Addiction to property underlies China’s woes

The property giant Evergrande borrowed heavily to develop in out-of-the way places such as Lu’an.

The Evergrande Changqing community in Wuhan. Picture: Getty Images

Rows of residential towers, some 26 stories high, stand unfinished in the provincial city of Lu’an, bout 560km west of Shanghai, their plastic tarps flapping in the wind.

Elsewhere in Lu’an, golden Pegasus statues guard an uncompleted $US9bn ($12.4bn) theme park that was supposed to be bigger than Disneyland. A planned $US4bn electric vehicle plant, central to local leaders’ economic dreams, remains a steel frame with overgrown vegetation spilling into the road.

The structures are monuments to the once-grand ambitions of China Evergrande, now among the world’s most indebted property companies, and a case study in how China’s dependence on real estate as an economic engine helped feed those ambitions.

Evergrande is in trouble in part because it developed properties aggressively in places such as Lu’an, where its debt-fuelled building spree came as the city’s population dwindled. It launched hundreds of projects across more than 200 Chinese cities.

As it expanded, Evergrande racked up more than $US300bn in liabilities. In September, it said it was facing unprecedented difficulties and was trying to protect customers. Days later, it missed a scheduled interest payment to overseas bondholders. On Monday, Evergrande and its property management unit halted trading in Hong Kong; the unit said it could be subject of a takeover bid, which could bring in much-needed cash for Evergrande.

The company’s troubles are among the impacts unfolding since Beijing, concerned about risks to the financial system, last year began forcing developers to start cleaning up their balance sheets. Global investors are worried the crackdown could trigger financial market distress or a protracted real estate downturn. People who bought units in unfinished towers are wondering where their money went.

“We spent all our family’s savings on this apartment,” said a 59-year-old farmer surnamed Jiang, who, like other buyers in Lu’an, didn’t want to provide her first name because she is worried about upsetting the company.

In August, she said, she bought a unit for 890,000 yuan ($190,000) in an Evergrande project called Junting or “Jade Palace” with 47 apartment buildings. Work halted months ago, locals said. Ms Jiang said she didn’t know when or if it would restart. “We really don’t know what to do,” she said.

Evergrande has completed many projects in Lu’an over the past decade and turned homes over to buyers. An Evergrande spokesman said the company would do everything possible to ensure completion of its projects “wherever the city or region is”. Lu’an officials didn’t respond to requests for comment.

Central to Evergrande’s expansion was a real estate economy across China in which people from developers to financiers to city leaders had an incentive to perpetuate the boom. Evergrande found a market for its projects among a range of buyers – including corporate employees and farmers seeking to move to more urban areas – who believed values would rise no matter what and assumed Beijing would protect them against decline.

For local leaders, developers represented a revenue stream. With limited power to tax, Chinese cities get roughly a third of their revenue from selling land to property developers like Evergrande. Cities annex farmland to sell to developers; farmers often get to buy apartments at a discount.

Real estate became some cities’ biggest economic driver and the most important source of revenues. Lu’an’s take from land sales totalled $US1.2bn in the first half of this year, compared with total tax revenue of $US900m.

But property construction in smaller cities ran well ahead of demand from prospective occupants for the last five years in China, leaving the market increasingly dependent on speculators and investors to buy properties, said Logan Wright, China markets research director at Rhodium Group, a research firm based in New York. About 21 per cent of homes in urban China were already vacant in 2017, which equated to 65 million empty units, according to data from China Household Finance Survey.

As China cracks down, new-home construction has slowed and housing prices are falling in many places. Local governments’ land sales revenues fell by 17.5 per cent in August from a year ago, according to Rhodium.

A sharp deceleration in China’s property market could “exacerbate and amplify downward pressure” on the job market and China’s overall economy, Goldman Sachs economists warned in a recent note. By some estimates, real estate-related activity now accounts for nearly one-third of China’s economy.

Most economists and investors believe China’s government will restructure Evergrande. Late last month, the People’s Bank of China said it would “maintain the healthy development of the property market and safeguard the legitimate rights and interests of house buyers”.

Still, economists say there will be lost economic activity if Beijing continues to drain away excess debt and root out speculation in real estate.

Some Evergrande projects appear to have fared better in bigger cities. Some Chinese media have reported that while it halted construction on some developments in Guangzhou in southern China, construction on some projects resumed in late September.

Lu’an has lost 5 per cent of its population in the past 10 years. Among Lu’an’s four million people, many are over 60 and residents’ average annual disposable income of $US3500 is below the national average of around $US5000.

Yet from around 2011 through 2020, Evergrande invested more than $US10bn and launched multiple major projects in Lu’an, including residential complexes, the EV plant and the “Fairyland” theme park featuring pastel-coloured European-style pedestrian blocks and a melange of animal characters, including a reindeer-like creature and a blue dragon.

Four unfinished Evergrande projects in Lu’an that The Wall Street Journal visited in late September appeared to have stopped construction. Nearby store owners described the loss of business after construction workers stopped showing up. In one Evergrande office, staff took naps or huddled over smartphones.

At least 23 lawsuits involving commercial bills – a form of IOU among Chinese businesses – have been filed this year against Evergrande’s subsidiaries in Anhui province, where Lu’an is located.

The Wall Street Journal