What happened?

Shares in Evergrande fell earlier this week. This was off the back of its chairman being put under police surveillance and current and former executives being detained.

Evergrande shares closed more than 21% lower in Hong Kong this week. and this has dragged down the stocks of other Chinese property developers in the process.

Let’s re-wind the clock…

Pre- 1998 saw China under a strict Communist regime, led by Mao Zedong. Property at this time, was state - owned, and so the ability to privately purchase homes was not available. Reforms in 1998 meant that anyone who wanted to purchase a new home, could now do so privately. It was also a time that offered low costs of borrowing, which increased the demand for housing even more.

Image courtesy of the BBC

Image courtesy of the BBC

The property market accounts for roughly 25% of China’s Gross Domestic Product (GDP). To put this into more context: this figure stands at around 15-18% for the US, 13% in Singapore, and 7% in the UK.

These graphs show us that to cater to a rapidly growing number of people moving into urban areas, more homes had to be build. The demand had to match the supply. However, what has unfolded has meant that supply has outstretched demand - by a colossal mile. And with this, brings colossal problems.

Out of this increasing demand, arose China’s largest property developers- Evergrande and Country Gardens.

Evergrande: A snapshot

Industry: Real Estate.

Current CEO/Chairman: Hui Ka Yan

Company HQ: Shenzhen. China.

Company mission: Its corporate mission is to build the brand “with quality”, and to establish the enterprise “with integrity”.

Have financed their constructions by: Borrowing heavily from financial institutions and other investors and using payments from people who have purchased houses.

Current debt: More than $300 billion.

Other things they do: They have an electric vehicle company called, Evergrande New Energy Auto and own  Guangzhou F.C (formerly known as Guangzhou Evergrande Taobao Football Club) a Chinese football club.

Shares: Currently suspended until further notice.

Future prospects: Not looking good.

2021: the year of the default

Evergrande defaulted on its financial obligations to creditors toward the end of 2021.

Why? The answer can be narrowed down to two words: low demand.

Evergrande had been reeling off the high demand for homes for years, this was in part due to the laws and regulations in place which made it easy for developers to borrow money. However, a pandemic coupled with the introduction of new laws, designed to curb developers borrowing to finance the construction of new homes ground this to a halt.

I’ll touch upon the two important points in more detail below.

The Covid-19 pandemic brought along a whole host of issues and concerns for the country. It resulted with its borders being shut, millions of people being tested and confined to their homes and an overall decrease in consumer spending. Not good for any economy. What is unique to China, is that it resulted in a pandemic related lockdown for more than three years. Specific to its real estate industry, it led to a decrease in demand for those wanting to buy homes and less people seeing property as a good investment. You can almost say that Evergrande’s default was inevitable.

Evergrande had borrowed heavily to fund its rapid expansion into a wide range of sectors, including setting up an electric vehicle company. A year prior, the Chinese government introduced new laws designed to contain developers excessive borrowing. One measure they introduced was an increased scrutiny of real estate companies finances. Such new moves had a direct impact on Evergrande and they default a year later. As developers continued to struggle to receive funds, developments slowed. Many homebuyers were concerned at the prospect of not moving into the homes they had already invested in, and as a result, some projects were left unfinished, and some didn’t even begin.

Image and Article courtesy of Business Insider

Image courtesy of Business Insider

Image courtesy of Wall Street Journal

A domino effect…

When one of the largest real estate companies is struggling, it’s only a matter of time until others within that sector and even beyond, start to feel the pinch too. Not long after, Country Gardens a private real estate company in China also announced concerns about being able to pay off their debt. They have avoided a default (for now…), but have warned that if its financial performance “continues to deteriorate”, it could default on its debts.

According to Standard & Poor’s, more than 50 Chinese developers have defaulted or failed to make debt payments in the last three years. Yikes.

A little caveat: when I was looking into this massive story, I couldn’t help but think that the bigger and more successful companies have it slightly…easier. They tend to have more finances, somewhat more stability and are often helped out by governments in times of crisis (think of the bank runs that occurred earlier in the year in the US). This is especially the case if you’re apart of an ‘important’ industry, such as real estate or banking.

How have they tried to resolve the problem?

The company has been racing to raise cash by selling its assets and shares to repay creditors and suppliers. Evergrande has tried to use a few solutions to resolve the issues.

·       They had been working on a new repayment plan, they even filed for US bankruptcy protection, a positive step seen by many.

·       They also planned to reissue its debt overseas as new bonds, and planned to for creditors to have stakes in the company as shares.

However, recent negative events have dented hopes for Evergrande coming out of the disaster it has found itself in. For example, they suspended their shares on the Hong Kong stock exchange in 2021 for a 17-month period. This was done as a way to try and restructure its offshore debt and pay creditors. Shares had started to resume just a month prior, but have been suspended once more after the recent events.

Evergrande shares closed more than 21% lower in Hong Kong this week. and this has dragged down the stocks of other Chinese property developers in the process.

Evergrande collapse: What could happen

Evergrande collapsing is a catastrophe that many do not want to see. It could mean

·       Socially: Those who have purchased homes could lose the money they invested. It could mean a decrease in financial security for many. Many may struggle to make ends meet.

·       Business relationships: Suppliers and other creditors will also not likely receive their money back too. It could lead to sour business relationships and a lack of trust between suppliers and businesses.

·       A potential credit crunch. This is when companies struggle to borrow money at affordable rates. It could result in banks and other types of lenders being forced to lend less, as assurance that businesses can repay the loans (with interest) will drop. Businesses may find it harder to grow too.

·       Global fears. China has the second largest GDP in the world. It has many ties with different countries, companies and people all over the world. For example, China is Australia’s biggest trading partner, accounting for nearly one-third of its overseas trade and China accounts for more than 60% of Qualcomm’s revenue. A crisis in China, could potentially mean a crisis for them.

Is there still hope?

So, what’s next for China’s real estate crisis? Let’s have a brief look at what has happened recently.

·       Key meetings with creditors to restructure its offshore debt were cancelled. The question looms of when, if ever, will creditors get their money back.

·       Property sales have been disappointing. Many people’s wealth and savings are tied up with property. Less sales, falling valuations of homes, the government cutting interest rates amid an economic slowdown…these are things that they don’t want to happen.

·       In March 2023, China set an economic outlook of 5% for the rest of the year. However, given how high the percentage China’s real estate market is, a slump in property sales directly correlates to a slump in China’s GDP.  

·       An important source of revenue for local governments in China is the selling of land to developers. A slump in sales means that local governments aren’t bringing in as much revenue as they once were. In turn, they are cutting back on services needed, which can continue to have knock on effects for those who need them.

·       Regulatory probes and police surveillance. Evergrande’s chairman Hui Ka Yan was put under police surveillance earlier this week and many current and former executives has been detained. Its main subsidiary, Hengda Real Estate Group defaulted on 4 billion yuan of debt.  (which could jeopardise Evergrande’s plan to restructure its debts). Things keep on going very well for the company.

Due to these factors, I’ll say that it isn’t looking too good for the company as well as China’s economy.

One thing is clear – the world (especially the US,  China’s frenemy) is watching very closely.

Let’s keep our eyes peeled.

What are your thoughts on the story? Do you think Evergrande will cease its business operations? If so, what kind of ramifications could this have? Is Evergrande too grand and important to fail? Do you think the government will step in and bail them out? If so, what kind of message could this send to other businesses within the sector? What about to other countries globally?

That’s it for this week!

Until next time, remember to stay curious!

DISCLAIMER:

This blog is for educational purposes only. What I post is not financial, investing or legal advice.

This blog isn’t written by an individual who has years of experience within the corporate world. Nor is it written by someone who has a lot of accolades or academics behind her within these fields. However, it is written by one who has a desire to better understand these industries and has just decided to share her journey with others.