Issue Background
Over 70% of Chinese household wealth is held in real estate and it and related industries constitute around 29% of GDP. This has created some of the world’s largest property developers, which are now facing uncertainty over a volatile market. Cultural expectations, macroeconomic and political factors have created an emphasis on real estate investment.
Evergrande Group ,founded in Shenzhen in 1996 by Xu Jiayin, was the second largest property developer with a business model riding on the back of the Chinese real estate boom in the last 20 years, getting larger loans to pay back earlier loans totaling to over $300 Billion USD of debt. In late summer of 2021 the grossly overleveraged developer reported that it could not pay back loans leading to a liquidity panic for institutional & retail investors (not to mention the millions of homebuyers who’s houses still haven’t been constructed). Now a national crisis, Evergrande’s defaults have cascaded downstream impacting lenders and threatening the broader economy as a whole. The Chinese government has tried to play a backseat role but increasingly is taking steps to release liquidity into the system, correct clear gaps in legislation, and put pressure on the CEO and other real estate executives to dip into their own pockets. What is clear is the government prioritizes the stability of domestic investors creating more uncertainty from overseas debt holders.
In light of the crisis, the local government of Guangdong has taken over operations of Evergrande and are in the process of slowly restructuring the over-bloated property developer. This event and the policy reaction to it, may threaten the era of real-estate centered growth for the Chinese economy and will require innovative solutions to pursue their GDP goals.
Key Points
- Key Point 1: This event is predicted to impact the Chinese economy by leading to lower predictions of GDP growth for 2022 to 4.3%, a drop from the average of 9.19% from 1989 to 2021.
- Key Point 2: This has caused China to prioritize “high quality growth” , a buzzword of government propaganda, that will place more emphasis on tech, biotech and on the startup space. All these are industries which will require more cooperation and technology transfer from outside sources.
- Key Point 3: $19 billion of the debt is USD denominated and considered offshore. This will have an effect on credit ratings of Chinese borrowers especially in real estate.
Recommendations
FAO Global recommend extensive due diligence into the market and regulatory environment to assess country & sector risk prior to deploying capital in China. This requires bringing on China experts that can translate the cultural & geopolitical drivers of corporate decision making. China’s growth projections are still attractive for REITs and debt originators but additional due diligence should be performed and risk diversified prior to a China transaction.
Analysis & Research by
Juan Hertsens Marques, Analyst
Brandon Hughes, Managing Director
Relevant Links
- The Economist: https://www.economist.com/leaders/2021/09/25/evergrandes-crisis-highlights-chinas-shortcomings
- The China Briefing: https://www.china-briefing.com/news/explainer-whats-going-on-in-chinas-property-market/
- World Economic Forum: https://www.weforum.org/agenda/2021/09/evergrande-debt-crisis-global-economy/
