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By now you have likely already heard the headlines about China’s largest developer Evergrande. Or maybe you saw the grainy video of protestors outside of Chinese banks demanding their deposit back. Either way, I am going to assume that you already have some idea of the economic problems facing the world’s largest country. The global effects of one real estate company or one regional bank’s struggle are likely minuscule, but some investors are wondering if these are just the first signs of a larger problem.
Some of the recent troubles that the Chinese real estate sector has been experiencing comes from the economic transition that the country has undergone from strict communism to highly regulated pseudo-capitalism. In the late 90s China allowed all of their citizens, not just those that work for the state, to purchase property. To spur this new avenue for investment the People’s Bank of China subsidized interest rates, stimulating home purchases and quickly making the country the largest residential mortgage market in Asia.
The housing boom was further fueled by the abolishment of the Hukou system, which divided their population into two classes, rural and urban. With a newfound ability to move to urban areas, the Chinese population moved to cities at an incredible rate, spurring demand for new home construction.
The way that land is developed in China is a bit different than the rest of the world. Local governments will often outline a master plan for a new neighborhood, often far removed for the rest of the urban area, and then use this plan to attract developers to buy the land. Developers then sell investments in the future development to investors, oftentimes years before any of the needed infrastructure for the area is even completed. Long development periods and a miscalculation of the demand for certain locations is the cause of the Chinese ghost towns that have become the focus of many alarmist articles and documentaries.
Ghost cities might make for good editorial but they don’t necessarily mean that there is a housing bubble in the country. It would be easy to assume that the recent astronomical appreciation in home prices (housing price indexes appreciated by around 250 percent from 2003 5o 2013) but those numbers don’t seem as ridiculous when compared to the growth in the Chinese economy which has averaged around ten percent growth every year in that same time period.
For decades the hot housing market has been buoyed by the country’s increasingly wealthy population. But that support might have stopped. It all began with a short letter written by an angry purchaser of a half-built home in a large Evergrand development. “All homebuyers with outstanding mortgage loans will stop paying” unless construction resumed, the letter claimed. In days the letter became a template for others to cut and paste for their own protests. Censors have done their best to keep these off of social media but after decades of censorship the Chinese people have become quite good at spreading their clandestine messages online.
The mortgage boycott might not be enough to drag the enormous property industry down, but it could be a catalyst for a downturn. China has already had to reduce their interest rates, despite pretty much the entire world raising theirs to combat inflation. Chinese property companies are also seeing their stocks hit all time lows. About 7 percent of the total mortgage landscape might be impacted by the default but those losses shouldn’t be enough to make Chinese banks insolvent, especially since they have been raising a record amount of capital from bond sales.
What might happen, though, is a general loss of confidence in the Chinese economic path. Much of the world is already leery of investing in China, investments often come with limited protection from foreigners and the economic data has always been suspect. If the Chinese people also lose confidence in their system, it could lead to a much larger problem. The troubles that Chinese developers are going through now might not pop the country’s real estate bubble, but they could be one more nail in the coffin of China’s complicated balance of communism and capitalism.
We are currently researching for an article about how offices are incorporating child care as a way to bring employees back. If you or anyone you know has a good example of an office property or occupier succeeding with this strategy, please reach out.