The slowdown in the Chinese real estate market has put pressure on China’s GDP growth. Here are some answers to crucial questions about the risks related to the Chinese property market.
What caused the property slowdown? Between 2010 and 2020, China saw a strong property market, with property prices in the top 70 cities rising by 60%, leading some home buyers to complain about property affordability. The government became concerned that this could lead to a property bubble.
As a result, in 2020 and 2021, some cities in China tightened home purchase restrictions to cool off the housing market. At the same time, the government instructed banks to tighten lending criteria to highly leveraged developers. The combination of these measures led to liquidity issues for some high-risk developers, who have defaulted on their debt. In the past 12 months, we have seen prices tilt lower (see figure 1).
What are the key risks in the Chinese real estate market?
Troubled developers have halted the construction of some projects. Sentiment has become quite harmful for the sector, leading to tighter financial conditions. Home buyers are also cautious about the property price outlook and have become less eager to buy homes, which could lead to further deterioration of the sector. These risks, if not controlled, could spill over to the whole financial sector.
The national real estate climate index follows the theory of economic cycle fluctuation, based on the business cycle theory and business cycle analysis, using time series, multivariate statistics, econometric analysis, taking real estate development and investment as the benchmarks, selecting related indicators such as real estate investment, capital, area, sales, excluding the impact of seasonal factors, including random factors, compiled by adopting the growth rate cycles method. Typically, the most appropriate national real estate climate index level is 100, the moderate level is between 95 and 105, the lower level is below 95, and the higher level is above 105.
Are we seeing high risks for mortgages?
Mortgage underwriting in China is relatively conservative. First-time home buyers typically pay a down payment of a minimum of 20% to 30%, while second-time home buyers are generally required to pay a down payment of 40% to 70% of the property’s value. There is no subprime mortgage lending. As a result, Chinese households are not overly leveraged, and household income is growing. In our view, this provides a substantial cushion for the repayment of outstanding mortgages.
What about the mortgage boycott?
In China, homebuyers often purchase new homes from developers’ plans and begin making mortgage payments before the projects are finished. As some troubled developers halted construction on specific projects, homebuyers announced they would stop making mortgage payments until construction resumed.
The mortgage boycott is only related to those projects which have been halted. Importantly, this is not homeowners unable to pay mortgages due to financial troubles, which we saw during the 2008 financial crisis in the US.
According to S&P Global research, the impacted mortgages could amount to 0.5% to 1.5% of total bank loans — manageable, in our view. In addition, home buyers should start paying their mortgages again once construction resumes. Recent policies have focused on ensuring the completion of halted projects.
What measures has the government rolled out to support the property market?
• Regulators have reduced mortgage interest rates for first-time home buyers
• Many cities have loosened home purchase restrictions to encourage home buying
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• In July, the Chinese authorities promised to establish an initial rescue fund of 80 billion yuan ($16.1 billion) and could grow to 300 billion yuan, according to Reuters. This is aimed at resolving the debt crisis and restoring confidence in the property sector
• Chinese officials said in July that banks and other government departments would meet reasonable financing needs of real estate developers. The Ministry of Housing, Urban-Rural Development, the central bank and other departments will support local governments to ensure the delivery of buildings, protect people’s livelihoods and maintain stability
How does China deal with troubled developers’ projects?
It is estimated that there are 97,000 developers in China, and a few hundred go out of business every year. In the past, the projects of those troubled developers were handled mainly through restructuring or liquidation.
Most of the projects were resolved through restructuring, whereby the government helped find a more robust developer to act as a partner or take over the projects. In the case of liquidation, assets were auctioned off, and the proceeds were used to compensate home buyers and other creditors. As expected, the above measures need time and could take months or even years.
What is your assessment of the impact of the property slowdown?
Given the above factors, we see a very low probability of the property slowdown leading to systematic risks in China’s financial system. However, the property sector boom years are likely behind us. Some experts estimate that annual new home sales will likely decline to 1 to 1.2 billion sq m in the coming years from 1.6 billion sq m in 2021 and will drag on the GDP growth rate.
To a certain extent, mortgage payment burdens have crowded out other discretionary spending. If mortgage payments take up a smaller portion of consumers’ income, we believe this could lead to more spending in other areas.
Jian Shi Cortesi is the investment director of China and Asian equities at GAM Investments