Evergrande liquidation forces ripple effect on China’s property sector

After a prolonged period of failed negotiations with creditors, beleaguered real estate giant Evergrande was ordered to liquidate by a Hong Kong court in late January.

The company’s inability to present a viable restructuring plan despite several court hearings and negotiations with offshore creditors led to the court’s action. Its debt load exceeding $300 billion against $245 billion worth of assets left it teetering on the brink of insolvency, prompting Justice Linda Chan to order the liquidation process.

The problem, however, is not only limited to Evergrande as many other property developers in China are also in debt. Despite assurances that the immediate impact on the struggling sector may be limited, the Evergrande precedent raises concerns about the future of other developers facing similar challenges.

The liquidation process itself is expected to be protracted and politically sensitive, involving the appointment of provisional and official liquidators tasked with selling off assets to repay outstanding debts. However, the complexity of navigating cross-jurisdictional issues between Hong Kong and mainland China adds another layer of friction to an already intricate process.

Amid fragile market sentiment, there are growing concerns about the implications for financing future projects, and the ability of developers to meet their obligations. With authorities in mainland China prioritising the completion of unfinished projects to mitigate disruptions in the property sector, the liquidation of Evergrande raises questions about the fate of ongoing developments and the broader economic repercussions.

A calculated risk

The decision to not rescue the once-largest real estate developer in China seems to be one that prioritises long-term stability and economic diversification. The real estate sector makes up about a quarter of China’s gross domestic product, with an estimated 70% of family assets being tied up in property. Not rescuing the troubled developers will no doubt be a disaster to China’s economy in the short to medium term, however, to a certain degree, this is going according to China’s long-term plans.

The country’s real estate titans are mostly operating by borrowing billions in loans and speculating on market prices. While this model has helped China supercharge its economy, it has always carried plenty of risk, as there is now an over abundance of properties listed at prices unaffordable for most people. The Chinese government admitted to being aware of this problem when in 2017 President Xi Jinping was quoted saying: “Houses are built to be inhabited, not for speculation.” He then proceeded to enact policies that would lead to many developers defaulting. The Chinese government has always anticipated setbacks if they popped the real-estate bubble themselves, but to what extent these would devolve remains to be seen.

Stabilising the economy

Other property developers across China are notably selling their offshore properties even at a loss in order to recoup cash. Earlier this month, Guangzhou R&F Properties said it plans to sell a development project in London for only $13 cents—the project has $792 million in net liabilities. A joint venture project in London between Cindat Capital Management and CITIC Capital has also gone into administration after defaulting on the venture’s loans. Country Garden’s Risland property also sold a combined $319 million in development projects in Australia after it announced that it was unable to pay its offshore debts. Shimao Group and CIFI Holdings also revised their restructuring offers last year, which will see offshore creditors taking less than initially proposed to them.

Offshore creditors will be the hardest hit by the Evergrande liquidation since most of the properties are in mainland China. As for local creditors, this move will provide some protection and help stabilise the economy during and after the liquidation process.

Meanwhile, in a bid to stimulate its economy, People’s Bank of China (PBoC) has announced plans to reduce the reserve requirements for its banks, effective 5 February. The central bank's governor, Pan Gongsheng, stated at a press conference in Beijing that this would entail a 50-basis-point cut in reserve-ratio requirements, injecting CNY 1 trillion ($139.8 billion) of long-term capital into the economy.

Moreover, Pan disclosed that the central bank, in collaboration with the National Financial Regulatory Administration, is formulating new policies to support loans for high-quality real estate developers.

Growth of new frontiers

Last year, Lu Daliang, spokesperson of the General Administration of Customs and director of the Statistics and Analysis Department said that China had “vigorously explored emerging markets, created a high-level opening platform, cultivated and strengthened advantageous industries, and continuously gathered new momentum for foreign trade.”

Three industries with high growth potential were identified in a press release last year, namely electric vehicles, lithium batteries, and solar cells. China is keen to develop these industries and gain global dominance in the export of these products. China will dominate 80% of the global solar manufacturing capacity up until 2026. This is only expected to improve even more as nations everywhere are shifting towards renewable energies.

Unlike real estate, the risks in these industries are far less, and are politically attractive, bolstering China’s image in the international community. Increased manufacturing of these products will also absorb decreases in steel demand—another important industry for the country’s economy. China is currently the world’s largest steel producer, accounting for almost half of the world’s output, and real estate accounts for 37% of that output.

Ultimately, the outcome of Evergrande’s fate will reverberate throughout China’s property market, impacting investors, homebuyers, and the broader economy. As stakeholders brace for the fallout, the future of the sector hangs in the balance, with the resolution of Evergrande’s crisis serving as a bellwether for the challenges and opportunities ahead.