China’s property woes are worsening, requiring bolder policy relief

China’s real estate woes are accelerating. Potential homebuyers are deterred from buying and selling, leading to poor sales, adding to the urgent need for policymakers to step up support for the industry.

New home sales for the top 100 developers fell by about a third in June and July from a year ago, after double-digit growth earlier in the year, said Edward Chan, director of S&P Global Ratings. As most apartments in China are sold unfinished, weak new home sales are likely to cause significant cash flow problems for developers.

“We think the situation is probably getting a little bit worse because of this Country Garden incident,” Chan told CNBC in a phone interview Thursday. He added that he has seen no improvement in new home sales to date.

This lack of improvement, at a time when most data points to a rapidly slowing economy, Village garden‘s expected default, makes it difficult for property developers to raise funds.

Evergrande, the world’s most indebted property developer, filed for bankruptcy protection in the United States on Thursday, further shaking investor confidence.

A deepening crisis of confidence is increasing pressure on the world’s second-largest economy.

China’s property sector has been reeling since 2020, when Beijing’s mainland real estate developers clamped down on debt levels.

Years of growth have led to the construction of ghost towns where supply outstrips demand as developers seek to capitalize on the desire for home ownership and property investment.

The measures, known as China’s “three red lines” policy, refer to three specific balance sheet conditions that developers must meet if they want to borrow more.

The rules require developers to limit their debt in relation to the company’s cash flow, assets and capital levels, with a highly indebted developer Evergrande First title defaults at the end of 2021.

A default by Country Garden could add $9.9 billion to global emerging markets high-yield corporate defaults, bringing total defaults for the Chinese property sector to $17 billion in 2023, JPMorgan noted. Dated August 15.

The US investment bank expects Chinese property to account for around 40% of all emerging market defaults in 2023.

Many of the Garden Country’s problems stem from its heavy influence on the less developed parts of China, known as low-tier cities. According to the company’s 2022 report, about 61% of developments are in these lower-tier cities, where housing supply outstrips demand.

“The country garden sales performance has been kind of disastrous,” said S&P Global’s Chan, noting that sales in June and July were down nearly 50% year-on-year.

Chan said lower-tier cities began to see sales weakness in May, while higher-tier cities experienced worsening sales in subsequent months.

As a result of Country Garden’s problems, Chan said China’s total real estate sales are “increasingly difficult” for the S&P to reach 13 trillion yuan this year, up from 12 trillion yuan.

“It could be a descending staircase instead of an L shape,” he said.

Chan said S&P’s bearish outlook for China’s property sector is 11 trillion yuan in sales this year and 10 trillion yuan in 2024.

That’s still about half of what the country’s real estate market sales peaked in 2021 at 18 trillion yuan, according to figures shared by Chan.

At the annual economic review meeting in July, China’s top leaders pledged to “timely adjust and optimize policies” for its beleaguered property sector.

To date, they have yet to clearly demonstrate plans to adapt to “fundamental changes” in the supply-demand dynamics of the property market.

“Country Garden’s debt problems and the uncertainty of government support add to broader concerns in China’s housing market,” Louise Loo, chief economist at Oxford Economics, wrote in a note on Aug. 11.

As China’s property sector strengthens amid the debt and credit crisis, state-owned developers are faring better than the non-state sector.

According to data from Natixis Corporate and Investment Banking, state-owned developers saw contract sales rise 48% in the first seven months of this year compared to a year ago, while sales from non-state developers fell 19%.

This increases the ability of state-owned developers to buy land from local governments, as strong home sales increase their cash flow.

“Currently, 87% of land purchases are accounted for by (state-owned enterprises), so how do you expect (private enterprises) to grow further?” Natixis chief economist Gary Ng said in a telephone interview on Tuesday.

According to Natixis data, 87% of land purchases by July this year were by state-owned developers, the same as last year. This is a sharp increase from 59% in 2021, the data shows.

Ng expects state-owned developers to dominate China’s real estate market in the future. But he said that while non-state-owned developers have had leverage problems in the past, having so many state-owned developers in the industry can make it difficult to predict actual demand.

Still, core housing demand in tier-one cities remains somewhat robust and untapped and may emerge once more policy clarity is achieved.

“Timely policy would be crucial in stabilizing demand and sales in top-tier cities,” said S&P Global’s Chan.

“If this could be achieved, over time stabilization could trickle down to lower-tier cities. But it would take much longer.”