Sales of new homes built by the top 100 developers in China decreased substantially in June and July when compared to the same period in the previous year, a study done by S&P Global Ratings has shown. This was after a steady 10% increase earlier on in the year. Late Thursday night, The world's largest debtor, Evergrande, declared bankruptcy in the United States, giving even poorer assurance to investors. This, combined with Country Garden's potential default, is causing developers to struggle in raising funds, leading to issues of contagion amongst the Chinese property market. The real estate sector contributes about 25% of China's gross domestic product (GDP).
The severity of China's real estate woes is increasing. Many prospective home buyers are not yet committing to purchases, exacerbating the necessity for policymakers to bolster the sector.According to Edward Chan, a director at S&P Global Ratings, sales from the top 100 developers have decreased by nearly one third in the months of June and July compared to the same period last year, despite the double-digit growth at the beginning of the year. As many of the Chinese apartments tend to be sold prior to their completion, poor new home sales will likely impact cash flows for developers.Chan also commented to CNBC in a call on Thursday that the Country Garden incident has made the situation worse and that new home sales have yet to demonstrate any improvement. The lack of revitalization, compounded with the pending default of Country Garden, makes it difficult for property developers to raise funds in the midst of data that points to an unhealthy economic climate.To add to investor jitteriness, the most indebted property developer, Evergrande, filed for bankruptcy in the U.S. late Thursday.Given that the real estate sphere makes up nearly a quarter of China's GDP, this further decline in faith does not bode well for the world's second largest economy.
Studies suggest that up to a quarter of economic activity in the mainland can be attributed to the real estate sector. On Tuesday, JPMorgan increased their forecast for global emerging markets corporate high-yield defaults due to the potential for contagion from issues at Country Garden. Last week, this large non-state-owned developer postponed the payment of two bonds totaling $22.5 million, suspended the trading of 11 domestic bonds, and alerted that a possible loss of up to 55 billion yuan ($7.5 billion) could be incurred in the first half of the year.
Since 2020, the Chinese property sector has experienced a sharp downturn due to Beijing's efforts to constrain the debt levels of mainland property developers. Years of rapid growth had resulted in an excess of supply in the market, as developers sought to capitalize on the desire for home ownership and property investment. This so-called "three red lines" policy stipulates that developers must stay within pre-defined debt thresholds based upon cash flow, assets and capital levels. These stringent regulations led to the much-publicized default of Evergrande in late 2021.
Should Country Garden default, it would contribute $9.9 billion to the 2023 global emerging markets high-yield corporate default tally, JPMorgan noted in a Aug. 15 report. As a result of the possible default, this year's Chinese property sector default volume could reach $17 billion, representing almost 40% of all emerging market default volume seen in the same period.
The underlying cause of this looming default is attributed to Country Garden’s heavy exposure to lower-tiered cities across China, where supply of housing outweighs demand. As outlined in their 2022 annual report, 61% of their developments are in these lower-tiered cities.
S&P Global's Chan noted that Country Garden's sales performance has been "disastrous" with a year-on-year decrease of roughly 50% in June and July. Lower-tier cities experienced a decline in sales in May, while the higher-tiered cities faced a decreasing trend later on. As a result, Chan declared that it would be "challenging" for China's real estate market to meet S&P's estimated base case of 12-13 trillion yuan in sales by the end of the year, and that a descending staircase pattern could replace the original L-shape. In comparison to the peak of 18 trillion yuan in 2021, the bear case for China's real estate sector in 2024 is predicted to be 10 trillion yuan.
During their mid-year economic review in July, China's senior officials pledged to "timely regulate and improve policies" for the ailing property market.There has yet to be tangible evidence of their strategy to confront the "huge variations" in supply and demand. Louise Loo, main economist at Oxford Economics, remarked in an Aug. 11 report: "Country Garden's debt worries and doubtful government assistance are intensifying apprehensions in the Chinese housing sector."
Contracted sales by state-owned developers in China have increased by 48% in the seven months prior to this year when compared to the same period in the past year, whereas those not owned by the state have seen a 19% drop in the same period. This in turn has made it easier for state-owned developers to secure land from local governments, due to the improved cash flow resulting from the strong residential sales. Gary Ng, a senior economist at Natixis, expressed his view that “with 87% of land purchases by state-owned enterprises, it is difficult for privately owned enterprises to grow further.”
During the year up to July, Natixis data showed that 87% of land purchases by value had been made by state-owned developers, in line with last year, a steep increase from 59% in 2021. Ng anticipates that state-owned developers will steadily gain more control of China's real estate sector, however he highlighted how such a high concentration of state-owned developers might complicate the prediction of genuine demand. Nevertheless, the underlying demand for residences in first-tier cities continues to be largely untouched and could potentially be released when there's greater policy clarity. Chan from S&P Global said that "timely policy in stabilizing the demand and sales in the higher-tier cities would be very important" and that, with time, this stabilization could spread to lower-tier cities, but this would take a while.
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