China Can't Afford to Let Property Crash

As China’s economy picks up after the pandemic, the last thing you might expect is a renewed credit squeeze in the real estate industry. So the imposition of leverage thresholds for developers has come as a surprise, weighing on shares of highly indebted companies from China Evergrande Group to Greenland Holdings Corp. The concerns may be overstated.

China's widely circulated though unofficial “three red lines” policy sets limits on bank borrowings: a 70% ceiling on developers' debt-to-asset ratio after excluding advance receipts; a 100% cap on the net debt-to-equity ratio; and a requirement that short-term borrowings don't exceed cash reserves, according to S&P Global Ratings. UBS Group AG lists nine publicly traded companies that would breach the three thresholds.  

China Can't Afford to Let Property Crash

The policy builds on tightened restrictions in the interbank bond market. Under guidelines issued in August, homebuilders can sell new bonds only to refinance existing debt. Funds raised can’t exceed 85% of companies' total outstanding debt, preventing them from rolling over all their liabilities.

China's real estate prices have done well this year, helped by stimulus measures in response to the Covid outbreak. Prices rose 3.6% in tier-1 cities , 5.3% in tier-2 cities, and 4.4% in lower-tier cities in July from a year earlier, according to Moody’s Investors Service. Restricting the flow of credit to developers may help to curb a glut of housing supply, with the stock of unsold homes standing at 480 million square meters across 100 cities.

While that's a challenge to companies such as Guangzhou-based Evergrande, which at one point was the world’s most indebted developer, the big companies have always found ways to raise funds. Evergrande, for example, is considering listing its property management arm in Hong Kong. Valuations for management businesses are higher than for homebuilders because of their sticky client base and steady cash flows. 

It’s not alone. In recent weeks, a wave of developers has jumped on the property management bandwagon including China Resources Land Ltd., Sunac China Holdings Ltd., KWG Group Holdings Ltd. and Jinke Properties Group. All filed prospectuses online in recent weeks, with state-owned China Resources planning to raise as much as $1 billion from an IPO of its property management arm, according to Julia Fioretti of Bloomberg News. That would make it one of the largest such flotations in the city.

The overseas debt market also remains open. Shenzhen-based Kaisa Group Holdings Ltd., which gained notoriety in 2015 for being the first Chinese developer to default on a dollar bond, had $2.65 billion in subscriptions for a $400 million issue this month. Even onshore, there are options: Greentown China Holdings Ltd., for instance, is raising 950 million yuan ($139 million) selling bonds on the stock exchange, after garnering 15 billion yuan from the interbank market as recently as April.

The bottom line is that the property industry is just too important for the government to squeeze funding to the point where defaults may occur. By some measures, housing and related sectors like home furnishings make up a quarter of GDP. Franco Leung, associate managing director at Moody’s, says  the government will continue to fine-tune regulatory measures and control credit growth to avoid a run-up in prices. Restrictions on home purchases in cities such as Shenzhen have already had an effect. 

The current round of credit tightening is unlikely to be the end. With few investment outlets apart from the volatile stock market, real estate will always attract buyers, even if President Xi Jinping has admonished that homes are for living in and not speculation. Few things are safer than houses in China.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Nisha Gopalan is a Bloomberg Opinion columnist covering deals and banking. She previously worked for the Wall Street Journal and Dow Jones as an editor and a reporter.

©2020 Bloomberg L.P.

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