China property bust was plain to foresee
It was the greatest wave of construction the world had seen, but when it crashed on the shore of reality, millions of lives were ruined.
When New York hedge fund manager Parker Quillen visited a glitzy new development in northern China called Tianjin Goldin Metropolitan, he wondered how on Earth the developer would fill all that space.
It had apartments starting at $1.5m and plans for an office tower bigger than the Empire State Building, an opera hall, shopping malls and hotels. Its total square footage was to exceed the land area of Monaco.
Was there a plan for attracting buyers? Quillen asked. Polo, said the marketing agent.
“Polo? You mean the horse thing?” he asked.
“Exactly,” he recalled her saying.
The agent, dressed in riding gear, led him through a stable with more than 100 polo ponies. Quillen asked if Goldin’s founder, a billionaire polo enthusiast who got rich selling computer monitors, had done a viability study for the project. She said she had no idea.
“Then I realised that the vision was that international executives would come to Tianjin and set up their corporate headquarters here because they like polo,” Quillen said. “I was like, oh my God.”
When Quillen returned to New York, he poured more money into his wagers against Chinese property stocks.
That was 2016, during the heady days when the Chinese property boom was just getting going. Even then, the truth was obvious to anyone who knew what to look for: The boom had turned into a bubble – and was likely to end very badly.
The bubble proceeded to get even worse, though, because no one wanted the music to stop. Chinese developers, homebuyers, real estate agents and even the Wall Street banks that helped underwrite the boom all ignored warning signs.
Developers, with the help of bankers and lawyers, found ways to obscure the amount of debt they were holding. Buyers who suspected the property markets were overbuilt bought more anyway. Chinese and foreign investors seeking juicy returns flooded developers with funding.
The cheerleaders were operating on a seemingly bulletproof assumption that China’s government would never allow the market to crash. Chinese people had invested the majority of their wealth in housing. Letting the market tumble could wipe out much of the population’s savings – and erode confidence in the Communist Party. Now China is paying the price for failing to act earlier to rein it all in.
More than 50 Chinese developers have defaulted on their international debt. Around 500,000 people have lost their jobs, according to Keyan, a private think tank focused on Chinese property. Some 20 million housing units across China have been left unfinished, and an estimated $660bn is needed to complete them.
Prices for second-hand homes in major cities fell 5.9 per cent in March. Local governments, deprived of income from selling land to developers, are struggling to service their debts. The overall economy is fragile, as real estate and related industries, which once accounted for around a quarter of gross domestic product, become a bigger drag on growth.
In 2016, the same year Parker Quillen toured the polo grounds in Tianjin, a pair of Hong Kong-based accountants travelled to mainland China and hit the road in a rented Buick.
Gillem Tulloch and Nigel Stevenson and their firm, GMT Research, specialise in digging out “financial anomalies” and “shenanigans”, and they suspected a lot of that in China’s housing market.
Decades earlier, in the Mao Zedong era, the market was controlled by the state, and most people lived in homes provided by their Communist Party work units. In the 1990s, authorities liberalised the market, and private developers sprang up everywhere, erecting row after row of housing towers in one of the biggest investment booms in history.
By the time Tulloch and Stevenson began their trip, many government officials and economists were warning of a bubble. But whenever the market showed signs of faltering, the government would step in. Beijing rolled out new policies to stimulate buying, lowered interest rates and lifted home purchase limits. Confidence was restored and sales took off again.
Tulloch and Stevenson were suspicious. As they drove across the country, they were amazed by the number of empty buildings and busted projects.
They zeroed in on the projects of China Evergrande Group, the country’s largest developer. Its founder and chairman, Hui Ka Yan, was on his way to becoming China’s richest man, with personal wealth of more than $60bn in 2017, according to Forbes.
Tulloch and Stevenson visited 40 Evergrande projects in 16 cities, concluding many were “dead assets,” earning little or no income. Those included sparsely occupied hotels, shops that had never been occupied and entire remote developments.
At one project, in a port city a few hours from the North Korean border, six residential towers were abandoned, with no workmen, residents or marketing staff. Yet according to Tulloch and Stevenson, Evergrande still treated the project on its books as a performing asset, without writing down its value.
Tulloch and Stevenson paid special attention to Evergrande’s parking garages. Many were nearly empty. By their reckoning, Evergrande had built some 400,000 parking spaces it was struggling to rent or sell, yet in audited statements it continued to value the spaces at $11bn, or nearly $30,000 per space.
The developer booked the parking spaces as investment properties rather than inventory assets – an accounting treatment, unusual among its peers, that allowed Evergrande to overstate their value and book gains early, the two accountants said.
“The company is insolvent by our reckoning, and its equity worth nothing,” they wrote to clients later that year, in a report titled Auditors Asleep. The report concluded Evergrande could stay afloat only by borrowing more.
Evergrande has defended its accounting and business practices, saying its financial results were audited.
Tulloch and Stevenson said many of their clients agreed with their analysis, but didn’t act.
They were right not to. China’s property market was on the eve of a rebound, thanks to the government’s property market rescue plan rolled out a year earlier. The next year, 2017, home sales rose 11 per cent, and Evergrande’s Hong Kong-listed shares surged 458 per cent.
To many Chinese people, real estate seems like a smarter and safer investment than stocks. Many bought multiple units and left them empty, satisfied just to see their values increase.
Chen Yanzhi, now 35, says she began buying homes while still in college, after making a bit of money trading stocks. Over a decade, she bought and sold more than 20 homes in places such as Nanjing, Shanghai and Hainan province. The first cost around $105,000. Years later, she paid almost $5m for a property in Shanghai. “I love houses, and I love everything about houses,” Chen said in an interview.
Young people made fortunes working for developers. Remen Xia, 40, was a sales manager at Evergrande in China’s northern Jilin province before he jumped to other property companies. By 2018 and 2019, he said, he was earning $420,000 a year, when the average salary for Jilin was less than $6750.
Developers needed a lot of capital, which meant fees for financiers willing to raise it. From 2017 to 2021, Chinese real estate developers raised $377bn by selling dollar-denominated bonds, according to data provider Dealogic. Banks, including Wall Street heavyweights such as Goldman Sachs and Morgan Stanley, collected almost $3bn for underwriting them
Bankers met in the lobby of the Hong Kong Four Seasons hotel to discuss deals. One hedge fund manager recalled attending parties at least once a month on yachts owned by Chinese developers, with champagne and female escorts.
A popular tactic, nicknamed “hole-digging”, involved using shell subsidiaries to borrow money, guaranteed by the parent development companies. The structure enabled the parent companies to avoid disclosing on their own balance sheets the liabilities incurred by guaranteeing the subsidiary’s debt.
Developers sometimes pledged the same collateral multiple times when borrowing money, according to developers and bankers familiar with the activity.
An executive at one hedge fund recalled seeing the same list of collateral – shares of developers’ subsidiaries, receivables or company officials’ private jets and mansions – on term sheets for a half-dozen private debt offerings. He bought the debt anyway, given the need for high returns.
Chinese banks were so eager to underwrite such offerings that they sometimes agreed to invest tens of millions of dollars of their own money in the bonds, no matter the pricing. Such bank participation would suggest to other investors that the deal was hot.
“At that time, we chose investors, not the other way around,” the executive said.
Evergrande, having become China’s biggest developer, set its sights on becoming one of the world’s top 100 companies by 2020.
One executive at a Chinese rating agency said Evergrande asked him to award the company a sovereign credit rating, which would signal Evergrande was as safe as the Chinese government.
Three large Chinese domestic companies awarded it triple-A ratings, the highest possible. S&P Global gave Evergrande only a B-plus rating – junk-bond territory.
Chinese state media highlighted the discrepancy, with the People’s Daily writing that it was partly due to “a lack of understanding of (Chinese) companies”. The People’s Daily blamed Western firms for “exaggerating the potential risks of the Chinese economy and companies”, and said international firms could be helping short-sellers.
The total value of Chinese homes and developers’ inventory hit $75 trillion, according to Goldman Sachs, twice the size of the US residential market. Chinese people had nearly 78 per cent of their wealth tied up in residential property.
Skeptics such as New York hedge fund manager Quillen and Hong Kong accountants Tulloch and Stevenson were flummoxed.
Quillen had lost millions of dollars on the short positions he accumulated after his visit to the Tianjin development. Shorting China property stocks, he said, was like having a conversation with the devil in which the devil promised that a $10 stock would go to zero within two years.
“But what the devil didn’t tell you,” he said, “is that within those two years, the stock goes to 100 first, then goes to zero.”
By late 2020, it was becoming harder to ignore the warning signs.
Prices in Tianjin were comparable with the most expensive parts of London. Millions of units across China sat empty.
Quillen figured the writing was truly on the wall now. President Xi Jinping kept declaring “homes are for living in, not for speculation”, and reports surfaced that regulators were planning to tighten credit. Quillen made new short bets.
On the first day of 2021, regulators imposed a policy known as the “three red lines”, which restricted new borrowing by overleveraged developers. Banks started demanding early loan repayments. Investors stopped buying.
Within months, Evergrande was unable to pay suppliers of building materials and construction services. In August 2021, it stopped construction at hundreds of projects. It sought government help but was not bailed out.
Chinese homebuyers, spooked by the possibility developers might run out of money and leave their homes unfinished, stopped buying. At China’s biggest 100 developers, sales nosedived and they fell like dominoes.
Chen, the individual investor who had been buying and selling homes for years, said half of her homes are now without tenants, and several are worth less than what she paid. However, she said she isn’t in a hurry to sell, and remains optimistic.
Stevenson, one of the Hong Kong accountants, had written in August 2021 that it was still possible to profit by shorting Evergrande’s stock, even though the Hong Kong-listed shares were down 95 per cent from their peak. He predicted they would go to zero.
In December 2021, Evergrande defaulted on its international bonds. Last January, a Hong Kong court ordered Evergrande to liquidate, and trading in its shares was suspended at 2 cents. In March, China’s securities regulator said Evergrande overstated its sales in 2019 and 2020 by a total of $100bn, one of the largest-ever alleged financial frauds.
PricewaterhouseCoopers resigned as Evergrande’s auditor in early last year, saying it was unable to obtain information relating to revenue recognition for some property sales, among other issues. Tulloch, the other Hong Kong accountant, said he recently sent his firm’s 2016 Evergrande report to a complaint line at PwC, but doesn’t expect a reply.
Goldin Financial, the company that developed the Tianjin project Quillen visited, is bankrupt. An office tower there, designed to look like a walking stick, has become a favourite of international urban explorers who stage stunts there and post videos to YouTube. Guinness World Records has certified it as the world’s tallest unoccupied building.
The polo centre’s horses, wines and furniture were listed on an auction website in 2021.
Quillen, won’t say how much he eventually made on his bets against Chinese developers. He said anyone shorting the stock after the 2017 spike who didn’t get squeezed out when the stock rose would have notched a 100 per cent return.
He said he felt vindicated, but regretted his bet wasn’t bigger.
The Wall Street Journal.
Cao Li contributed to this article
