The story of the Chinese real estate raid and the lessons for the Philippines

APARTMENTS IN SHANGHAI — KAJA SARIWATING-UNSPLASH

Wthe hat that goes up must come down. China’s mighty economy faces serious challenges. The culprit is its real estate sector in crisis. The real estate crisis has caused hundreds of real estate companies to default on their loans. Banks have had to cancel debts of nearly half a billion US dollars. Thousands of construction-related suppliers face insolvency and millions of investors are stuck with the UNfifinished properties that cannot be sold.

The story of China’s housing bubble began in the early 1990s. In the wake of the country’s manufacturing revolution, millions of families migrated from the countryside to urban areas, lured by jobs and better incomes. In 1995, only 29.04% of China’s population lived in urban areas. That number has ballooned to 63.89% today. The growing demand for new homes in urban areas led property developers to build at a dizzying pace.

In China, land cannot be owned, but is rented from the state. Property developers took out massive loans to pay off these leases and build their residential blocks. Banks were liberal in lending, as high demand and good profit margins meant low risk.

The state also supported the housing boom. As far as the government is concerned, a thriving real estate market has translated into a domino effect of economic benefits. The demand for construction materials such as steel, glass and cement skyrocketed. Millions of jobs were created. Wealth was generated, fueled by property appreciation. Purchasing power increased. They were all happy. The real estate sector became so large that it grew to constitute 30% of China’s gross domestic product.

The dizzying property boom has sent property prices skyrocketing to the point where it now takes the average Chinese worker 56 years to pay for an average apartment in Beijing. He will take you 50 years in Shanghai and 46 years in Shenzhen. For context, it only takes 17.3 years to afford an equivalent flat in London.

Cultural nuances played a role in the property’s explosion. In China, property is widely believed to be the most stable investment to make. Also, one can only be a respected professional if he owns his own house. These ideas forced the Chinese to buy property, even at outrageous prices.

Chinese developers, buoyed by easy loans, built to the point where their inventories were out of sync with actual demand. In the worst case, the homes of 90 million people remained unoccupied. They are known today as “ghost towns”.

The prevalence of ghost towns made the Chinese government pay attention and temper the construction boom. The government declared that new loans can only be obtained if property developers pass three red lines fifinancial proportions. First of all, their passive to active ratio had to be less than 70%. Second, their net leverage ratio had to be less than 100%. Third, its short-term cash-to-liability ratio had to be less than one.

Corresponding levels of loans were awarded to companies based on the number of indices they beat. Those who failed all three were denied access to the bank. fijoint financing.

Among the thousands of property developers raising red flags was Evergrand Group. Evergrand is China’s second-largest real estate developer and, to the state’s horror, failed to break above three redline ratios. Evergrand’s debts totaled $305 billion, equivalent to 2% of Chinese GDP. Its cash reserves amounted to just $15 billion. He owed money to 171 domestic banks, 121 foreign banks, and to the Chinese people who bought his bonds.

Evergrand’s downfall can be attributed to overexpansion. He used all the money he raised to start new projects instead of finishing existing ones. As of October last year, Evergrand had 1,200 projects in development, with just 200 completed and 700 pre-sold but unfinished. With so many unfinished projects that it couldn’t fully monetize and even more new projects that needed financing, it was only a matter of time before the company ran out of cash.

Evergrand is just one example of thousands of Chinese real estate firms in dire financial straits. Two-thirds of all Chinese developers have failed at least one redline relationship.

What has been the effect on the Chinese economy?

The real estate sector represents 20% of banks’ credit portfolios. Banks cannot collect until existing inventories are sold. The problem is that most of the inventories remain unfinished and funds have been depleted to fifinish them. Buyers rightly steer clear of unfinished projects. Banks are caught in the middle and must absorb an avalanche of bad debt.

With thousands of properties ficompanies that become insolvent, suppliers of building materials cannot collect. Evergrand alone owes its suppliers more than $100 billion. Suppliers and subcontractors are also defaulting on their debts.

Knowing that its developers do not have the funds to fifinish their units, investors who bought in pre-development using banks fifinancing have stopped paying their mortgage. The banks are again caught in the middle and must write off about $220 billion in unpaid home mortgages.

Those who bought bonds from struggling developers can’t redeem them. Thousands have lost their life savings.

The Chinese government recently announced that it plans to relax the three red-line indices to give more property developers access to cash. With a financial lifeline, it is hoped that they can fiFinish your projects and monetize them. While this will provide relief, it does not negate the serious damage that has already been inflicted on the banking system, providers and private investors.

There are valuable lessons to be learned for Filipino real estate developers. First, build in sync with demand. Second, in the use of funds, priority should be given to completing existing projects rather than starting new ones. Third, debt should not be abused, no matter how easy it is to get. Prudent fifinancial management must be paramount.

On the part of the buyers, they should look at the fifinancial stability of the developer before buying properties from them. The three indices of the red line are good parameters to evaluate your fifinancial stability.

It is not true that real estate is the soundest investment since it never depreciates. As we have seen from the Chinese experience, property values ​​can fall when the bubble bursts.

Andrew J. Masigan is an economist

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Facebook@AndrewJ. Masigan

Twitter @aj_masigan

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