What the police shooting of a protester means for Hong Kong; danger signs emerge for China’s property sector

SinoInsight 1
Evergrande Group, China’s largest property developer, made 81.99 billion yuan in sales in September, according to recent mainland media reports. Evergrande also had the most sales among mainland property companies in September.

Evergrande’s sales appeared to be in part boosted by various promotions and steep discounts which it started to offer from Aug. 20 this year. Homebuyers who are able to pay in full without taking a mortgage were entitled to a 23 percent discount; closing sale units were sold at a 38 percent discount, while some of those units were discounted by as much as 40 percent. In comparison, the steepest discount Evergrande gave in 2018 was 15 percent off.

OUR TAKE
1. Evergrande’s discounts affirm our China 2019 outlook prediction that property prices will likely “fluctuate drastically (small spurt in prices followed by sharp drops)” and with prices falling in some areas by as much as 30 to 50 percent.

According to housing price data for 70 medium to large cities in August 2019 by China’s National Bureau of Statistics, new home prices in 14 cities had risen by more than 1 percent from a month ago and over 2 percent in just two of the 14 cities (Hohhot and Nanning). Meanwhile, new home prices in 15 cities fell by 1 percent from the previous month; five cities saw new home prices remain flat from the previous month; and new home prices in the rest of the 70 cities saw slight increases, including in the first-tier cities of Beijing, Shanghai, Guangzhou, and Shenzhen.

As for second-hand home prices, nine cities saw price increases of more than 1 percent, with the highest being 1.8 percent. Over 20 cities saw second-hand home prices drop by not more than 1 percent (prices in Beijing fell by 0.4 percent); prices in seven cities stayed flat (including Guangzhou and Shanghai); and prices rose slightly in the remaining cities (prices in Shenzhen rose by 0.2 percent).

The above data indicates that property prices in China have reached an inflection point. This trend is consistent with the significant reduction in local government land revenue from land sales between January to August 2019 (see the Sept. 30 edition of this newsletter). The property bubble, however, has not yet burst because the CCP government is using administrative measures to keep prices stable (property prices have increased and decreased by only about 1 percent).

2. Over the past decade, a key pillar of China’s economic growth was ever-increasing property and asset prices. Virtually all real estate companies in China relied on taking huge debts for expansion. The sustainability of property sector-driven economic growth is dependent on ever-increasing property prices; once price increases slow, the property sector will see cash flow pressures and bankruptcies. Should large property companies go burst, this would likely puncture the property bubble and trigger systemic financial risks in China.

Recent signs indicate that China’s largest property developer is feeling the heat.

According to mainland media reports, Evergrande’s 2019 mid-term financial report showed that the company had a negative net operating cash flow of 45.6 billion yuan in the first half of the year. In contrast, Evergrande had a positive net operating cash flow (18.3 billion yuan) in the same period in 2018.
On Sept. 5, American credit rating company Standard & Poor’s released a report which indicated that about half of Evergrande’s loans were secured through trust financing, entrusted loans, and outbound guarantees (内保外贷), or short-term (1-2 years) financing channels. With short-term debt accounting for 46.2 percent of total borrowing, Evergrande’s short-term debt pressure is currently the largest in its history. As of September 2019, Evergrande has 813.17 billion yuan of total debt.
On September 16, American ratings agency Moody’s Investors Service downgraded the Evergrande’s rating from positive to stable. Fitch, another ratings agency, also downgraded the company’s rating to stable on Sept. 20. According to speculation on Chinese social media, Beijing is restricting the movement of Evergrande boss Xu Jiayin by not allowing him to leave the country.

Other signs also bode ill for the property sector in general.

In June, China Banking and Insurance Regulatory Commission head Guo Shuqing warned that “history has proven that there is a price to pay for over-dependence on property” at a forum. He also said that the household leverage ratio of some cities in China has risen sharply and that the leverage ratio has reached unsustainable levels for some households. What is more serious, Guo added, is that about half of new savings in the whole society has been invested in real estate, and that property companies are borrowing too much and taking up credit resources.
At the end of July, the central government rolled out a series of policies to limit property companies’ access to financing.
According to statistics from real estate consultancy Shenzhen Worldunion Group, China’s property sector has to finance a total debt of 1.8 trillion yuan between 2019 and 2021. The amount of debt payable in 2019 alone is 446.4 billion yuan, nearly twice the figure in 2018.
As of Sept. 30, there were 888 bankruptcy cases and 221 referee documents filed that were related to limited property companies, according to data from the website of the People’s Supreme Court.

In our China 2019 outlook, we predicted that “a few major property companies could file for bankruptcy.” Given the current trajectory of the property sector, there is a good chance that our prediction will be verified.