Moody’s Analytics: China’s real estate market is too big to fail

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KUALA LUMPUR: Moody’s Analytics expects China to do everything possible to avoid a hard landing as it seeks to tame the housing market as financial pressure on developers has increased.

In his Tuesday research note, he said the long-term goal of deleveraging the debt-ridden industry and lowering housing costs will not change.

The Chinese real estate market is cooling off, with measures of price growth, housing starts and home sales that have slowed significantly in recent months, he said.

Below is the Chinese real estate market report and Moody’s Analytics views:

New home prices rose 3.5% in August from a year earlier, the weakest growth since the real estate market rebounded after the pandemic fallout in June 2020.

Of the 70 major cities for which China publishes monthly house prices, 20 recorded monthly declines in new home prices in August and 33 in resale prices.

Even in leading cities such as Guangzhou and Shenzhen, home resale price inflation has slowed significantly compared to the previous month.

Home sales contracted in July and August, with square footage sold falling 18% year over year in August.

The pace of new housing starts has been quite slow compared to the same period over the previous two years, with some real estate developers halting new projects amid tighter regulatory control of their financial health.

Chinese policymakers released new funding rules called “the three red lines” for real estate companies in August 2020, prohibiting companies with excessive leverage ratios from taking on more debt.

Other regulatory actions

Since then, many other regulatory measures have been taken to contain the sharp recovery in house prices following the pandemic crisis.

Regulators fear that an overheated real estate market could remove resources and capital from the real economy and increase the risk of financial instability.

They tightened restrictions on bank lending to the real estate sector, prompting some banks to raise mortgage rates. Some local governments have also tightened eligibility for home purchases and set price caps for sales.

The impacts of the curbs have become stronger than expected, raising concerns that they will get out of hand. As real estate sales decline, the financial pressure on developers has started to increase, leaving many people in a cash crunch amid battered property sales, tight borrowing, and high financing costs. Growing concerns about the debt repayment capabilities of developers have rocked the financial market.

China Evergrande building in Hong Kong

Evergrande Group, the country’s second-largest real estate giant with $ 300 billion in liability, is the most compelling example in the headlines recently.

Evergrande is not the only one struggling. In the first half of the year, 12 Chinese real estate companies reported bond defaults, amounting to CNY 19.2 billion, according to data from Wind. This represented nearly 20% of total corporate bond defaults in the first six months of the year, the highest of any industry.

Real estate companies face a historic debt maturity of CNY 1.28 trillion this year, but total bond issuance in the onshore and offshore markets in the first eight months was less than CNY 700 trillion, down 21% from the previous year, according to the Beike Research Institute. .

The sector’s funding environment will become more difficult due to declining investor confidence, which will put strong liquidity pressure on companies that depend on new borrowing to repay old debts. Foreign investors are equally nervous about a hard landing, as 30% of the debt has been issued abroad.

Banks see bad loans

As developers struggle to repay their debts, banks are seeing more and more bad debts. Non-performing loans to the real estate sector jumped 30% at the five largest banks in the first half of the year.

Despite the recent slowdown in mortgage lending after regulators imposed ceiling ratios on banks’ mortgage lending, outstanding loans to the sector still represent 27% of the CNY 186 trillion total in loans at the end of June, of which 20 % come from mortgage loans to households and 5% from developer loans.

Although banks’ direct risk exposure to real estate developers is under control, the ripple effects of a faltering real estate sector on buyers and entrepreneurs are potentially serious.

In addition, among the 40 listed Chinese banks, 11 failed to meet the mortgage-to-total loan ratio requirement while 10 exceeded the total mortgage-to-mortgage ratio threshold at the end of the second quarter.

This reflects regulatory pressure that would restrict bank support to the sector.

Developers are now resorting to asset sales and aggressive apartment price discounts in order to recover funds. Unfortunately, it doesn’t work well.

Prospective buyers are taking a wait-and-see approach, as their expectations about short-term house prices may have been turned upside down.

This can generate a negative feedback loop in the short term, as lower prices fuel lower expectations, leading to delayed purchases and increased pressure on developers to lower prices further.

Price expectations aren’t the only reason holding back potential buyers. Rising income uncertainty amid regulatory crackdowns on a range of private industries and the authorities’ broader pursuit of “common prosperity” are contributing factors.

Drastic crackdowns on the country’s burgeoning sectors such as technology, private education, gaming and entertainment are likely weighing on property sales, as employees in these sectors are relatively well paid and represent a significant burden on property sales. large group of potential buyers.

Recent regulatory measures have shaken the sense of security of high-income workers, making them more cautious about investing in real estate. ByteDance employees suffered a 20% pay cut a few weeks ago after the company ended a weekend overtime policy due to regulatory pressure.

The repeated mention of “common prosperity” and government pressure to curb excessive income will likely be headwinds for the real estate industry for the foreseeable future.

Home buyers on the hook

Compared to developer defaults and falling house prices, Chinese authorities are more concerned that developers will fail to deliver projects to homebuyers who have put their or even their parents’ savings on purchases. .

The Evergrande group has more than 1,300 real estate projects in more than 280 cities in China, according to the company’s website.

Many projects have been put on hold as the developer struggles to pay their contractors and suppliers. This has fueled fears that his bankruptcy would leave homebuyers with nothing but a huge mortgage to pay off.

Such a scenario would be devastating for the economy and could trigger social unrest. Policymakers are expected to do everything in their power to prevent this from happening.

Housing is the most valuable asset for Chinese urban households. In 2019, housing accounted for 59.1% of total household assets, while other financial assets only represented 20.4%.

The result is a high mortgage burden, representing 75.9% of total household liabilities. In more mature economies like the United States, the weight of financial assets is much higher and housing represents less than half of household assets.

Therefore, any shock to China’s real estate values ​​will have significant impacts on household balance sheets, especially their debt leverage ratios.

This in turn will have implications for consumer behavior through the wealth channel.

Implications for public finances

China’s public finances are also closely linked to the housing market. Revenues from land sales and property taxes represent a substantial portion of government revenues.

According to a study by a Chinese investment platform Gelonghui on land sales as a percentage of local government revenues for 44 major Chinese cities, 20 of them had ratios greater than 100% in 2020 and 19 greater than 50%. , a sign of deep tax dependence on the real estate sector.

The slowdown in the housing market in recent months led to a slowdown in land sales in August, putting pressure on already strained local finances.

Given the gigantic size and importance of the sector to the economy, we expect China to do everything possible to avoid a hard landing, especially at a time when the economy faces uncertainty. heightened amid a pandemic and other growing headwinds such as vulnerable domestic consumption and latent geopolitical tensions.

The long-term goal of deleveraging the debt-ridden real estate sector and lowering housing costs will not change, but the pace will need to be managed with caution.

China could reassess its debt, common prosperity and environmental goals priorities for better policy coordination to avoid a perfect storm pushing developers into a corner. Some government support will be necessary, and should arrive soon, to ensure greater financial and economic stability.


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