Beyond Evergrande, China’s property market faces a $5 trillion reckoning

China Evergrande Group, the embattled property developer, is the first high-profile real-estate company to run into serious trouble in Beijing’s campaign to tame a roaring property market.

It might not be the last.

As China enters what many economists say is the final stage of one of the largest real-estate booms in history, it is confronting a staggering bill: More than $5 trillion in debt that developers took on when times were good, according to economists at Nomura Holdings Inc.

That debt is nearly double what it was at the end of 2016 and is more than the entire economic output of Japan, the world’s third-largest economy, last year.

CHINESE MARKETS RETURN FROM BREAK TO MORE EVERGRANDE ANGST

Global markets are braced for a possible wave of defaults, with warning signs flashing over the debt of about two-fifths of development companies that have borrowed from international bond investors.

Chinese leaders are getting serious about addressing the debt, with a series of moves meant to curb excessive borrowing. But doing so without torpedoing the property market, crippling more developers and derailing the country’s economy is quickly turning into one of the biggest economic challenges Chinese leaders have faced in years, and one that could reverberate globally if mismanaged.

Luxury developer Fantasia Holdings Group Co. failed to repay $206 million in dollar bonds that matured Oct. 4. In late September, Evergrande, which has more than $300 billion in obligations, missed two interest-payment deadlines for bonds.

Asia’s junk-bond markets suffered a wave of selling last week. On Friday, bonds from 24 of the 59 Chinese development companies in an ICE BofA index of Asian corporate dollar bonds were trading at yields of above 20%, levels that indicate high risk of default.

Some prospective home buyers are balking, forcing the companies to cut prices to raise cash, and potentially accelerating their slide if the trend continues.

Total sales among China’s 100 largest developers were down by 36% in September from a year earlier, according to data from CRIC, a research unit of property services firm e-House (China) Enterprise Holdings Ltd. It showed that the 10 biggest developers, including China Evergrande, Country Garden Holdings Co. and China Vanke Co. , saw sales down 44% from a year ago.

Economists say that most Chinese developers remain relatively healthy. Beijing also has the firepower and tight control of the financial system needed to prevent a so-called Lehman moment in which a corporate collapse snowballs into a financial crisis, they say.

In late September, The Wall Street Journal reported that China had asked local governments to prepare for problems potentially intensifying at Evergrande.

But many economists, investors and analysts agree that even for healthy ventures, the underlying business model—in which developers use debt to fund a steady churn of new construction despite demographics becoming less favorable for new housing—is likely to change. Some developers might not survive the transition, they say.

Of particular concern is some developers’ practice of relying heavily on "presales," in which buyers pay in advance for still-uncompleted apartments.

The practice, more common in China than the U.S., means developers are in effect borrowing interest-free from millions of households, making it easier to continue expanding but potentially leaving buyers without finished apartments should the developers fail.

Presales and similar deals were the sector’s biggest funding source this year through August, according to the National Bureau of Statistics of China.

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"There is no return to the previous growth model for China’s real-estate market," said Houze Song, a research fellow at the Paulson Institute, a Chicago think tank focused on U.S.-China relations. He said China is likely to keep in place a set of limits on corporate borrowing it imposed last year, known as the "three red lines," which helped trigger the recent distress at some developers, though he said China might ease some other curbs.

While Beijing has avoided clear public statements on its plans for dealing with the most indebted developers, many economists believe leaders have no choice but to keep the pressure on them.

Policy makers appear determined to revamp a model driven by debt and speculation as part of President Xi Jinping’s broader efforts to defuse hidden risks that could destabilize society, especially ahead of important Communist Party meetings next year. Mr. Xi is widely expected then to break with precedent and extend his rule into a third term.

Beijing is worried that after years of rapid home-price gains, some people may be unable to get on the housing ladder, potentially fueling social discontent as wealth gaps widen, economists say. Young couples in large cities are beginning to get priced out, making it harder for them to start families. The median apartment in Beijing or Shenzhen now costs more than 40 times the median family annual disposable income, according to J.P. Morgan Asset Management.

Authorities have said they are worried about the property market posing risks to the financial system. Reining in the developers’ business models and limiting debt, however, is almost certain to slow investment and cause at least some downturn in the property market, which is one of the biggest drivers of China’s growth.

The real-estate and construction industries account for a large part of China’s economy. A 2020 paper by researchers Kenneth S. Rogoff and Yuanchen Yang estimated that the industries, broadly construed, accounted for 29% of China’s economic activity, far more than in many other countries. Slower growth in housing could spill into other parts of the economy, affecting consumer spending and employment.

Government statistics show about 1.6 million acres of residential floor space was under construction at the end of last year. That was equal to about 21,000 towers with the floor area of the Burj Khalifa in Dubai, the world’s tallest building.

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As restrictions on borrowing imposed last year kicked in, housing construction tumbled in August to 13.6% below its pre-pandemic level, calculations by Oxford Economics show.

The revenue local governments earn by selling land to developers fell by 17.5% in August from a year earlier. Local governments, which are also heavily indebted, count on land sales for much of their revenue.

To read more from The Wall Street Journal, click here.