Real estate is (again) troubled

The second largest economy in the world is showing signs of difficulty. Chinese economy is going through hard times following its return to openness after the pandemic, and the bankruptcy of the real estate giant Evergrande is probably a strong reason.

China is known to be the world’s largest exporter; indeed, its economic empire is built on large scale production, low labor costs and a strong presence of the government as a sharp regulator of the economy. The effective policies enhanced by its regulators led China to have experienced high rates of growth over the last decades: its GDP annual growth rate averaged 8.92 percent from 1989 until 2023, against the average of 1.65% in Europe since 1996 and 2.3% annual average GDP growth of the US. Overall, its GDP increased by an astonishing amount of +4988% over the last thirty years.

The economic boom of this country began in 1990 with the policies enhanced by the leader Deng Xiaoping to open the country to global opportunities. To achieve growth and gain a strategic position in the international landscape, the government bet on the large number of poor people in rural areas and of its strong influence in all aspects of the economic life of the country. Firms and factories started to receive incentives by the state to expand production, and to do this they had to hire workers. To adapt to the requests of the job market and to have access to a better quality of life and higher wages, around 400 million families migrated from rural areas to cities over the period of 20 years. 

The priority of the government policies was to quickly have new workers placed into factories, and so they pushed for a fast construction of new houses to host the new immigrants. Real estate agencies were the most profitable sector of the economy at the moment because they could borrow money at extremely low interest rates and were encouraged to build new houses. The money obtained with favorable conditions were used to purchase new (cheap) land, used as collateral to ask for more credit. On the other hand, people who wanted to buy a new house were also given loans with very low interest rates and with a low collateral. In addition, the government sold land to build at very low prices and financed construction of public infrastructures to increase the value of properties in degraded areas. Investors started to realize the potential of the housing sector, and so they pumped even more money into this industry, further increasing the demand and the price of new houses. Real estate companies were gaining under all aspects: they could borrow money at very favorable conditions, had a huge demand for their apartments and were in an industry with a high potential of growth. The real estate industry became a pillar of the Chinese economic boom, accounting for a third of its domestic economy.

It is in this extremely favorable environment for the housing market that Evergrande was born, founded in 1996 by Hui Ka Yan, son of those poor rural immigrants who looked for better living conditions in large cities. The company soon started to expand, building lots of new apartments and selling them even before they were completed. The firm raised $9bn in its Hong Kong market listing in 2009, and since then grew until reaching its highest market cap of $354 billion at the end of 2017, which made Hui Ka Yan the richest man of China in 2017. To diversify and finance its debt, it also made investments in other areas, like solar panels, water, football and many more and with this numbers, Evergrande became the biggest player in the real estate industry. In 2017 the situation changes: there are no more so many people coming in cities from rural areas and investors realize the fact that the huge growth of this industry was no longer based on concrete earnings from selling of apartments, but it was prey of speculation. In this typical bubble situation, a little change is enough to cause a disaster. In this situation of predictable reduction of profits, companies like Evergrande ignored the signals and kept building and building. It is estimated that in China there are around 85 million uninhabited houses.

However, in 2017 the number of houses in phase of construction was much higher than new willing buyers, and the investments of Evergrande made to repay its debt started to go bad. It is in this situation; the company has to ask the help of the government to restructure its debt and keep operating. The intervention of the government to save Evergrande was expected, also given the strong presence of the Chinese Communist Party in the economy, also in private firms. However, this didn’t happen, and the government responded with the “Three Red Lines” policy to limit the huge indebtedness firms. This policy put a cap to debt-to-cash, debt-to-assets, and debt-to-equity ratios to limit the indebtedness of companies like Evergrande. This all was made to make sure that companies have enough money to repay at least its short-term debts and to operate even in a situation of crisis. Evergrande in 2020 had a total debt of $300 billion, much more than its possibility to repay this amount. As a consequence, the company no longer had access to credit to finance its debts, and so tried to cut its costs and capitalize its investments to pay short term creditors. However, this is not enough, and the company is forced to declare default on its debt in 2021. At the moment in which this article is written, Evergrande has already obtained two postponements of the final decision of liquidation or restructuring of its debt by the Hong Kong court.

This crisis of the real estate industry is one of the causes of reduced growth in China over the last years, while other reasons are the rigidity of the Zero Covid policy that hit the manufacturing sector and the depreciation of the yen. As a consequence, another negative factor is added to this already bad economic situation, which is the outflow of capital from China. In this situation of deflation and slowdown of growth, Chinese investors are moving an estimated 50 billion dollars a month outside their country, by purchasing gold, luxury apartments in occidental cities and opening bank accounts in foreign countries to subscribe insurance products that resemble bank certificates of deposit. In other words, they are parking their money in safe places in case the Chinese economy conditions worsen.

Even though the Chinese government always tries to give a positive impression about its economy, this time there are concrete signals that things are not going as desired; for example, it stopped publishing the indexes about consumers’ confidence and youth unemployment. On the 29th of January this year, 2024, Evergrande representatives showed up in front of Linda Chan, the judge of Hong Kong Court to receive the final verdict about the future of the company. After several delays and postponements, Linda Chan decided that, because of the impossibility in matching the restructuring requests of Evergrande and the claims of its credits, the company must embrace the process of liquidation, thus bringing an end to the story of the most indebted society in history.

To conclude, even though the bankruptcy of a large real estate firm such as Evergrande may seem to concern only its native country, we should pay attention to the next moves of the Chinese government, because the economic situation of China has concrete consequences on the rest of the world. It is true that every crisis has its own causes and effects, and each economic event in general is unique, but we should well keep in mind what happened when the last housing market crisis hit the United States. It is true that the Communist Party has a huge power in its economy and that often it can bend things at its own pleasure, but we must keep in mind that we are talking about the second largest economy of the world.