China's Real Estate Problems

For years, the real estate sector has been a key driver of China’s inexorable economic growth, with rising property prices creating wealth for the middle class. But the party in Chinese property markets appears to have come to an end.

The sector has been in a slump, triggered by a debt default from the nation’s largest developer last year. Evergrande’s inability to repay its debt grabbed global attention, and founded fears that a potential bankruptcy would trigger a broader crisis in the country’s debt markets. A year later, defaults on Chinese property bonds remain elevated. Shanghai-based Shimao Group is the latest addition to the list, after it failed to pay off a $1 billion offshore bond earlier this month.

Chinese policymakers have been trying to rein in leverage in recent years, and the real estate sector has been at the center of those efforts. Having borrowed extensively to support growth, Chinese non-financial corporations are among the most indebted in the world. The property development sector is sitting on 33.5 trillion renminbi ($5 trillion) worth of debt, according to Nomura. The Three Red Lines policy has been a key step towards instilling fiscal discipline, limiting debt in relation to a firm’s cash flows, assets and capital levels. Interestingly, Shimao had met all three of those policy requirements, and still found trouble.

Home sales have been plunging on the back of a weaker Chinese economy and diminished confidence among potential homebuyers. The Three Red Lines forced developers to reduce their debt levels, with banks becoming less willing to lend to the sector. Higher borrowing costs have made offshore refinancing unviable for many. As a result, developers are under financial stress and unable to deliver projects.