China Home Prices Decline, Evergrande Bankruptcy Fears Rise

Pressure is mounting on China’s financial authorities to roll back on borrowing restrictions in the property development, sector after home prices fell for the second consecutive month and Evergrande debt problems persist.

According to the National Bureau of Statistics new home prices fell 0.25% year on year in October for the 70 major cities that are used to collate the figures.

Home prices in September fell 0.08%, which was the first negative reading in six years. October’s data represents an acceleration in the rate of decline.

The news comes as the country’s real estate sector grapples with the fallout from heavily indebted Evergrande, which is struggling to meet bond interest payments.

Can Evergrande dodge bankruptcy after further deterioration in real estate sector?

Rumours last week that Evergrande might default on a bond payment and may have to declare itself insolvent have so far proved to be unfounded, but speaks to the nervousness surrounding the sector. There are fears that the liquidity problems at Evergrande are indicative of similar problems across the entire sector.

Alongside the slide in home prices, the volume of sales has also gone into sharp decline, dropping nearly a quarter (24%) on October last year, which will further add to the problems faced by cash-strapped developers.

The property sector has been the key driver of growth in the Chinese economy for many years, so the risks a recession in the sector would transmit to the rest of the economy must be high.

An area of acute concern is the offshore debt market where China’s developers where USD-denominated sub investment-grade bonds have been a popular source of funds.

Evergrande – downward price spiral hits real estate developers’ revenues

The sector could be facing a downward spiral of declining prices as the depreciation in property values becomes self-reinforcing. Demand from buyers is badly affected by falling prices because it puts market participants off closing a deal if they believe prices will be lower in the future. Less demand means less sales and less sales means pressure for lower prices to attract more buyers, and in turn lower revenues for developers.

Tommy Wu, an economist at Oxford Economics, says China’s real estate sector problems can be contained: “We think that China’s property downturn will be significant but contained, due to a low stock of unsold housing, room for policy easing, continuing urbanisation and significant income growth.”

Some smaller cities have introduced rules to put in place a floor under which developers cannot reduce prices, according to China Business News.

Declining property values are impacting plans for investment by developers. According to data compiled by Bloomberg real estate investment  contracted 5.4% year on year. Worryingly new starts crashed 33%.

Chinese developers saw their share prices slip 1.5% and junk dollar bonds rallied on hopes of state intervention to ease the strains in the debt markets.

Stress in the junk dollar bond market means companies are having to turn to the capital markets for funds and yet others are stopping dividend payments altogether. For example, today big developer Sunac was able to raise nearly $1 billion in a placing for new shares, while another large developer Kaisa said it was scrapping its  interim dividend.

Bursting China real estate bubble could hurt US economy

But there are currently no signs of a loosening of deleveraging goals by the China Banking and Insurance Regulatory Commission, which on Friday stated that the debt-raising clampdown would continue as it seeks to contain speculative bubbles in what it describes as the “financialization of real estate”.

The move to curtail leveraged borrowing comes against the background of President Xi pushing wider reforms across the economy aimed at achieving “common prosperity”.

In the wider economy, data released today shows industrial production (3.5% v 3.0%) and retail sales (4.9% v 3.5% forecast) both beating analyst predictions. Unemployment was unchanged at 4.9%.

The US Federal Reserve said last week that the Chinese property sector posed a risk to the US economy if it had the effect of acting as a drag on GDP growth in the country.

The Fed said in its financial stability report that “Stresses in China’s real estate sector could strain the Chinese financial system, with possible spillovers to the United States.”

Paul Christopher, head of global market strategy at Wells Fargo Investment Institute, commenting on the Fed’s report findings said: “The nexus of the Fed’s concern is that China’s real estate activity is slowing, but the developers have large debts [and] some of them (like Evergrande) are diversified into other areas of the economy.”