As China’s real estate crisis spreads, home sales fell sharply in October, and prices fell for the first time in six years. Many of China’s biggest developers are unable to make debt payments, leaving projects unfinished and creating a liquidity crisis throughout the sector.
How did the largest real estate market in the world come unraveled?
It began in August 2020, when the Chinese government announced a new policy to control the debt in the real estate sector. Known as the “three red lines”, these rules limit the amount of debt a company can take on. They include keeping the liability to asset ratio below 0.7, the debt to equity below 1.0, and a cash-on-hand to short-term borrowing ratio above 1.0.
Half of China’s 30 largest developers have already crossed the “three red lines”, according to an Oct. 8 analysis by the Financial Times. These real estate giants, including Evergrande, Oceanwide, and others, are now unable to take on new debt, and have started selling assets to raise cash.
The problem is there are very few buyers for these distressed assets. Other over-leveraged developers can’t buy them. Smaller developers can’t borrow money without crossing the “red lines”. And individual investors now have serious doubts about the market.
It seems to be an engineered collapse in demand, courtesy of the Chinese Communist Party. Through these new regulations, they may have intentionally popped their own real estate bubble. Analysts are left wondering what comes next.
Beijing’s options include: undoing its new “red line” rules to allow more borrowing; allowing foreign investors to rescue distressed Chinese companies; and bailing out the real estate sector with government funds.
Bursting Bubble
What’s at stake is huge by any measure, said economist Max Firth of Stoic Finance. “The Chinese property market is worth roughly $60 trillion,” he explained, “twice the size of the US real estate market. The sector accounts for roughly 29 percent of China’s gross domestic product, compared to about 8 percent in the US. And in China, real estate makes up 66 percent of household wealth, compared to just 24 percent in US.”China’s real estate is so big, said Firth, “It might be the largest asset class in the world.”
One of the reasons that real estate is so valuable in the county is that Chinese citizens have very few choices when it comes to investments. Stocks, for example, are very difficult for the average person to legally invest in. This makes real estate one of the few ways to grow wealth for China’s 658 million families.
Another oddity is that in China, real estate doesn’t have to be useful to be valuable. In fact, millions of Chinese apartments have been sold and resold at a profit without ever having been lived in. They are part of China’s “ghost cities” which exist only as investments.
An estimated 65 million homes in China are not only empty, but completely uninhabitable—without connections for water, electricity, or heating.
“That’s 20 percent of China’s housing supply,” said Firth. “These are not real homes. They don’t have any real value. When prices start to drop, these will drop off a cliff. This entire industry is a house of cards.”
This makes China’s real estate market different from anyplace else on earth. “With a normal investment,” Frith explained, “the price is derived from the return on investment. These empty ghost apartments never generate an income. Their value is derived purely from the idea that someone else will want to buy the apartment from you.”
“So maybe you were a fool for buying it,” said Firth, “but the new buyer is an even greater fool for buying it from you at an even higher price. The entire Chinese property market is based on the greater fool theory.”
This has created a bubble where average home prices surpass 40 to 50 times the average household income, compared to only seven times average household income in the U.S. market.
Opportunity?
Economist Gerald Celente of Trends Research has a different take. “Let’s put this in perspective,” he said in an interview. “Back in the 1990s, only 5 percent of the Chinese population was considered middle class. Today it is 35 percent. The Chinese economy is now the second-largest in the world. The development of China is such a short amount of time is unprecedented in human history.”“The real estate boom has been part of that,” he said, “and it’s lasted twenty years. Like any other boom, it’s overinflated and it’s going to burst.”
But Celente doesn’t see catastrophe for the Chinese economy. In his forward-looking Trends Journal, he has repeatedly stated: “The 20th century was the American century – the 21st century will be the Chinese century.” Even now, he stands by that assessment.
“Will this crisis soften economic growth in China? Yes. Are house prices going to go down? Are companies going to go bust? Sure.”
“That’s part of life,” said Celente. “What in life goes straight up forever?”
“Of course there’s going to be a real estate collapse,” he explained. “But will it bring down the country? No, I don’t see that happening.”
The Chinese economy is so robust, and growing so quickly, said Celente, that “even a big slowdown in China’s economy will still have China growing faster than the U.S. or Europe.”
Celente believes China’s regulators will ensure the orderly settlement of massive debts, and impose even more strict controls on the real estate market. “Beijing will not let these developers fail,” he said. “The government is in control.”
Instead of danger, Celente sees the opportunity for China to diversify its economy. “The United States lost the trade war to China. But China knows they can’t rely on cheap exports forever. And real estate can’t continue to go up forever.”
“They are becoming more self-sustaining,” he explained. “China’s dual-circulation economic model is creating domestic markets for their goods, keeping jobs and profits within the nation, relying less on global trade.”
Celente is clear: “The data shows that China will be the world’s largest economy by the end of the decade.”
But Celente takes no pleasure in making this assessment. “I’m a man of freedom,” he said. “My heart is broken when I think what has happened to America. We lost our manufacturing base. We have all the resources we need to self-sufficient. But we were sold out.”
“Now China will lead the world economically,” he said. “They are our competitors, but we shouldn’t look at China as an enemy. And we certainly shouldn’t copy them.”
“China,” said Celente, “is all about business, the bottom line. Let’s not do the same.” Instead, he said, “Let’s bring back the spirit of life and culture that made our country what it was. The spirit of life, not just the bottom line of life.”
“We can beat the Chinese,” said Celente. “We can beat them culturally, philosophically, and spiritually.”
“The one thing the communist Chinese don’t have,” he said, “is a free human spirit. They are not allowed to be free thinkers. Let’s make sure we keep that alive in America.”
