Chinese real estate – is contagion building?

Please note this wire was written by Chris Watling and Brad Waddington

Key Points

• Real estate accounts directly and indirectly for 30% of Chinese GDP.
• Developers (such as Country Garden, Wanda, Shui On Land, etc.) are missing bond payments and increasingly seeking debt restructuring.
• Macro data, especially that related to property, continues to deteriorate
  

Overview

In prior research (see HERE), we outlined the significance of the Chinese real estate sector which accounts, directly and indirectly, for approx. 30% of Chinese GDP. The direction of that sector, therefore, is critical to the direction of the overall economy. 

Currently, it’s turbulent. See, for example, the sharp fall-off in real estate transactions (fig 3) or the marked contraction in property investment (-8.5% Y-o-Y YTD on latest data published this week – see fig 5), as well as the monthly contraction in new home prices.

SOURCE: Longview Economics, Macrobond

SOURCE: Longview Economics, Macrobond 

There have been numerous developments (mostly negative) in the Chinese property sector over the past two months. With that, while there have been some supportive measures (e.g. with Chinese real estate indices rising on the Politburo meeting on 24th July, and supportive comments from the housing minister on the 28th July, among others – see fig 2), property developers have continued to languish given the significant decline in sales volumes. 

SOURCE: Longview Economics, Macrobond

We outline some of the key bearish developments below:

• Major signs of liquidity shortages among developers (18th July): Significant concerns began with three key bearish developments for developers Wanda, Shui On Land, and Sino-Ocean in mid-July. Wanda announced that it was suffering a $200mn shortfall on an offshore bond maturing on 23rd July. Shui On Land indicated that it would suffer bond payment delays when it put out a notice to identify bondholders. Likewise, Sino-Ocean halted trading in a $279mn onshore bond maturing on 2nd August. 

Since then, those developers have struggled to resolve their liquidity issues. Sino-Ocean has requested numerous bond payment delays, while Wanda sold off almost half of its investment arm to Tencent (see HERE). 

• China’s largest property developer misses bond payments & signals large losses (8th August): Country Garden, China’s biggest property developer after the collapse of Evergrande, missed bond payments worth $22.5mn. That followed multiple warnings from the company pointing to large losses in 1H 2023 due to increases in loan loss provisions. Since then, Country Garden has suspended trading in ten onshore bonds. 

All of that highlights the significant challenges that continue to face China’s developers. The company needs approximately 30bn yuan ($4.1bn) in monthly sales to breakeven but is currently averaging just over 10bn yuan ($1.4bn). It has $2.9bn in bond repayments due by year-end.

• Chinese wealth management products suffer contagion (15th August): Two Chinese wealth management trusts (a key source of shadow financing for real estate companies) failed to meet bond payments over the past month due to large exposures to Chinese real estate. Roughly 10% of Zhongrong’s assets are invested in the property sector, for example, albeit the risk profile of those liabilities is not disclosed. 

Data from the China Trustee Association suggests that 1.1tn yuan of 23tn of assets in Chinese wealth management products (WMPs) are invested in the property sector. The actual exposure, though, is likely to be much higher, given that WMPs often “do not do proper disclosure about underlying assets” coupled with the fact that real estate accounts for 30% of GDP.

Other indicators of pressure

Commodity prices have also come under renewed pressure. In July, for example, copper prices rallied by 7%, and broke above the long-term pennant formation (fig 1) In the past couple of weeks, though, prices have swiftly reversed those gains and fallen sharply. Currently they are down 9% from those July highs (and now at the bottom trend line of the pennant – fig 1).

SOURCE: Longview Economics, Macrobond

Whether or not the Chinese authorities announce any meaningful stimulus will probably determine whether or not they break that lower support line. Equally, iron ore is at multi-month lows while Chinese HY bond indices have sunk to their lowest levels since late 2022 (fig 4). 

SOURCE: Longview Economics, Macrobond

Need for 'bazooka' like stimulus

Overall, despite numerous (modest) attempts at supporting the real estate market – officials have remained cautious (so far). As we demonstrated last month (see HERE), the decline in Chinese real estate should continue without meaningful (i.e. ‘bazooka’ like) stimulus from officials (especially given that the bubble would appear to have burst).

The developments also highlight the potential risks of contagion to the financial/shadow banking sector (NB Chinese wealth management products must be directly and indirectly heavily exposed to the real estate sector, given that it accounts for 30% of GDP – in forthcoming research, we will delve deeper into the risks of contagion from the decline in real estate, i.e. ‘follow the money’ trail).