Is the Chinese real estate bubble about to burst?


Last week, the national Bureau of statistics announced that the real estate prices dropped in 70 major Chinese cities. On average, between February 2014 and February 2015, prices fell by 5.7%.

According to the Shanghai daily newspaper, several private surveys revealed that during the year, sales dropped by 11% in 48 cities across the country. In the first two months of the year, the government land sales collapsed by 36.2%.

In short, people no longer buy from property developers who consequently stopped purchasing land to the government. In a country where real estate accounts for 20% of the GDP and where housing is the main source of savings, this price drop could have a real impact on the world’s first economy.

In 2013, a study conducted by economist Gan Li showed that 65% of the savings of Chinese households were dedicated to real estate. In early 2014, M. Li said: “the current housing stock is enough for every household to own a home. However, each year we build approximately 15 million new houses and apartments. The Chinese real estate bubble will burst. But no one knows when.”

Property developers are highly indebted

Although the Chinese real estate crisis recalls the early days of the subprime crisis, there are notable differences. The Chinese usually buy their homes with cash and try to avoid getting into debt as much as they can. They have much less pressure to sell, unlike the Americans during the subprime crisis, who must pay off significant interests in addition to the capital.

On the other hand, the Chinese real estate bubble is probably bigger and not everything depends on the consumer. The debt burden of the Chinese consumers represented 23% of the GDP at the end of 2013, mostly for mortgage loans.

The prices of real estate in Chinese cities such as Shanghai or Beijing have been multiplied by 40% since 2009. HSBC compared the total value of residential housing to GDP and discovered that China had exceeded the level reached by the Japan in 1990, just before the bubble burst and the collapse of the real estate market.

At that time, residential real estate in Japan was worth 3.7 times its GDP. Hong Kong, which was 3 in 1997, and the United States about 1.7 in 2006 were pale in comparison.

The investigation of the Research Centre on Chinese household spending is quite instructive: in Chinese urban areas, more than one home out of five is vacant, with 49 million units sold, but vacant, and 3.5 million homes unsold. The proportion of apartments for rent in Shanghai, Beijing or Guangzhou is about 1 to 1000.

“Chinese property developers are mainly responsible for this real estate bubble”, said economist Richard Vague. According to him, “China has simply produced and built too much, thanks to over-investment in steel and cement companies. China has amassed the largest accumulation of bad debts in history.”

At the moment, the Chinese private debt is about 211% of the GDP. It is almost the same level observed before the bubble burst in Japan and a large part of this debt is based on real estate.

According to Richard Vague, “China could currently have from 1.75 to $ 3.5 trillion worth of toxic loans – a figure well above the $ 1.5 trillion of capital available to the entire Chinese banking system.”

Evergrande to be the first affected

As was the case with the US subprime in 2008, the housing bubble has greatly weakened some of the top property companies in China.

On 17 March, Evergrande Real Estate Group, one of the largest Chinese developers, obtained a $ 16 billion funding from large public banks as a rescue plan.

The $ 4.1 billion injected into Countrywide Financial by Bank of America in early 2008 seem very small in comparison. One can only hope that losses will not multiply in the same way as it did with Countrywide.

According to documents provided by the company in June 2014, Evergrande’s equity amounted to $ 15.74 billion. Therefore, without the $ 16 billion rescue plan, the company would have gone bankrupt.

Rumours claimed that Evergrande was unable to pay off its debt with one of its main construction contractors which stopped all activity afterwards. Analysts were speculating that to stay afloat, the company would sell all of its assets to 55% prior to the rescue plan.

As with Countrywide and Bank of America, Chinese banks have managed to plug the gaps, because property developers and construction companies are intertwined in a Ponzi scheme. If a chain link does not pay, the following will default.

The Chinese banking system and by extension, the Chinese regime, are both at the end of the chain. They are too big to fail and too big to consider a rescue.

© Graydon Manor