In 2020, the debt crisis of Chinese real estate giant Evergrande, one of the largest junk bond issuers in Asia, sent shivers down the spine of the market and investors. Last year, the Chinese Communist Party also issued a series of real estate regulation policies, and industry insiders have warned that the “gray rhinoceros” of China’s real estate debt is approaching.
On the other hand, as of Jan. 16 this year, more than 15 real estate companies on the mainland have seen top-level personnel changes, including the departure of their chairmen, presidents and other senior executives; in addition, while the vacancy rate of Grade A office buildings is surprisingly high, the prices of second-hand properties have risen in many places. There is also the fact that China’s real estate offshore debt this year will be more than double that of last year, and a series of defaults will inevitably occur. Who will carry this much debt?
So what signals do these chaotic scenes in China’s real estate market reveal? In this episode, let’s explore it with you.
In early 2020, the CCP virus (New Coronavirus) epidemic spread rapidly in mainland China, and several cities issued notices to suspend sales activities in their sales offices, and the real estate industry quickly went into a freeze. At the time, Singaporean media outlet finews.asia reported that the probability of a “black swan” type event in China’s real estate market and energy sector would increase if factories on the mainland were to close for an extended period of time.
Then, in February 2020, Evergrande Real Estate said it would offer an unprecedented 25% discount, in addition to several other offers at the same time. At that time, some netizens had calculated that if they enjoyed the maximum discount of each offer at the same time, they could actually enjoy a discount of 64%. At that time, this discount initiative of Evergrande was really a sensation to the mainland property market, however, this 25% discount was not the bottom line.
In August, the Chinese Communist Party introduced new financing regulations and the “three red lines” standard, and Evergrande “stepped on all three lines”, so it was difficult to obtain financing from financial institutions, so it had to adopt a stronger discount promotion. What is the “three red lines”? Simply put, it means that the net debt ratio of real estate enterprises shall not be greater than 100%, the asset-liability ratio of real estate enterprises after excluding pre-receipts shall not be greater than 70%, and the “cash to short term debt ratio” of real estate enterprises is less than 1.
Thus, Evergrande, which “stepped on all three lines”, launched a 30% discount on its entire property line in September. The day after Evergrande issued the news of discount promotion, the Chinese Communist Party’s Academy of Social Sciences issued a report saying that it should guard against the risk of property price plunge. Behind Evergrande’s increasing discount, the outside world already expected that the risk of Evergrande’s debt and capital was rising. Immediately afterwards, the prophecy about the “black swan” was fulfilled, and a “Evergrande debt crisis” broke out.
After causing a big shock in the market, Evergrande said soon that it had reached an agreement with some strategic investors to hold the equity of Evergrande Real Estate for a long period of time, and on the surface, the debt crisis of Evergrande was temporarily lifted. In addition, on November 1, Guanghui Energy Co., Ltd. made an announcement showing that Evergrande transferred its 40.964% equity interest in Guanghui Group to Shenneng Group, and the transaction amount was RMB 14.85 billion.
At that time, some investment sources believed that this transaction was obviously a move by Shen Neng Group to save Evergrande, and the fact that Evergrande sold the shares held by Guanghui Group at almost the original price also reflected the urgency of the transaction. Shenneng is a state-owned enterprise under Shanghai State-owned Assets Supervision and Administration Commission, and a state-owned enterprise with such a background saved a private enterprise in Guangzhou, which also makes the deal intriguing.
Evergrande explained that the equity transfer would help the group focus on its core business and achieve long-term stable and healthy development, so is Evergrande’s capital crisis really over?
Two days ago, the Wall Street Journal reported that Evergrande’s total debt due in 2021 is close to US$3 billion, while the outstanding US dollar bonds have a yield rate between 13% and 17%, while an ANZ credit executive said it is difficult for the company to obtain bank financing when the yield rate exceeds 15%.
Offshore maturity debt doubles regulation adds another red line for real estate companies
In a related story, the Wall Street Journal also mentioned that Chinese real estate developers have a lot of international debt to refinance, but are facing strict lending conditions that are driving up the risk of default. And how high is the total amount of debt? The report said Chinese real estate companies need to repay as much as $53.5 billion in offshore debt this year, more than double the $25.4 billion in offshore debt due the previous year, the vast majority of which is in U.S. dollars, at $47.6 billion. And as dollar bond issuance in China and elsewhere in Asia reaches record levels, a series of defaults will inevitably occur.
At the time of 2020, China’s real estate industry experienced a harsh test of its capital chain, partly due to the epidemic, with the sales side under pressure due to the CCP’s new crown epidemic, and partly due to policy, with the CCP issuing a succession of policies requiring real estate companies to reduce leverage last year. Guo Shuqing, chairman of the CBRC, has pointed out that the biggest “gray rhinoceros” in China’s financial risk is real estate.
In August 2020, the Central Bank of the Communist Party of China and the Ministry of Housing and Urban-rural Development convened a symposium for key real estate enterprises, which resulted in new financing regulations for the real estate industry and set “three red lines” for real estate enterprises regarding their debt ratios.
On the last day of 2020, the real estate industry once again received a red line from the Chinese Communist Party’s regulators, and on December 31, 2020, the Communist Party’s Central Bank and the Joint Commission on Insurance Supervision issued a circular (“Circular on the Establishment of a Centralized Management System for Real Estate Loans of Banking Financial Institutions”), which bound the proportion of banks’ real estate loans to all loans. “The Circular divided banks into five classes, each with two upper limits, including the proportion of real estate loan balances and the proportion of personal mortgage balances.
For example, ICBC, China Construction Bank, Bank of China, China Development Bank and other first-tier banks, its real estate loans accounted for 40% of the upper limit, the upper limit of personal mortgage loans is 32.5%; while the second two upper limits were 27.5%, 20%, including China Merchants Bank, Bank of Beijing, Agricultural Bank of China, etc..
According to mainland media reports, as of December 31, 2020, the total market value of the 50 listed real estate companies on the mainland is RMB 2.88 trillion, while the total market value in 2019 is RMB 3.69 trillion, a shrinkage of over RMB 800 billion.
After the Notice was issued, the market capitalization of China’s top 30 real estate companies evaporated by RMB 90 billion immediately after the mainland stock market opened on Jan. 1 this year.
The shrinkage of the market value of real estate companies also reflects the expectations of the industry and investors, about the market and the impact of the regulatory measures. At the same time, another danger signal for China’s real estate industry has emerged, with a “wave of departures” of executives of mainland real estate companies starting in early 2021.
According to reports in the mainland media, as of January 16, 2021, more than 15 real estate companies have had senior personnel changes, including the chairman, president and other senior executives have announced their departure, involving companies such as Longguang Group, Rongsheng Development, and New City Holdings. The newly appointed executives, however, mostly have financial backgrounds. The report said, real estate executives frequently leave, sales results do not meet expectations is the main aspect, in addition to the “financing difficulties” in the context of the enterprise is facing a large number of maturing debt, is also another reason that led to the executives under heavy pressure to take the initiative to leave.
In this regard, mainland China’s accounting training institutions believe that the financial origin of the boss is better at capital operations, to speed up the speed of capital restructuring. According to this explanation, it may also reflect the pressure of real estate companies in terms of funding, as well as future plans.
Asset shortage saved “Xu Jiayin” people
So, what is the current situation of the real estate market in mainland China?
According to recent data released by Savills, a real estate service provider, the rental index for Grade A offices in Shenzhen fell by 1.6% in the fourth quarter of 2020 from a year earlier and by 6.3% year-on-year, which is the ninth consecutive quarter of rental decline, while the office vacancy rate reached 28%, ranking first among the four top tier cities. The vacancy rate also reached 28%, ranking first among the four top tier cities.
“Davis expects the vacancy rate of Shenzhen’s Grade A offices to rise in 2021, and rents to continue to fall across the city.
In the fourth quarter of 2020, the average price of office space in the city was RMB 47,900 per square meter, down 9.1% year-over-year. In contrast, residential prices are rising sharply, with data from the Communist Party’s National Bureau of Statistics showing that in November 2020, Shenzhen’s primary and secondary residential price indices rose by 4.9% and 14.6% year-on-year, respectively.
And after Shenzhen, Shanghai’s property market has seen the same situation.
According to CCTV Finance last December 21, the vacancy rate of premium office buildings in Shanghai was 20.4% in the third quarter of 2020, while the vacancy rate in Qiantan and Da Hongqiao reached 40%.
The China Securities Journal, for its part, recently reported that second-hand property prices in Shanghai began to heat up in 2021, with the number of intermediary second-hand property listings decreasing, but cases of landlords jumping prices and hesitating to sell increasing.
According to Chuang Tai-liang, associate professor of economics at the Chinese University of Hong Kong, the threshold for Grade A office space in Shenzhen is high, but not all business on the mainland can reach this high threshold. Grade A offices are usually supplied to the financial industry or trading companies, while Shenzhen itself has more technology companies, which usually locate their headquarters near their factories. So in terms of industrial structure, the demand from intermediary trading companies and financial companies in Shenzhen is not enough to support such a large supply of office space. There is too much supply and not enough demand in the market, which is a phenomenon that exists in mainland China as a whole.
According to investment analysts of Financial World, the rising property prices in first-tier cities are supported by a large amount of investment capital. Both the property and stock markets are currently being driven by capital, and major global central banks are executing quantitative easing, leaving the market short of quality assets, whether it is private investment or foreign capital looking for quality assets. For the average Chinese investor, in terms of practical value, will still conservatively choose to invest in property, so the real estate industry is still selling houses, which has saved people like Evergrande owner Xu Jiayin. The Chinese Communist Party is still using the real estate and stock market as two reservoirs to absorb the excessive amount of funds, and at the same time, the Chinese Communist Party is “packaging” large state-owned enterprises as “high-quality assets” to attract overseas funds. This is a collusion between the CCP and Wall Street and the big capitalists.
In the past, state-owned banks were a good investment target for investors, but the epidemic has made the banks’ life difficult. We see that the mainland, from the central to the local level, in a year out of hundreds of real estate regulation policies, housing prices are still rising, this situation, do not rule out that the Chinese Communist Party is opening a gap to the housing enterprises and local governments, so the opportunity for bank stocks.
The sales fever of mainland real estate seems to be continuing, but from the official data released by the CCP, it can be seen that the enthusiasm of Chinese real estate investment developers has started to cool down.
According to data from the National Bureau of Statistics of the Communist Party of China, in the first 11 months of 2020, the area of commercial properties sold in China was 1.51 billion square meters, up 1.3% compared to the previous year; however, the area of land purchased by real estate development enterprises in the same period was 205.91 million square meters, down 5.2% year-on-year; and in terms of the area of new housing construction, it also dropped 2% year-on-year in the first 11 months.
In the new year, a new wave of epidemic is raging, and the Chinese real estate industry will face a new round of torment under the pressure of escalating regulation and control by the Communist Party and the “three red lines”.
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