Defaults in China real estate have been unprecedented—is policy support forthcoming and what will this market look like in the future?
The China property sector has been volatile since 4Q21, as fallout from the Evergrande failure caused finance options for POE (private-owned enterprise) developers from financial institutions and from presales escrow funds to dry up. Despite some regulatory easing, the mantra of “housing is for living, not speculation” remained and financial institutions were unwilling to extend their exposure to POE developers. Problems that had accumulated during the boom period (2015 – 2019) were exposed in a matter of months, as many developers had believed that the “good times” would continue to bail them out from hidden debt and poor governance. All of this contributed to market concerns.
On March 16, the State Council’s financial stability and development committee, chaired by Vice Premier Liu He, helped improve market dynamics even though limited concrete measures followed. Before Liu’s speech outlining their approach, 70% of property bonds (ex-defaulted) were trading below a 50 cash price versus the current 44%.
Policymakers would like to strike a balance between stabilizing the sector and managing housing prices, which has kept them from launching effective nationwide policies. City-specific measures, such as a lower payment ratio, have been released in some lower-tier cities since February; while taking time to feed through, we expect property sales decline to narrow year-over-year and show improvement toward the end of Q2.
However, we can’t rule out tail risk from policies that are “too little too late,” while the dynamic of consumers’ purchase power has changed with the recent COVID disruptions. Without more concrete steps by the government, the sector could remain volatile, while property sales and investment could remain weak in 2H22, creating spillover into other sectors including local government financing vehicles (LGFVs), which heavily rely on land-bidding income. This would also hit the credit impulse in the system. Over the longer term, we expect the market structure of China property industry to see fundamental change, with a smaller size (from its RMB18.2 trillion level in 2021), fewer market players, and lower margins, along with more exploration of new business models involving commercial buildings, and affordable and long-rental apartments.
Our framework to analyze China property credits will change accordingly. The importance of ESG factors will likely increase, with a focus on senior management quality and their corporate strategies to navigate the industry transition, along with improving governance to regain trust. Involvement in and funding of social welfare projects will also be key to watch.
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