Real Estate Rumbling

Xiao Xin

Updated guidance for the real estate industry seeks a delicate balance between deleverage and overcorrection as China transitions away from economic reliance on the property sector

Of all the sectors capable of starting a profound domino effect that would touch the entire Chinese economy, the property market is the clearest frontrunner. For this reason, even the subtlest tweaks to real estate regulatory policies are often intensely scrutinized for possible broader economic implications.

Scouring changes in policy tone seems especially imperative in the wake of the Evergrande crisis, as a debt crunch implicating some of China’s biggest property developers is awakening homebuyers and investors to a seismic shift in the real estate sector.

At that very moment, December’s Central Economic Work Conference, known as an annual tone-setting meeting, commenced. The conference issued updated guidancefor the real estate industry seeking to foster a virtuous cycle and healthy development of the property sector. It was accompanied by reiteration of a phrase first mentioned at the 2016 conference: Houses are for living in, not for speculation.

According to economists and industry watchers, the crucial update offered a glimpse into the country’s resolve to curb property speculation and escape the deleveraging conundrum.

Evergrande in the Limelight

Property heavyweight China Evergrande’s debt problems made global headlines in the second half of 2021, stirring concerns that the real estate sector, responsible forroughly a quarter of China’s GDP, could be experiencing a Lehman moment.

Within months, the Hong Kong-listed developer known for its finely decoratedapartments, and Xu Jiayin, its billionaire founder, had been knocked off lofty perches.

The company had run into difficulties inpaying off its bonds and wealth management products. Notably, it was stumbling throughinterest payments on its US dollar bonds that were considered last in line in the event ofliquidation. Mounting fears among overseas investors about default on overdue interestpayments fanned worries about the economy at large.

Xu hovered near the top of numerous rich lists and earned the internet nickname “belt brother” after photos of him wearing a gold- buckled Hermes belt while attending theannual Two Sessions in 2012 went viral.

In stark contrast to the fanfare-filled old days, media coverage of Xu has centeredon Evergrande’s debt predicament that purportedly prompted the developer tycoon to sell personal mansions in Hong Kong, fancy homes in Shenzhen and Guangzhou, and several private planes. He also took out new loans against his equity in the company as part of efforts to set Evergrande in motion again.

The Evergrande crisis exemplified many problems that have plagued otherdevelopers, especially private companies like Kaisa Group (also Hong Kong-traded), on an expansion spree over the past few years.

The emergence of debt problems and bond defaults, among other crisis-mongeringphrases, has likely shaken public confidence in the seemingly everlasting bull run inChina’s property market. Rising home prices, especially in bigger cities, over the pasttwo decades have underpinned a rags-to-riches fantasy in the case of lucky early movers. This has nonetheless rendered home ownership a difficult goal for many others.

Such concerns culminated in a momentous evening in early December when theGuangdong provincial government summoned locally headquartered Evergrande afterthe property developer warned earlier that day in a filing with the Hong Kong stockexchange that it may fail to honor its obligations in the amount of about US$260 million.

After the news, three major financial regulators, the central bank, the banking andinsurance regulator, and the securitiesregulator, quickly moved to reassurethe markets in rare simultaneous late-night remarks that the Evergrande issue shouldn’t be a concern for the country’ s capital and housing markets at large.

Attributing Evergrande’s debtproblems mainly to its poormanagement and blind expansion,the central bank mentioned supportfrom relevant departments to facilitate overseas bond repurchase.

The central bank’s remarksindicated that “there has been nomajor deterioration in the housingmarket and the emergence of risksassociated with certain developers can be attributed mostly to their excessive expansion,” according to the English- language daily Global Times, citing Yan Yuejin, research director at Shanghai- based E-house China R&D Institute.

Those events happened to occur only a few days before the annualeconomically themed conference.

Embracing Changes

For the first time, the pushfor “a virtuous cycle and healthydevelopment of the property sector”was written into the annual conference takeaways, pointing to a delicatebalancing act between overcorrectionand deleverage.

The authorities’ resolve againstspeculative housing bets was tobe bolstered by measures focusedon long-term rental properties,affordable housing, and supporting the commercial real estate market to better meet homebuyers’ reasonable housing needs, according to a statement issued after the conclusion of the three-dayCentral Economic Work Conference on December 10.

In so doing, policy arrangements that vary by city were planned to supportoperation of a healthy property sector.

Strengthening of expectationsmanagement alongside rooting forreasonable housing needs wouldreduce deviations amid the real estateoverhaul such as overcorrection, withefforts to satisfy first-time homebuyers and upgraders’ inelastic demands,wrote analysts from the Bank ofCommunications in a research note circulated following the conference.

The statement is indicative of anextension of policymaking shrewdness beyond mere property transactions,said analysts, expressing expectationsfor an official endorsement ofresidents’ inelastic demands as wellas normal property development,mergers, and the resultant lending and debt issuance needs of real estate firms.

Some said the deliberately lesshawkish tone indicates a pivot towardstabilization as the conference made a caveat to three major challenges facing the Chinese economy in 2022: demand contraction, supply shocks, and theweakening of expectations.

A stable property market certainly matters considerably to the economy amid continued fallout from theprolonged Covid-19 pandemic andsweeping reform moves on multiple fronts if a grand common prosperity vision is to materialize.

The late-night remarks by the three regulators gave property industryparticipants a sigh of relief in the form of easing of the reins on property-related funding.

Further, the central bank and thebanking and insurance regulator issued a notice on December 20 encouragingbanks to proceed with loan services formergers and focus on championingthe acquisition of premium projects at troubled major real estate firms by select property firms.

Homebuyers suddenly found it easier to secure mortgage loans.

Outstanding personal housingmortgage loans rose by 401.3 billionyuan (US$63.14 billion) to 38.1 trillionyuan (US$5.99 trillion) in Novemberof 2021, central bank data showed. Themonthly addition increased by 53.2billion yuan (US$8.36 billion) fromOctober. The monthly data was only the second such numbers the central bank made publicly available.

Evergrande seems to have emerged from its worst low. In a post on itsWeChat official account on December 26, the company disclosed that thenumber of projects as a percentageof its total development nationwidehit 91.7 percent after rebooting, up40 percent from the level in earlySeptember.

Destined to Decline

Whatever preluded the fine-

tuned policy tone and consequentlyrevived home buying and propertydevelopment activities will by no means deviate the Chinese economy from itsshift away from real estate, essentiallya sunset industry, as it gives way to sci-tech innovation-driven sectors.

A look back at the country’sproperty policy over the pastfive years since the much citedslogan “homes are built to livein, not for speculation” emerged from the annual conference in2016 speaks volumes about anindustry destined for decline.

About two months before the2016 conference, major citiesincluding Beijing, Shenzhen,Guangzhou, and Suzhou wereselected to roll out property curbs, mainly restrictions on homepurchases and mortgage loans.

The tightening trend continued into the next year when theeconomy revolved around twomain tasks: destocking anddeleveraging. As a consequence,China’s macro leverage ratio,noticeably buttressed by realestate-related leverage, fell for the first time in 2018.

Throughout 2019, realestate fine-tuning policyannouncements across thecountry amounted to 620, arecord high and up 38 percentfrom the 2018 level, accordingto Centaline Property ResearchCenter. The property consultancy opined that the harshest ofproperty curbs are now over andthat the housing market shouldstabilize.

Nonetheless, the real estatesector first saw the new financing rules drafted by the central bankand the Ministry of Housing and Urban-Rural Development inAugust 2020.

Commonly known as the“three red lines,” the game-changing new rules crystallized the requirements developersmust meet when seeking toborrow more.

The metrics consist of threelimits: a maximum 70 percentliabilities to assets ratio excluding advance proceeds, a 100 percentceiling on net debt to equity ratio, and a minimum cash to short-term debt ratio of one.

Based on how many limitsdevelopers violate, they will becategorized into different groups that suggest varying caps on their debt expansion. If a developersucceeds in passing all threethresholds, it becomes eligiblefor a maximum 15 percent debtgrowth in the subsequent year.

A group of 12 propertydevelopers including Evergrande were selected to test the three red lines before the new rules wentinto effect industry-wide.

Moreover, at the end of 2020,the central bank and the bankingand insurance regulator unveileda regulation that caps banks’outstanding property loans asa percentage of their total loansand their outstanding mortgagesversus total loans, apparently atougher inhibitor targeting anysigns of excessive real estate loans.

Guo Shuqing, chairman of the China Banking and InsuranceRegulatory Commission,provided an exemplary accountof the overall tough stance onthe property sector in an articlepublished in late 2020 describing real estate as the biggest “greyrhino” as measured by currentfinancial risks, citing property-related lending that represents 39 percent of bank loans in addition to bonds, equities, and trustfunds that foray into the market.

Despite being overshadowedby the Evergrande crisis, theprinciple of “houses are for living in, not for speculation” remained the cornerstone of the propertyportion of the Central EconomicWork Conference takeaways.

Bumpy Road Ahead

All these propertydeleveraging moves thatsomewhat settled for reality-based recalibration in propertyfinancing also served as a wake-up call for an eagerly pursued yet tough-to-reach goal: rebalancing the economy toward being techinnovation-oriented and driven by the domestic market.

For starters, a falteringrecovery in domesticconsumption, as evidencedby the overall weaker-than-expected retail sales growthamid the pandemic and a flurry of antitrust moves againstunchecked expansion of capital in the platform economy, thebackbone of China’s digitaleconomic prowess, complicated the rebalancing.

Secondly, housing speculation could still make an easycomeback. A typical instancewas a prominent rise in homeprices especially in Shanghai and Shenzhen during 2020, as buoyed by the virus-targeted monetaryeasing and eased restrictions onhousehold registration in thesetwo metropolises.

Craving for property-powered growth remains prevalent among the country’s less developedregions that have borne the brunt of lackluster housing activities in the wake of the aforementionedstringent financing curbs.

The government of NortheastChina’s Heilongjiang Provinceposted a late-night statement onits official website on December20 claiming that local housingauthorities had hosted a property- focused meeting mandating apush for real estate growth tosprint at full speed.

The post had been removedfrom the provincial government website by the next day.

Unnerved by moderationof home prices, both first andsecond homes, a total of 21cities had issued administrative mandates that cap local homeprice decline as of November,according to Chinese news siteguancha.cn.

Evidently it may take longerthan expected for China to wean off habitual reliance on theproperty sector.