reverse the major decline in home prices.

A Hong Kong-based senior investment executive for Asia at a multinational life insurance company with whom I spoke agreed.

“The property rescue plan may keep unfinished projects from stalling. But we will definitely see a slowing of property sales growth and you're seeing that reflected along a lot of these multiples on the credit side. You're seeing a lot of these are expected to default with bond maturities coming out over that one-to-two-year period,” the life insurer’s senior investment executive told AsianInvestor.

“You are pricing in a lot of risks. I think banks are also being impacted a lot on this,” he said.

“So, it has a large systemic risk that could basically spread across the financial system, from the developers to the banks to the wider financial market,” he said. “The size and scale of it, I think is quite large. This will definitely have an impact on GDP growth going forward and also the consumer wealth effect.”

Still, there is a general consensus among the investment community that the central government’s early intervention is a positive indication of its intention to stabilise the situation.

“Overall, I think that this is not something that would derail a lot of the growth potential for China over the long term,” the life insurer investment executive said.

“One way or another, no matter what plans they have in mind, they must spend a lot of money and effort on this, and it has to be fast. The window is narrow for them to react slowly as they used to,” a Hong Kong-based head of emerging market equities at a European asset management firm told AsianInvestor.

But the experts generally agreed that the issues won’t be resolved in 2022.

“The longer the problems persist, they become more complicated,” said the restructuring expert.

In China’s case, the “high debt, high leverage, high turnover” development mode of property developers has been there since day one of the housing market boom.

So, it’s going to be a U-shape rebound rather than a V-shape, the expert said.

Two things need to happen – if the fundamentals of the housing industry return to normal and the restructuring of big deals progresses, then global capital will come back to look at those deals, he said.

The crisis even creates opportunities for investors that can differentiate the good credit names from the bad ones, especially among state-owned names with deep pockets.

But until the central government’s rescue plan becomes strong, convincing and clear enough, it’s still a developing crisis that can’t use enough extra cautiousness.