Understanding the China Property Developer Crisis

China’s second largest property developer, Evergrande, is in big trouble and that caused global stocks and crypto to crash today.

Here is a video by Asianometry which goes over how Evergrande grew quickly from 1996 to 2021.

They used a lot of debt and leverage. They have US$300 billion in debt.

They have development projects in over 170 cities in China. Evergrande Group owns 45.8 million square meters of development land and real estate projects in 22 cities.

Chinese regulators created Three redlines at the start of 2021 which required less debt for real estate.

* The policies forced deleveraging to improve financial health for the real estate sector;
* The government is moving to address debt build-up in the sector and we have high confidence in the scope of these policies;
* Future access to financing will be predicated on developers’ adherence to strict criteria including liability to asset ratio (excluding advance receipts) of less than 70%, net gearing ratio of less than 100%, and cash to short-term debt ratios of more than 1x.

The Chinese government forced and is forcing Evergrande and other property developers to get less debt but Evergrande was too indebted and could not adjust.

Asianometry believes that Evergrande will be broken up but the Chinese government will protect the (mostly state) banks holding the debt.

Evergrande is a poster child for excessive debt and excessive risk and they are being imploded as planned by the Chinese Government. They have assets that will be dispersed as the company is crushed. There could be a few more property developers that will also be collapsed.

Differences for China versus the US in 2008.
* China can take all of the assets of these companies and send them to banks or others
* China protects the state banks and others who hold the debt

But what about the firesale of real estate does that crush real estate prices? If too much supply becomes a problem, China can physically bulldoze or implode as many extra buildings as they need to get back into balance. China can rebuild and build anew in a few years when there is demand.

SOURCES -Wikipedia, Asianometry, UBS
Written by Brian Wang, Nextbigfuture.com

31 thoughts on “Understanding the China Property Developer Crisis”

  1. Indeed. The Primal Revolution has started. Once China wakes up to the self humiliation of power addiction, the change is permanent.

  2. "China can physically bulldoze or implode as many extra buildings as they need to get back into balance. China can rebuild and build anew in a few years when there is demand."
    Or the government could buy or seize the buildings and keep them off the market.

  3. Because all economies crash after a long period of growth. They are not special. The economy tends to accumulate fatal faults during period of growth that are camouflaged by the successes. Once things start to slow down those faults become exposed and the economy tumbles.

    There is also the tendency to pour money into the economy on its way up, and to pull the money out on the way down that causes the boom and the bust to be bigger than they should be.

  4. As a lifelong libertarian, I see your point. But! as we enter the true gold rush of micr0g in O'Neill Space, made much closer by the NASA re org, don't sweat the small stuff.

  5. I'm suggesting we do exactly as O'Neill proposed in the 70s. And, with the NASA re org, much better and easier to do now. Put as few people on the Moon as needed for mining, build Space Solar to solve energy problem. Help "Mostly big cities near coasts". Open Space with the proceeds. Eventually, thousands of bubbles in Solar orbit, trillions of people.

  6. Are you suggesting that we instead build inside some kind of bubble – a property bubble, if you will? One that will never crash?

  7. I finally understand why Chinese cities are so ugly.

    When you're just focused on explosively building as much as possible, as fast as possible, you don't bother to hire an architect for each building. Just getting each design approved would slow things down. So they end up with the cookie cutter mass development thing that Americans do with suburbs, but they do it with the largest building a plot will support. The handful of billionaires at the top have no real pride in these developments – their own homes are the penthouses in a more trendy location. Everywhere else is just a financial vehicle.

    They had the opportunity to build something beautiful and bequeath it to future generations, but instead everything is a sea of identical boxes, and everyone is treated like a product on a Walmart shelf.

    Hell of a thing to crash your economy for.

  8. To be fair, there are some regions of the developed world that seem to have the same problem. Mostly big cities near coasts.

  9. effA simpler explanation is that most real estate companies and a great many other companies in China have been engaged in the practice of what accountants call, "lapping". Lapping is where a company uses the proceeds it receives in the current fiscal quarter to pay costs it accrued in the past. E.g. For Evergrande it means they were using money from home presales to pay bills from construction contractors for work done months in the past on other projects.

    This works and can produce explosive growth but only so long as Evergrande has new loans, and billions of dollars from apartment presales coming in. Once those ended, Evergrande was drowning in debt from unpaid bills from previous projects within a few months.

    For Evergrande's part this practice lead to the explosive growth that both the company and the CCP wanted as they could never have grown as fast as they did if they actually used their presale money to work on existing projects instead of new projects (like any company in the West is legally required to do). When growth is your only economic metric Evergrande and its practices are what you'll get. The problem is that not only Evergrande but every other major construction company followed the same formula because of greed and the CCP's demand for GDP growth uber alles. So by no means is this crisis going to end anytime soon. At this point there are at least two decades of bills to sort out if the CCP is no longer going to underwrite growth at any costs.

  10. The Chinese economy is not built on thin air. They built the cities, they built the transportation infrastructure, they built the energy infrastructure. They made their farms and mines productive. Their working class works, even labors when needed.
    So why should it tumble like the house of cards stuff, that is just paper and ink?
    The only genuine vulnerability I see is oil, but the value of their exports easily covers that.
    Beyond oil, you would need some kind of true catastrophe, in my opinion. A large dam break killing over 100 m would be the most likely of these. Historically, in China, this specific type of event ends dynasties. 
    Another pandemic with a much higher fatality rate and much easier to spread striking the working class…is possible…but not terribly probable. And that would likely hurt everyone on the plant except the casket and urn makers. And even if economies contracted as a result, per capita, it would likely still be fine. Probably better, because they could just use the better power plants, mines, and soil. Of course, if 99.9% of people quickly died on the planet, it is near impossible to predict what would happen…other than a race to repopulate. If people are smart, maybe there would be some concentration on preserving and maintaining structures and infrastructure, so it is not all crumbled to dust by the time population expands to fill it. I guess I am drifting off topic. But I guess is shows how far fetched one must go, to see a China collapse.

  11. I took economics classes at an Ivy-League school (Brown University). Our professors were heavily influenced by the Chicago School of Economics.

    It was beat into our brains that banks, (local, regional, national, and tertiary) must only make loans with a reasonable expectation (>99%) of being paid back.

    Does anyone truly believe the US Government will EVER repay what is owed to the Fed?

    We are in a brave new world. Up is down, wrong is right, there is no such thing aas a dollar being backed by the full faith and trust of the United States Treasury.

    I am baffled.

  12. Here's the thing that puzzles me, both in the U.S. and in China: Do faith and trust mean nothing anymore? Is accountability now a thing of the past? Is it only the middle and lower classes that must pay their bills and taxes, or face bankruptcy and court-ordered seizure of bank accounts?

    It seems large banks and private equity funds get bailed out (or bailed into) when they can't come up with the funds to pay their bills. Governments can spend with impunity, and the Fed can just whip up infinite funds to lend to them.

    Is there any such thing as a tipping or inflection point?

  13. My biggest advantage in investing has been my complete determination not to risk investing in places where they don't especially value life, liberty, or the pursuit of happiness.

  14. It is not as simple as that… If a a major property developer is not bailed out, there is a fear of a domino effect… A Lehman moment.

  15. People waiting for the Chinese economy to implode have been disappointed for decades. Not to worry, it will eventually happen. The higher the climb, the longer the fall. My hope is that the Chinese government will try to cushion the fall and won't go nuts on the Chinese people when they try to vent their frustration.

  16. I think there will be no bailout of property developer companies. All the assets get taken. There is like US$500 billion in land and unfinished buildings. I think Evergrande is like 4% of China's real estate. The other risky property developers total up to another 11%. Unlike 2008 in the US, there is no 20X derivative multiplier. There is a lot of almost no money down on a large scale and using real estate to get more real estate.

  17. The *bet* was that China would not, according to libertarian thinking, be able to have both "free" economy and social, well, socialism. Power addicts are so predictable.

  18. I'm not aware that they sold financial products globally.

    Evergrande MOST DEFINITELY sold financial products to Chinese citizens, Construction companies, Chinese banks, and their own employees.

  19. I think the Chinese will be fine however the debt was probably converted to derivatives which is nothing more than insurance. The holders of the derivatives are global and will be impacted, its 2008 again buckle up its going to be a bumpy ride.

  20. Productive, viable companies don't need bailouts. That's why Apple doesn't get a bailout but GM did.

    Throwing tens of trillions of RMB at Chinese companies is a good way to get BTC to $100k.

  21. "If something cannot go on forever, it will stop."

    That's what is happening to Chinese Real Estate. Home prices only going up cannot go on forever. Government charging more for land (for development) only going up cannot go on forever. Two generations pooling their money to provide a down payment cannot go on forever.

    So its stopping.

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