The Bottom Line:
- China’s property sector is in crisis, with housing starts falling by 60% and house prices declining for 12 straight months.
- 90% of Chinese households own their homes, with 70% of their wealth tied up in property, leading to reduced spending and a negative impact on businesses.
- Chinese property development has been likened to a Ponzi scheme, with developers using pre-sale funds to complete previous projects.
- The government’s ‘three red lines’ rule in 2020 led to a debt crisis among developers, shaking investor confidence and slowing the real estate market.
- Despite government efforts to boost demand, funding for developers remains weak, and the broader economy continues to face challenges due to reduced consumer spending.
China’s Property Sector in Freefall: Housing Starts Drop 60%, Prices Decline for 12 Months
Plummeting Housing Market Indicators
According to the IMF, housing starts in China have fallen by more than 60% relative to pre-pandemic levels. New home sales have been falling for 12 consecutive months, and house prices are declining rapidly. The situation is particularly concerning for Chinese citizens, as approximately 90% of households own their homes, and roughly 70% of their wealth is tied up in real estate. With falling house prices, Chinese citizens are feeling the financial strain and have reduced their spending, leading to lower income generation for businesses across various sectors, as evidenced by the poor performance of the CSI 300 index.
The Ponzi-like Nature of China’s Property Development
Over the past few decades, China has experienced significant urbanization, with people moving from rural areas to cities. This trend has driven an immense demand for residential properties, not only for living purposes but also as investment products. Chinese property developers capitalized on this insatiable appetite by engaging in a practice resembling a Ponzi scheme. Developers would sell pre-sale rounds, where buyers put down deposits and start paying mortgages before the homes are built. The revenue collected from these pre-sales would be used to fund the completion of the previous year’s developments, rather than the current project. This cycle continued as long as there was fresh demand and no obstacles hindering project completion.
The Three Red Lines and Evergrande’s Bankruptcy
In 2020, the Chinese Communist Party (CCP) introduced the “three red lines” rule to curb the over-leveraging of property developers. This rule required developers to meet specific financial criteria to be eligible for new debt. However, in 2021, nearly half of China’s property developers breached at least one of the three red lines, leading to a sector-wide funding crisis as old debts came due. The debt crisis shook investor confidence and contributed to a significant slowdown in China’s real estate market, with declining property sales and prices. The bankruptcy of the Evergrande Group, a prominent property developer, further highlighted the severity of the situation.
Chinese Households’ Wealth Tied Up in Property, Leading to Reduced Spending and Economic Woes
Wealth Concentration in Real Estate Amplifies Economic Woes
The concentration of wealth in real estate has become a significant issue for Chinese households. With approximately 90% of households owning their homes and roughly 70% of their wealth tied up in property, the falling house prices have left citizens feeling the financial pinch. As a result, they have reduced their spending, which has had a ripple effect on businesses across various sectors. Lower consumer spending means that businesses generate less income, leading to poor performance in the stock market, as evidenced by the CSI 300 index. This reduction in spending can also lead to potential layoffs as businesses attempt to cut costs, further exacerbating the negative economic spiral.
Government Measures to Stimulate the Property Market
In an effort to address the lackluster property demand, the Chinese government has recently taken action to support the residential property sector. Reuters reports that local government authorities will be allowed to purchase homes at reasonable prices to provide affordable housing. Additionally, the government plans to cut interest rates on mortgage loans and reduce down payment ratios for home buyers. However, despite these stimulus measures, investors have yet to respond positively. Bloomberg notes that funding for developers has remained weak since the government introduced a whitelist of property firms eligible for loans in the previous year. Data shows that a broad gauge of financing for developers, including loans, bonds, and proceeds from home sales, continues to shrink heavily, down 24.3% from the previous year.
Deflation and Belt-Tightening in China’s Economy
Unlike the United States, which implemented large-scale stimulus measures during the pandemic, China chose not to follow suit. This decision has led to a different economic outcome compared to the U.S. While the U.S. experienced inflated consumer spending and a higher savings rate due to the stimulus, China has been grappling with deflation. The prices of goods and services have been shrinking as citizens tighten their belts. A recent survey conducted by the People’s Bank of China, involving 20,000 households, revealed that in the first quarter of this year, more people were looking to increase their savings, while there was a lower focus on investment and consumption. This shift in consumer behavior has had a significant impact on the share prices of Chinese companies, particularly those directly related to consumer spending, such as Alibaba and JD.com.
The Ponzi Scheme of Chinese Property Development: Pre-Sale Funds and Debt Crisis
The Ponzi Scheme of Chinese Property Development
China’s property development sector has been operating in a manner reminiscent of a Ponzi scheme. Developers would sell pre-sale rounds, where buyers put down deposits and start paying mortgages before their homes were even built. The revenue collected from these pre-sales would then be used to fund the completion of the previous year’s developments, rather than the current project. This cycle continued as long as there was fresh demand and no obstacles hindering project completion. However, this system was a disaster waiting to happen, as it relied on a constant influx of new investors and the absence of any disruptions to the development process.
The Three Red Lines and the Evergrande Crisis
In 2020, the Chinese Communist Party (CCP) introduced the “three red lines” rule to curb the over-leveraging of property developers. This rule required developers to meet specific financial criteria to be eligible for new debt. However, in 2021, nearly half of China’s property developers breached at least one of the three red lines, leading to a sector-wide funding crisis as old debts came due. The debt crisis shook investor confidence and contributed to a significant slowdown in China’s real estate market, with declining property sales and prices. The bankruptcy of the Evergrande Group, a prominent property developer, further highlighted the severity of the situation.
The Ripple Effect on the Chinese Economy
The concentration of wealth in real estate has become a significant issue for Chinese households. With approximately 90% of households owning their homes and roughly 70% of their wealth tied up in property, the falling house prices have left citizens feeling the financial pinch. As a result, they have reduced their spending, which has had a ripple effect on businesses across various sectors. Lower consumer spending means that businesses generate less income, leading to poor performance in the stock market, as evidenced by the CSI 300 index. This reduction in spending can also lead to potential layoffs as businesses attempt to cut costs, further exacerbating the negative economic spiral.
Government Measures Fail to Revive Investor Confidence and Boost Demand
Ineffective Stimulus Measures and Persistent Funding Challenges
Despite the Chinese government’s recent efforts to support the struggling property sector, investor confidence remains low, and demand continues to be sluggish. The government has announced measures such as allowing local authorities to purchase homes at reasonable prices for affordable housing and reducing mortgage loan interest rates and down payment ratios for home buyers. However, these stimulus measures have yet to yield positive responses from investors.
Bloomberg reports that funding for developers has remained weak since the government introduced a whitelist of property firms eligible for loans in the previous year. Data indicates that a broad gauge of financing for developers, encompassing loans, bonds, and proceeds from home sales, continues to shrink significantly, with a 24.3% decline compared to the previous year. This persistent funding challenge further exacerbates the difficulties faced by the property sector.
Deflation and Belt-Tightening Among Chinese Consumers
In contrast to the United States, which implemented substantial stimulus measures during the pandemic, China opted not to follow a similar path. This decision has led to a markedly different economic outcome. While the U.S. experienced inflated consumer spending and a higher savings rate due to the stimulus, China has been grappling with deflation, as the prices of goods and services have been shrinking in response to citizens tightening their belts.
A recent survey conducted by the People’s Bank of China, involving 20,000 households, revealed that in the first quarter of this year, more people were looking to increase their savings, while there was a lower focus on investment and consumption. This shift in consumer behavior has had a profound impact on the share prices of Chinese companies, particularly those directly related to consumer spending, such as Alibaba and JD.com.
Ripple Effects on the Broader Economy
The ongoing property crisis and the subsequent decline in consumer spending have far-reaching consequences for the Chinese economy. As businesses generate less income due to reduced consumer spending, they may resort to cost-cutting measures, such as layoffs, further dampening the spending appetite of the population. This negative spiral can lead to a broader economic slowdown, affecting various sectors beyond the property market.
The poor performance of the CSI 300 index, which tracks the largest stocks in China, is a testament to the widespread impact of the property crisis and the resulting economic challenges. Companies across different industries have seen their share prices plummet, reflecting the overall sentiment of investors and the difficulties faced by businesses in navigating the current economic landscape.
Weak Funding for Developers and Broader Economic Challenges Persist
Persistent Funding Challenges for Developers
Despite the Chinese government’s recent efforts to support the struggling property sector, funding for developers has remained weak. Bloomberg reports that a broad gauge of financing for developers, encompassing loans, bonds, and proceeds from home sales, continues to shrink significantly, with a 24.3% decline compared to the previous year. This persistent funding challenge further exacerbates the difficulties faced by the property sector, even after the government introduced a whitelist of property firms eligible for loans in the previous year.
Deflation and Reduced Consumer Spending
In contrast to the United States, which implemented substantial stimulus measures during the pandemic, China opted not to follow a similar path, leading to a markedly different economic outcome. While the U.S. experienced inflated consumer spending and a higher savings rate due to the stimulus, China has been grappling with deflation, as the prices of goods and services have been shrinking in response to citizens tightening their belts. A recent survey by the People’s Bank of China revealed that more people were looking to increase their savings, while there was a lower focus on investment and consumption in the first quarter of this year. This shift in consumer behavior has had a profound impact on the share prices of Chinese companies, particularly those directly related to consumer spending.
Ripple Effects on the Broader Economy
The ongoing property crisis and the subsequent decline in consumer spending have far-reaching consequences for the Chinese economy. As businesses generate less income due to reduced consumer spending, they may resort to cost-cutting measures, such as layoffs, further dampening the spending appetite of the population. This negative spiral can lead to a broader economic slowdown, affecting various sectors beyond the property market. The poor performance of the CSI 300 index, which tracks the largest stocks in China, reflects the widespread impact of the property crisis and the resulting economic challenges faced by businesses across different industries.
