China’s real estate crisis is still a political danger

2 June 2023

The real estate industry in China is facing an existential crisis. A series of offshore dollar-denominated debts have defaulted and stringent government limits on debt levels leave Chinese developers looking desperate for bailouts. In addition, house buyers have resorted to protests, their delayed mortgage payments creating a black hole of problems that are viciously interconnected and explicitly political. The rise of protests is a mounting humiliation for Chinese Communist Party (CCP) leaders, indicating that stern tests lie ahead of party oligarchs. The dissent among home buyers in China against big property developers is symptomatic of China’s biggest systematic incompetence in dealing with crony capitalism, which lets debts, defaults in payments, and non-deliveries of houses erode trust in the Chinese economy. Accounting for one-third of China’s GDP in investment, the slump in the property and infrastructure sector is causing significant distress.

The reforms and rapid development of cities since the late 1980s lured young city dwellers and migrants into investing their wealth in housing. Today, China claims that 80 per cent of its household wealth is locked in land and real estate. The societal expectation and importance of owning a home as a precondition to starting a family and building wealth put tremendous pressure on young Chinese citizens. This pushed many young Chinese to invest in properties as a generational investment. With the average home buyer in China being approximately 29.5 years old, home ownership anxiety is particularly acute among the young population. As the population starts to feel the consequences of the crisis — the average income-to-repayment ratio for home buyers is outrageously high outside first-tier cities — the Chinese government must find ways to address its systemic economic challenges or get ready to face increasing protests.

Systemic risks behind extravagance and the sprawl of Chinese cities

Chinese cities have experienced significant political, economic, and social pressures stemming from the developmental currents of globalisation, migration, and market reform. Still, the expansive growth of China’s cities also led to the development of a flourishing property market, with the number of real estate developers and their projects growing proportionally. This has been particularly evident since 2000 when the supply of commercial housing and complexes grew manyfold. The land prices offered handsome returns for cash-strapped local governments. The infinite greed for money led to deliberate regulatory incompetence and a super-inflated property market.

To prevent growing unrest and panic among young Chinese and instil faith in Beijing’s rule of law, the government must show that it is willing and able to deal with real estate problems and deliver more than sprawling cities and glossy development.

Thus, the growth of the cities and urban spaces across China was founded on significant systemic risks of excess borrowing. Party elites hailed the extraordinary rise of Chinese cities and eluded city indexes or growth models as an alternative model of development to neoliberal globalisation. Subsequently, China’s internal economic transformation intensified the contradictions, resulting in enormous social and political costs. Among the most critical ones were the end of the welfare housing system, the rise of the race for ownership, and the affordability of owner-occupied housing in Chinese cities.

The distortions in the property market created severe tensions among common Chinese as well as political and economic leadership. The big developers cashed in on the Party’s fear of slums, widespread squatting, crumble shacks, and low-rises in dusty suburban landscapes in urban China, assuring higher and quicker returns for the state-owned land and delivering on urbanisation campaigns run by the leaders. Additionally, the state allowed private developers to invest in residential real estate and the property developers rose to the expectations of state institutions — including hospitals, universities, provincial schemes of redevelopment, and urbanisation.

The real estate bubble burst

By commodifying housing into real estate, the Chinese state planned to reduce the financial and welfare burdens of the state and provide a much-needed boon for state-owned banks and state-controlled construction companies. Real estate soon became the critical pillar of China’s development and prosperity, and with leaders inaugurating projects and banks and firms providing essential resources, young Chinese were drawn to urban properties. As a result, a significant percentage of Chinese residents applied for loans to purchase homes. In 2014, about 70 per cent of urban residents owned houses. This rose to 80 per cent in 2020, leading to China’s Central Bank unveiling that the state urban homeownership rate would soon even reach 96 per cent.

The Chinese state overestimated the promise of property developers in generating a balanced macroeconomic metabolism. In the 1990s, when private businesses looked to lead China’s market reforms from the front, property developers shot to fame with their ability to stimulate hypergrowth. Property management and development, the construction sector, and the commodity sector followed this growth trajectory, making the real estate sector appear promising. However, what was overlooked was the sharp rise in the construction industry’s debt-to-common equity ratio over the last decade. The scale of borrowing appeared unsustainable, and the property developers could not reduce their reliance on debts as it would have exposed their balance sheets and imminent bankruptcy. This was harmful as it directly affected the long-term outlook for Chinese growth. The problems started surfacing when property developers delayed projects and used prepayments by house buyers to maintain their cash flows.

Until a few years ago, with cheaper land banks and higher demand for housing, Chinese developers enjoyed a cash-rich balance. However, the current financial crisis in China triggered by widespread defaults in debt repayment of Chinese developers has led to a severe systemic crisis. Offshore bond defaults by Chinese property developers have highlighted the over-dependence on offshore financing, which has worsened the situation. Thus, the high-leverage financing model of Chinese property developers failed to yield an increase, leading to the bursting of the property market. The Chinese state’s decision to impose restrictions on property developers’ leverage (their ability to borrow more money) amplified the real estate crisis, leading to a dent in the image of property developers. Large-scale construction projects were assumed to have had the support of the state, but this was only the case until some of these property developers failed to deliver houses on time due to a severe cash crunch. The defaults by Chinese property buyers unleashed a chain reaction, with more and more property developers finding it challenging to repay even the interest on their loans. Amid the mounting debt and rising risk of looming bankruptcy, the global (offshore) stakeholders grow anxious, with some forced to take the legal course and with others forced to risk further funds infusion to save the Chinese developers and, in extreme cases writing off loans. Eventually, the consequences could be catastrophic for China’s economy and global financial stability.

The role of Beijing’s technocrats in containing systemic risks

Beijing’s approach of stopping developers from leveraging and curbing speculative buying has yielded limited success so far because developers are already struggling to repay interest loans. Even if the developers attempt to sell their properties, they cannot do so at the prices they were initially put up for sale as there is also a lack of willingness among buyers to invest. Moreover, property developers cannot sell all their properties because these houses have already been sold or pledged against existing debts. The Chinese state’s approach to regulating asset sales, stopping further asset price sliding and potentially causing the bubble to burst, makes it even more difficult for developers to find a solution.

The real estate market uncertainty will continue in the foreseeable future. The situation will get worse if deleveraging is delayed, especially when revenue continues to decline, and steeply rising operating expenses look unsustainable vis-à-vis the tighter liquidity, i.e. debt to capital ratio. Inflated growth driven by firms and local authorities to please Beijing leads to leveraging and results in bond-market chaos and protests. The Chinese state has to lead by ending the opaque operations of Chinese enterprises in all sectors, not only the property sector. The state must ensure that developers follow the rules and that the regulators enforce them fairly. In addition, the government can provide social welfare schemes to support the citizens affected by the current crisis. There are speculations about the State Council considering listing the real estate sector under its national Social Credit System. While this is commonly used to assess an entity’s trustworthiness, it can also be used as a safety valve to monitor compliance and legal violations and control the developers so there is no excess risk of leveraging. Young people undoubtedly feel betrayed as their hard-earned household savings and social well-being are in danger. To prevent growing unrest and panic among young Chinese and instil faith in Beijing’s rule of law, the government must show that it is willing and able to deal with real estate problems and deliver more than sprawling cities and glossy development. Structurally, Beijing has to rethink its role in funding local authorities and find new sources of income to prevent their habit of rekindling local economies with leveraging.

DISCLAIMER: All views expressed are those of the writer and do not necessarily represent that of the 9DASHLINE.com platform.

Author biography

Dr Aravind Yelery is an Associate Professor at Jawaharlal Nehru University, New Delhi. Earlier, he was the MOFA Taiwan Fellow at the National Taiwan University, Taipei. Dr Yelery was also associated with Peking University, Beijing/Shenzhen, as the Senior Research Fellow (Associate Professor Grade). Yelery was also a visiting faculty at the Fudan School of Management, Shanghai. Before joining PKU, he was an Associate Fellow and Assistant Director at the Institute of Chinese Studies, Delhi, India. Yelery holds a PhD in Chinese Studies with a particular interest in Political Economy. He has co-edited a book titled “Tailspin: The Politics of India-China Economic Relations” (London: Routledge, 2021) and recently authored “China Inc.: Between State Capitalism and Economic Statecraft” (New Delhi: Pentagon Press, 2021). Image credit: Flickr/ILO Asia-Pacific.