The Current Real Estate Turmoil in China

China’s real estate sector is in turmoil due to various factors, ranging from low investment to declining trade numbers. It has far-reaching implications and is threatening the country’s economic growth. Therefore, the government has undertaken certain policy measures to limit the damages. However, a more extensive plan is needed to deal with this issue effectively.

The chaos in China's real estate sector has destabilized the domestic economy. This crisis is marked by substantial losses experienced by major property developers, and REITs. China Evergrande Group posted combined losses totaling USD112 billion for the fiscal years 2021 and 2022. The debt crisis is escalating, with Country Garden, one of China's top five developers, perilously close to a bond default. It has projected USD6–7 billion for the first half of 2023.

Factors such as diminished investments, weakening domestic demand, deflation worries, and unfavorable trade figures have been quoted as the reasons for the current situation. This has led to IMF revising down China’s GDP growth projection to 5.0% for 2023 and 4.2% for 2024, a 0.2% and 0.3% downward revision from earlier estimates. The negative state of China's real estate market will have far-reaching implications on various sectors and its overall economy.

Declining Property Prices

China has implemented the "three red lines" policy, outlining three precise balance sheet criteria that developers must adhere to if they intend to secure additional debt. These regulations mandate developers to restrict their debt relative to their company's cash flow, assets, and capital levels.

However, this crackdown has dampened economic growth, given that the real estate sector contributes directly and indirectly to nearly one-third of the economic activity in the world's second-largest economy.

Official data revealed that China's new home prices declined for the first time this year in July, dropping 0.2% month-on-month and 0.1% year-on-year, as calculated by Reuters based on data from the National Bureau of Statistics.

Existing home prices are plummeting at least 15% in prime neighborhoods of major metropolitan areas like Shanghai and Shenzhen, as well as in more than half of China's tier-2 and tier-3 cities. Even areas near Alibaba Group Holding Ltd.'s headquarters in Hangzhou have seen a steep drop of approximately 25% from their late 2021 highs. While official home-price indexes suggest a less severe downturn, experts believe they may underestimate the true extent of the crisis due to outdated methodologies. Even top-tier cities like Shenzhen, once considered immune to housing market fluctuations, have experienced a 15% decline in existing home prices over the past three years.

The challenge lies in lack of accurate data, as all sources in China face substantial obstacles in tracking home prices. According to Goldman Sachs China economists, there is no perfect gauge to assess the housing market.

The discrepancy in home price perceptions is partly due to the diverse policy tools available to Chinese authorities. Unlike countries like Australia, Singapore, or the US, China can implement unique measures such as restricting home purchases for non-locals or imposing limits on property ownership. The uncertainty in housing price statistics further complicates policymaking efforts, potentially hindering the development of effective strategies to stabilize the market. As the housing market continues to fluctuate, finding the right balance between downward pressures and easing hopes remains a key challenge for China's policymakers.

Some of the main reasons for the real estate crash are:

1. COVID-19 Lockdown - The main reason for the decline in rates in the property market is the stringent lockdown measures imposed during the pandemic. These restrictions disrupted construction projects, causing delays and uncertainties in project completions. Consequently, potential buyers hesitated to invest, dampening overall demand in the sector. To make matters worse, some individuals, facing financial uncertainties, ceased paying EMIs as a form of protest or financial strain. This accumulation of unpaid EMIs is now posing a significant threat to the asset quality of banks, creating a challenging situation for both the real estate industry and the financial sector in China.
2. Property Market Turmoil - China's property market remains ensnared in a crisis, with prominent developer Country Garden projecting a potential net loss of up to USD7.6 billion for the first half of 2023. This projection is indicative of a downtrend in the real estate market, contracting gross profit margins, and foreign exchange fluctuations. The situation is exemplified by Evergrande, the world's most indebted property developer, which recently revealed a combined loss of USD81 billion over two years (2021 and 2022).
3. Investment Decline - Investment in the Chinese property market plummeted nearly 8% year-on-year in the first half of 2023. This sharp decline in property investment is worrisome, as the real estate sector accounts for a quarter of China's economy, making it a critical driver of economic growth.
4. Youth Unemployment and Reduced Consumption - Youth unemployment has surged since January 2023, reaching an all-time high of 21.3% in June 2023, as reported by the National Bureau of Statistics of China. This is expected to reduce disposable income and subsequently lead to decreased consumption and demand for goods and services, further exacerbating the economic challenges.
5. Trade Woes - In July 2023, Chinese exports faced a substantial setback, registering a notable 14.5% year-on-year decrease, marking the most pronounced decline in over three years. From January to July 2023, exports contracted 5%, illustrating diminishing foreign demand for Chinese products. Conversely, imports decreased 12.4% annually in July 2023, marking their fifth consecutive drop and reflecting diminishing domestic demand.

Impact of the Real Estate Turmoil

The repercussions of the real estate issue extend far beyond the property market alone. It has far-reaching implications across various sectors of the Chinese economy. Struggling property developers and waning consumer confidence are dampening the construction industry, leading to diminished demand for projects and subsequent job losses. Consequently, the banking sector is grappling with rising defaults and unpaid loans, intensifying credit risks and impacting overall financial stability.

China's manufacturing and materials industries are also feeling the effects of the weakened real estate market. Disruptions in production and supply chains have cascading effects, leading to declining property values and reduced household wealth that has affected consumer spending and the retail sector.

The declining demand is mirrored in pricing dynamics, with the economy’s ongoing battle with deflation. Consumer prices fell 0.3% in July 2023, the first such drop since February 2021, and the producer price index (PPI) fell 4.4%, extending its downtrend for 10 months. These deflationary indications underline massive economic deceleration, driven by factors such as a sluggish real estate sector, weak trade, and restrained domestic demand, intensifying concerns about potential stagnation.

Policy Responses

As of July 2023, China has continued its efforts to boost economic growth and provide support to the struggling property market. Measures include extending loans to developers and decreasing mortgage rates. However, these measures may not completely stabilize the economy considering the various challenges outlined above, underscoring the immediate need for comprehensive strategies to address broader issues.

Forecast

JPMorgan has revised its global forecast for corporate high-yield defaults in emerging markets upward, primarily due to escalating concerns of contagion within China's property sector, potentially stemming from a Country Garden default.

In an August 15, note the US-based investment bank increased its 2023 global default forecast to 9.7% from 6%. Furthermore, it adjusted its forecast for Asia's high-yield default rate to 10%, up from 4.1%. However, this figure decreases significantly to just 1% when excluding China's property sector.

JPMorgan anticipates that China's property market will contribute nearly 40% to all default cases in 2023, followed by 35% from Russian corporate entities and 12% from Brazilian issuers.

Conclusion

The turmoil in China's real estate sector has had profound implications for the nation's economy, ranging from declining property investments and youth unemployment to weakened consumer spending and deflation concerns. While the government has taken steps to mitigate the crisis, a comprehensive and multifaceted approach is needed to address the broader economic challenges facing China. The nation's economic prospects remain uncertain, and it will require careful planning and effective policies to navigate these turbulent waters.