As Evergrande no longer publishes its financial figures since August 2021, it is now difficult for the market to learn the true scale of its crisis. The company has a substantial number of incomplete construction projects, and thanks to the lack of regulations on off-plan properties in China, Evergrande's debt problem is posing a great risk to the Chinese financial institutions while leaving homebuyers awaiting completion of their homes facing uncertain futures.
In too deepA debt mountain of 300 billion U.S. dollars and declining monthly sales became the breaking point for Evergrande. In late August 2021, the company defaulted on its first bond payments. Since then, the company warned about further defaults and a possible inability to pay its suppliers. This has triggered a chain reaction: two banks in Hong Kong have announced that they are not going to give out new loans for buyers of Evergrande homes. Furthermore, rating agencies have downgraded the property developer’s creditworthiness which further exacerbated its liquidity issues.
While being an overleveraged real estate company is nothing out of the ordinary in China, it was the new regulations that broke the camel’s back. The industry is known to engage in speculative behavior that promotes risky lending and financing practices. This risk is further magnified when real estate constitutes a significant share of China’s economy, so that a real estate crisis would affect the whole country. Policymakers in Beijing have been aware of this issue for many years and are continuously tightening regulations on the industry. These regulations include restrictions on household loans and limitations on private home purchases. The most impactful regulation has been so-called “three red lines”, which regulates real estate developers’ debt. However, as of June 2021, only half of China’s largest real estate companies comply with this framework.
Contagious or not?The severity of the crisis depends on the degree it spills over to other companies, sectors of the economy, or countries. While Evergrande can be regarded as severe case in the industry, it is by far not the only company who came under pressure. The property developers Fantasia Holding Group, Modern Land, and Sinic Holdings have missed bond payments as well and Experts state that Shimao, Seazen Holding, and Central China Real Estate are among the candidates for possible future defaults.
As real estate companies struggle, other players in the economy are going to feel the effects. Banks are going to have to find a way to manage the bad debt from developers, and investors must prepare to take a hit. The Chinese government as well as developers have expressed that they will prioritize finishing pre-sold projects to protect homebuyers which means that there will be little money left for debtors and investors in the case of default. Furthermore, property developers already have difficulties paying suppliers and have offered incomplete properties as payments instead.
Despite the expectation that the Chinese government will step in and attempt to limit the effects of Evergrande’s crisis as much as possible, there is still a chance that overseas markets and companies are going to feel the impact. First, some real estate bonds are traded overseas, so investors in foreign markets will have to prepare to take losses. In addition to that, the Chinese real estate sector absorbs a significant share of the world’s building materials. A downturn in the property sector can affect suppliers abroad.