A man works on scaffolding at a construction site of a residential compound in Beijing on October 19, 2020. After an impressive rebound following the first wave of Covid-19, housing sales have weakened. Photo: Reuters
The View
by Tommy Wu
The View
by Tommy Wu

As the Evergrande saga unravels, China’s property market can expect a further slowdown

  • Even before Evergrande’s troubles, developers were taking steps to reduce leverage to meet new rules, a tightening of mortgage approvals had dampened housing demand and market concerns over default risks had led to higher financing costs
China’s housing sector has been cooling, and a further slowdown of real estate activity and investment is on the cards in the coming quarters.
The Evergrande saga has shone a spotlight on the Chinese real estate sector. While Evergrande’s liabilities are likely to be restructured to limit broader financial and economic disruption, risks have emerged and hurt confidence at a time when the sector was already slowing.
After an impressive rebound following the first wave of Covid-19, housing sales in mainland China slackened in July and August this year as mortgage practices tightened.
Real estate investment growth and housing starts have also weakened sharply amid strict regulations on property developers’ financing. Reflecting weaker demand, growth in house prices has slowed broadly across cities in recent months.
Even before fears that Evergrande would default on its debt rattled markets, Chinese property developers were moving to improve their balance sheets and reduce leverage to satisfy strict regulations by mid-2023.
The “three red lines” – capping developer’s debt-to-asset ratio at 70 per cent, net debt-to-equity at 100 per cent, and short-term borrowing at no more than cash reserves – were implemented last year when the government resumed its efforts to curb corporate leverage, which had been suspended due to the pandemic. Developers will face different limits on their debt growth depending on how many of these red lines they fail to meet.
In addition, tightening of mortgage approvals and a small rise in mortgage interest rates, plus the stringent purchase restrictions that are still in place at local levels, have dampened housing demand and prices. This will reduce the growth in cash receipts generated from presales for property developers and, along with the push to reduce leverage, will weigh on real estate investment.

Finally, market concerns over rising default risks among property developers have already led to higher financing costs, dragging on real estate investment. This is likely to persist until there is more clarity on how the Evergrande saga will eventually be resolved.

Given this setting, expect the real estate outlook to be lacklustre in the fourth quarter and next year. The risk of a sharper slowdown in real estate activity can’t be ruled out, especially at a time when China’s economic momentum is dropping off after last year’s strong recovery.

In a more severe downside scenario in which the housing market turns sour quickly, or if the financial and economic fallout of Evergrande’s restructuring intensifies, a sharp economic slowdown would cause housing demand to fall precipitously.

Property developers’ financing costs would spike and funding could dry up. The government would probably take more significant steps to adjust its overall policy stance on property and more generally to limit the impact on overall economic growth.

Still, some of the fundamentals remain supportive of real estate investment and the housing market more broadly.

First, the stock of unsold housing is relatively low. Housing inventory, as measured by floor space awaiting sale, was only equivalent to 12 per cent of total floor space sold in the past six months. This was well below the average ratio of 22 per cent over the past decade or so. The need to replenish housing inventory will continue to support real estate investment.

Second, ongoing urbanisation and hukou (household registration) reform will support urban housing demand. Third, residential property remains the most favoured asset class by China’s households, whether for first-time homebuyers or investors, even though households are allocating more to financial investment.
A young man looks at residential buildings beside the Grand Canal in Hangzhou, China, at sunset, in November 2015. Real estate, particularly housing, remains Chinese household’s preferred investment avenue. Photo: Getty Images

With regard to Evergrande’s troubles and the deceleration in property activity, Beijing could ease policies somewhat to prevent real estate investment from declining significantly, without substantially shifting away from its relatively tight regulatory and credit stances on developers.

In particular, banks – especially those that still have room to increase exposure to the real estate sector under regulatory caps – could be asked to extend credit to property developers and their suppliers.

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That said, property developers may not be keen to increase their borrowing, given that many still need to improve their balance sheets to meet the three red lines. So the impact of easing could be less than expected unless the government extends the transition period to meet these requirements beyond the current mid-2023 deadline.

Meanwhile, as the housing market downturn persists, some lower-tier cities may well start to relax mortgage restrictions and other property cooling measures to boost sales and sentiment. This could encourage real estate investment and construction activity, staving off a sharp slowdown in growth in these local economies.

Residential buildings in the new city area of Yumen, in China’s Gansu province, on March 31. As the housing market downturn persists, some lower-tier cities may well start to relax mortgage restrictions Photo: Bloomberg

In the longer term, urban housing sales and real estate investment should continue to grow at a reasonable, but much more sedate, pace than in the past. The urbanisation campaign and still-high savings rate (albeit declining due to an ageing population) will continue to support future real estate investment. But house price increases are likely to be more moderate than in the previous decade.

Expect to see policies aimed at improving access to affordable housing, such as the promotion of rental housing, and the possible roll-out of a property tax to help achieve the goal of “common prosperity”. Indeed, while the demand for rental housing is still modest, even in major cities, it is picking up, as reflected in increased rents recently.

Tommy Wu is a lead economist at Oxford Economics