Evergrande case study
Demographic structure of China
With almost 96 Lakh km2 (37 Lakh sq. miles) of total surface area,
China is the 4th largest country in the world after Russia, Canada and USA.
Over
the past 40 years the total population in China has grown up from 96.3 Crore to
1.426 Arba in 2022 (equivalent to 18.47% of the total world population.) The
share of the urban population in China has grown from 18 percent to 57 percent.
The current population density in China is 151 people per square kilometer
(Nepal’s 203). However, Urban city of China are much dense in comparison to rural
area.
|
City |
Population Density (Per sq.Km) |
|
Shanghai |
3922 |
|
Beijing |
1334 |
|
Tianjin |
1194 |
|
Jiangsu |
847.9 |
|
Guangdong |
700 |
|
Shandong |
643.8 |
|
Zhejiang |
615.7 |
|
Henan |
600.5 |
Determinants of Housing Prices
Housing
Prices are mainly determined by demand and supply side. On supply side, the
amount of land supply and land prices are key factors. It is a known fact that
the residential land supply for formal housing development is limited in many
large cities. On the demand side, the strong demand for homeownership drives
the housing prices up. There are many factors influencing demand: household
incomes and savings, alternative means for household investments, the level of
social security, the level of housing speculation, etc. The variation in
housing affordability is mainly affected by the housing prices and the share of
population/households and their income level.
Housing affordability and housing distribution in China
“Housing
affordability” is defined as the extent to which house can be purchased and
loans to purchase these assets can be paid off, and this term involves a number
of disparate issues: housing price, housing quality, the distribution of
income, the ability of households to borrow, public policies affecting housing
markets, conditions affecting the supply of new or refurbished housing, and the
choices that people make about how much housing to consume relative to other
goods
Housing Distribution comparison in China and Globally
|
|
Private
Housing |
Public Housing under government
plan |
Housing by Tenants |
|
|
Multi-Family Housing |
Single-Family Housing |
|||
|
Globally |
38% |
34% |
14% |
14% |
|
China |
61% |
7% |
21% |
11% |
Housing Prices Boom in China and government policy
Housing
prices in China have nearly been tripled over past 20 years, with the ratio of
home prices to annual income now averaging 43.15 in Shenzhen, 42.47 in Beijing,
and 33.36 in Shanghai, compared to 13.37 in London and 8.76 in New York City.
Due
to relaxation of raising funds and ever-increasing real estate prices, Chinese
real estate companies had built too many skyscrapers, luxury hotels, and
high-end apartments. Later, it was found that they were not affordable to
the general public. So, China’s central bank had also made an effort
to make financing changes to ease liquidity strains in property markets.
China focused on strategy to increase supply of affordable housing to meet the
living needs for citizens.
In
order to stabilize housing prices and force real estate developers to
deleverage and reduce commercial banks’ exposure to the sector, the government
introduced “three red lines” policy measures for developers in August 2020,
which began to take effect in 2021 and after introduction of policy average new
home prices in China's 70 major cities declined by 0.1 percent year-on-year in
May 2022, reversing from a 0.7 percent gain a month earlier. The latest
figure represented the first drop in new home prices since September 2015, as
tighter COVID-19 restrictions decline buyer confidence in the property market.
The
three “three red lines” includes:
- a few large developers could not have a
liability-to-asset ratio of more than 70 %. (Criterion was applied to entire real
estate sector last year.)
- Net debt to Equity ratio should be below 1.
- Money reserves must be 100% of
short-term debt.
To simplify the implications of the policies, China’s
authorities created a color code scheme, which breaks down as follows:
|
Color code |
Number of red lines breached |
Allowable annual growth in debt |
|
Green |
0 |
15% |
|
Yellow |
1 |
10% |
|
Orange |
2 |
5% |
|
Red |
3 |
0% |
Other
policies introduced by government to control housing prices includes:
- Big state-owned commercial banks cannot lend more
than 40% of lending on property.
- control actions of local governments
on selling right to land. A limited number of centralized auctions helps
real estate prices to come down.
The
effect of these measures was seen in market with:
- the cumulative growth rate of real estate finance
plunged from 54.2 % in January 2021 to 4.2 % in December.
- the cumulative growth of housing sales dropped
from 104.9 % to 1.9 % in terms of value.
- the cumulative growth rate of investment in real
estate development in China fell from 38.3 % to 4.4%.
- total investment growth also dropped from 35 % in
January to 4.9 % in December. (Due to large share of real estate investment)
China’s government focused those vulnerabilities and structural problem should not impede economic growth. But, when it comes to real estate sector, it may not be an easy balance and depending on economy’s reliance on real estate, getting it wrong could have major economic impact. (According to National Bureau of Economic Research, Real Estate Sector contributes around 30% in GDP of China)
Evergrande and Chinese Economy
Evergrande
is the second largest real estate company in China. It has 1300 real estate projects
in 280 cities. Around 2 Lakhs employees are associated with Evergrande directly
and it is said that around 38 lakh jobs are generated by the projects of
Evergrande every year. Jiayin Xu, Executive
Chairman of Board of Evergrande was regarded as richest man of Asia in 2017
with net worth of $ 43 billion. Evergrande share 25% of the apartment sales in China.
The company had earned around $ 69.22 Billion as a sales revenue in 2021 ($112.92
in 2020). It had been listed as a fortune 500 company also. The developer had a
total of $ 300 Billion in liabilities as of 2021 (considered as highest indebted
property company in the world). The debt of company is 2% of the China’s GDP I,
e. $ 17.7 Trillian. The company had diversified its investment in new energy
vehicles, football companies, bottled water companies too. But, due to improper
planning and lack of proper diversification decision, it was not fruitful to
the company.
What went Wrong?
Evergrande
through its rapid expansion plan had raised significant amount of funds to
finance its construction projects using a financial instrument WMP (Wealth
Management Products) and sells it to retail investors. It is said that 80,000
investors invest $ 15.4 Billion in Evergrande wealth management products expecting
yield of 12% in 2016 (of which $6.1 billion is outstanding currently). As
Evergrande was among Fortune 500 companies, it was easier for it to raise funds
considering high return with low risk from investor’s side. But, in 2021 Evergrande
breached all three red lines as discussed above introduced by Chinese government
and there was sharp decline in prices of housing in China to make it affordable
to general public. In this situation, Evergrande faced three major challenging
situations as:
- Decline in housing prices due to governmental
policy
- Cut throat competition due to attractive growth
of real estate business over past years.
- No additional debt allowable
The
company started to face adverse situation where, it was not able to finance
it’s 800 ongoing projects under construction and it was not able to sell its
completed projects too. The company start to default its interest payment of
fund raised. The level of trust that investor put on company had started to
decline. The company had worth of US$41bn last year but its market value has
plunged to $3.7bn due to its increased chances of defaulting on raised funds.
Thousands of retail investors, banks, suppliers and foreign investors are owed
money by Evergrande who now fear that they will not be repaid if the property
group collapses. We are now witnessing heavy protect by such investors in China
in news channel.
What is its impact on global economy?
Many people are now expressing their opinion referencing the crisis caused in 2008 by collapse of Lehman Brothers. But, the case of 2008 of USA and 2022 of China are completely different. The global risk is largely reduced by the fact that international investors are not heavily involved and that its ties with banks are limited (In 2008, there was a collapse of fourth largest investment bank of USA). It will have some impact on global economy. But, as China is not as closely connected with world in its trade as of USA, the effect caused through interconnected economies will be minimum. It is obvious that Chinese government may struggle to maintain its current position in world economy. Some of companies/ person associated with Chinese economy as a supplier, customer, investors or other stakeholders may be affected to some extent in the crisis. In other word, the threat of direct impact due to fall down of Evergrande is minimal.
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