KUALA LUMPUR: Moody’s Analytics expects China to make every effort to avoid a hard landing as it seeks to tame the housing market while financing pressure on developers has mounted.
In its research note on Tuesday, it said the long-term goal to deleverage the debt-ridden sector and lower housing costs will not change.
China’s property market is cooling, with measures of price growth, housing starts and sales moderating significantly over the past few months, it said.
Below is the report on the China property market and Moody’s Analytics viewpoints:
New-home prices were up 3.5% in August from a year earlier, the smallest growth since the property market rebounded from the pandemic fallout in June 2020.
Among the 70 major cities for which China releases monthly housing prices, 20 recorded month-over-month declines in new-home prices in August and 33 for resale prices.
Even in top-tier cities such as Guangzhou and Shenzhen, resale house price inflation eased substantially from the prior month.
Property sales contracted in July and August with floor space sold logging an 18% year-over-year decline in August.
The pace of new housing starts was quite slow compared with the same period in the previous two years as some property developers halted new projects amid tougher regulatory scrutiny on their financial health.
Chinese policymakers issued new financing rules called “the three red lines” for real estate companies in August 2020, banning firms with excessive leverage ratios from taking on more debt.
Other regulatory actions
Since then, there were a slew of other regulatory actions taken to tame the strong rally in property prices coming out of the pandemic downturn.
Regulators worry that an overheated property market could draw away resources and capital from the real economy and increase the risk of financial instability.
They strengthened restrictions on bank lending to the real estate sector, prompting some banks to raise mortgage rates. Some local governments also tightened the eligibility for home purchases and set price caps for sales.
The impacts of the curbs have come in stronger than expected, stoking concerns that they will spiral out of control. As property sales ebb, the financing pressure on developers has begun to mount, leaving many in a liquidity crunch amid dented property sales, restrained borrowing, and elevated financing costs. Rising concerns about developers' debt repayment capabilities have rattled the financial market.
China Evergrande building in HK
Evergrande Group, the country’s second-largest real estate behemoth with $300 billion in liability, is the most compelling example in the news headlines recently.
Evergrande is not the only one struggling. In the first half of the year, 12 Chinese real estate companies reported bond defaults, amounting to CNY19.2 billion, data from the Wind showed. This accounted for near 20% of total corporate bond defaults in the first six months of the year, the highest across all sectors.
Property firms face a historical debt maturity wall of CNY1.28 trillion this year, but total bond issuance in onshore and offshore markets in the first eight months was less than CNY700 trillion, down 21% from the previous year, according to the Beike Research Institute.
The financing environment for the sector will get tougher because of waning investor confidence, imposing great liquidity pressure on firms that rely on new borrowing to repay old debt. Foreign investors are equally nervous about a hard landing as 30% of the debt was issued offshore.
Banks see bad loans
As developers are struggling to repay debt, banks are seeing more bad loans. Nonperforming loans to the real estate sector surged 30% across the five largest banks in the first half of the year.
Despite the recent slowdown in property loans after regulators imposed ratio caps on banks’ real estate lending, outstanding loans to the sector still account for 27% of the total of CNY186 trillion in loans as of the end of June, among which 20% comes from household mortgages and 5% from developers loans.
Though banks’ direct risk exposure to property developers is under control, the knock-on effects of a teetering property sector on homebuyers and contractors are potentially serious.
In addition, among the 40 Chinese listed banks, 11 failed to meet the requirement on mortgage-to-total-loan ratio while 10 exceeded the threshold for total real estate lending ratio at the end of the second quarter.
This reflects the regulatory pressure that would restrain banks’ support to the sector.
Developers are now resorting to asset sales and aggressively discounting apartment prices in order to recoup funds. Unfortunately, this isn’t working well.
Potential buyers are taking a wait-and-see approach as their expectations for near-term house prices may have turned upside down.
This may generate a negative feedback loop in the near term as lower prices fuel lower expectations, leading to delayed purchases and more pressure on developers to lower prices further.
Price expectation isn’t the only reason holding back potential homebuyers. Increased income uncertainty amid regulatory crackdowns on a range of private industries and authorities’ broader pursuit for “common prosperity” are contributing factors.
The sweeping crackdowns on the country’s booming sectors such as technology, private education, gaming and entertainment, are likely weighing down property sales as employees in those sectors are relatively well-paid and represent a large group of potential homebuyers.
Recent regulatory moves dented the sense of security for high-income earners, making them more conservative in property investment. Employees in ByteDance took a 20% pay hit a few weeks ago after the company ended a weekend overtime policy because of regulatory pressure.
The repeated mentioning of “common prosperity” and the government’s push to rein in excessive income will likely be headwinds for the real estate sector for the foreseeable future.
Homebuyers on the hook
Compared with developer defaults and a housing price crash, Chinese authorities are more concerned that developers fail to deliver projects to homebuyers who have put down their or even their parents’ life savings on purchases.
The Evergrande Group owns more than 1,300 real estate projects in more than 280 cities in China, according to the company's website.
Many projects have been put on hold as the developer struggles to pay its contractors and suppliers. This has stoked concerns that its bankruptcy could leave homebuyers with nothing but a whopping mortgage to repay.
Such a scenario would be devastating to the economy and may trigger social unrest. Policymakers are expected to do anything they can to prevent it from happening.
Housing is the most valuable asset for China’s urban households. In 2019, housing represented 59.1% of total household assets, while other financial assets contributed only 20.4%.
The result is an elevated mortgage burden, accounting for 75.9% of total household liability. In more mature economies such as the U.S., the weight of financial assets is much higher and housing accounts for less than half of household assets.
Therefore, any shocks to China’s property values will have significant impacts on household balance sheets, particularly their debt leverage ratios.
This will in turn have implications for consumer behavior through the wealth channel.
Public finance implications
China’s public finance is also highly intertwined with the housing market. Revenue from land sales and real estate-related taxes represent a substantial portion of government income.
According to a study by a Chinese investment platform Gelonghui on land sales as a percentage of local government revenue for 44 major Chinese cities, 20 of them had ratios above 100% in 2020, and 19 above 50%, an indication of deep fiscal dependency on the property sector.
The cooling housing market in recent months led to a slowdown in land sales in August, putting pressure on already strained local government finances.
Given the gigantic size and importance of the sector to the economy, we expect China to make every effort to avoid a hard landing, especially at a time when the economy is facing heightened uncertainty amid a pandemic and other growing headwinds such as vulnerable domestic consumption and simmering geopolitical tensions.
The long-term goal to deleverage the debt-ridden property sector and lower housing costs will not change, but the pace will need to be managed carefully.
China may reassess its priorities in deleveraging, common prosperity, and environmental goals for better policy coordination to prevent a perfect storm that pushes developers into a corner. Some government supports will be needed and are expected to come soon, to ensure broader financial and economic stability.