The Chinese real estate crisis is an ongoing financial crisis sparked by the 2021 default of Evergrande Group. Evergrande, along with other Chinese property developers, experienced financial stress in the wake of overbuilding and subsequent new Chinese regulations on these companies' debt limits. The crisis spread beyond Evergrande in 2021 to such major property developers as Country Garden, Kaisa Group, Fantasia Holdings, Sunac, Sinic Holdings, and Modern Land.
Following widespread online sharing of a letter in August 2021, in which Evergrande warned the Guangdong government that it was at risk of experiencing a cash crunch, shares plunged, impacting global markets and leading to a slowdown of foreign investment in China. The company unsuccessfully attempted to sell assets to generate money, missed several debt payments, was downgraded by international ratings agencies and finally defaulted on an offshore bond at the beginning of December 2021. The ratings agency Fitch declared the company to be in "restricted default".
At the beginning of the 2020s, thousands of retail investors, as well as banks, suppliers, and foreign investors were owed 2 trillion RMB (310 billion USD) by Evergrande alone. On 29 January 2024, a Hong Kong court ordered Evergrande to be liquidated.
Background
2000s and 2010s
In 2005, the Chinese property bubble was growing. Average land values in China tripled by 2009, and continued to 2011, when values temporarily stopped growing. Due to fiscal reforms from previous decades, local governments had become increasingly reliant on infrastructure development to earn revenue, through local government financing vehicles. Due to the financial benefits of selling land use rights, land value became central to the financial security of local governments. The 2008 financial crisis was addressed largely through local government investment in infrastructure, which further contributed to a reliance on increasing land value, despite accumulating larger and larger debts.
Between its 2009 initial public offering and 2017 the stock price of the second largest property developer in China, Evergrande Group had outpaced the 30% growth rate of the Hang Seng Index, having multiplied eightfold and it had become the world's most indebted property group in the process. By 2018, the central government was so concerned by the size of local government debts from land development that they announced they would not bail out creditors who were not able to be repaid.
"Three red lines" rule, 2020
In 2020, Chinese Communist Party (CCP) general secretary Xi Jinping's leadership started to tighten the real estate market based on the principle that "houses are for living, not for speculation." He had previously made this statement during the 19th CCP Congress and it became the basis of the three red lines rule. The rule regulated the leverage taken on by developers, limiting their borrowing based on the following metrics: debt-to-cash, debt-to-equity, and debt-to-assets.
Evergrande crossed all three red lines, resulting in a liquidity crisis and its later insolvency. Evergrande had leveraged itself heavily before 2020, which meant the three red lines rule was supposed to have a major impact on their borrowing. The Financial Times cited the director of S&P Global Ratings, saying that Evergrande was "so highly leveraged, it's likely to breach all of the alleged thresholds".
In 2020, many analysts considered Evergrande as "too big to fail." It was thought that a Lehman-Brothers–style collapse could have massive consequences on the Chinese economy and the world at large. Evergrande's land reserves alone were large enough to house 10 million people in 2020.
Evergrande's diversification strategy
In the years preceding the 2021 crisis, Evergrande had pursued an aggressive expansion, including ventures in electric vehicles, theme parks, energy, and many other sectors. These leveraged investments included Ocean Flower Island, a 100 billion RMB (US$15.5 billion) project to build an artificial island on the north shore of Hainan near Yangpu in the South China Sea, plans to spend over 45 billion RMB (US$7 billion) between 2019 and 2021 in electric vehicle development, and ownership of Guangzhou F.C., China's richest football club.
Evergrande wealth management products
The Financial Times reported that "Evergrande used retail financial investments to plug funding gaps". The company raised billions of dollars through wealth management products and used the money to plug holes in its own funding and to repay other wealth product investors. The products sold were highly risky, with an anonymous executive suggesting they were "too risky for retail investors and should not have been offered to them". They were marketed widely. Evergrande managers, for instance, pressured subordinates to purchase products advertised at over 10% annual return. Total wealth management product liabilities stood at 40 billion RMB in September 2021.
Referred to as a type of supply chain finance, investors would invest money in shell companies they falsely believed existed to supplement working capital. As sales of the products fell, their business model became unsustainable. An Evergrande executive was quoted in 2021 as saying "Many people ... might be arrested for financial fraud if investors don't get paid off. Our products were not for everyone. But our grassroots salespeople didn't consider this when making their sales pitches and they targeted everyone in order to meet their own sales targets." Other Chinese companies that sold wealth management products included Baoneng, Country Garden, Sunac, and Kaisa.
2021
Regulations
In 2021, other central and local government regulations, including mortgage lending limits, rent caps in big cities, and land auction cancellations, caused a slowdown in the property sector, as authorities attempted to control rising house prices.
In 2021, new regulations prohibited financial institutions from providing fresh liquidity to local government financing vehicles. Following these regulations, local governments are required to raise funds through issuing bonds, subjecting them to stronger oversight.
While Evergrande had announced in March 2021 that it was looking to cut its debt load by 150 billion RMB (US$23.3 billion), it was still expanding, having launched 63 new projects in the first half of 2021.
By 8 October 2021, 14 of China's 30 biggest developers had violated the three lines regulations at least once. Guangzhou R&F violated all three regulations; Evergrande and Greenland Holdings violated two regulations; and Aoyuan, CIFI Holdings, Country Garden, Greentown, Jiangsu Zhongnan, Risesun, Seazen Holdings, Shinsun Holdings, Sunac, Sunshine City Group, and Zhenro Group violated one of the regulations. The developers mentioned had total sales in 2020 of over 4.34 trillion RMB (US$672 billion).
Western exposure to Evergrande
In 2021, Evergrande was estimated to have $19 billion in overseas liabilities. American and European companies had significant exposure to Evergrande through their holding of corporate bonds. Ashmore Group, an emerging market specialist, owned more than $400 million at the end of June, while UBS owned over $300 million. BlackRock had a total exposure of $400 million across all its funds, with one of its high-yield funds having acquired an additional $18 million worth of bonds in August. Other companies had smaller exposure, with HSBC having a peak exposure of $31 million.
Impending default of Evergrande
Downgrading of credit ratings
On 22 June 2021, Fitch downgraded Evergrande's credit rating from B+ to B, and further downgraded it to CCC+ on 28 July. According to the company, the initial downgrade reflected "ongoing pressure for Evergrande to downsize its business and reduce total debt", the latter action due to "Evergrande's diminishing margin of safety in preserving liquidity".
On 3 August 2021, Moody's downgraded Evergrande's rating from B2 to Caa1. On 5 August, S&P Global Ratings downgraded Evergrande and its subsidiaries from B− to CCC, two steps on its scale, qualifying it as having extremely speculative credit worthiness.
On 7 September, Fitch downgraded Evergrande further from CCC+ to CC.
August letter
In the last week of August 2021, a letter became widely circulated online. In the letter, Evergrande informed the government of Guangdong province that they were close to running out of cash. Initially, the company claimed that the letter was fabricated. Evergrande denounced the letter as "pure defamation", and made a number of public announcements to reduce fears from investors and the public.
In a statement on 31 August 2021, Evergrande warned it would default on its debts if it failed to raise enough cash to cover them. At the time, Evergrande was China's most indebted real estate developer, and had several large bond payments to make for the foreseeable future. On 31 August, Evergrande filed for US bankruptcy protection.
Chinese government responses
On 22 September 2021, the governments in Zhuhai and Nanshan District, Shenzhen took control of sales revenue for Evergrande's properties in a state-controlled custodial account to protect home-buyers and continue construction of the company's developments. Various provinces followed suit as the developer put hundreds of projects on hold.
In October 2021, The Wall Street Journal reported that the central government was planning to implement a nationwide property tax, to tackle real estate speculation. However, the report detailed widespread resistance within the Chinese Communist Party (CCP), leading to an alternative proposal to provide state-owned housing. On 23 October, a five-year trial of the proposed tax was announced for select regions with high real estate prices, most likely Shenzhen, Hangzhou and Hainan.
Missed payments in September
On 24 September 2021, Evergrande missed off-shore bond payments totalling US$83.5 million. While the company had 30 days to avoid defaulting on the debt, analysts felt it was unlikely to manage doing so. On 12 October, Evergrande missed payments on three offshore bonds which totalled US$148 million. By this date, the developer had missed five bond payments during the crisis. On 20 October, Evergrande paid off US$83.5 million worth of interest in order to avoid a default on the 24 September bonds.
Evergrande's attempted asset sales
In order to raise capital, the group started to sell off some of its assets. On 29 September 2021, the company sold a 20% stake in Shengjing Bank, retaining 15%, raising 10 billion RMB (US$1.5 billion). On 4 October 2021, the Cailian Press reported that rival Hopson Development was set to buy a 51% stake in the Evergrande Property Services subsidiary for around US$5 billion. On the same day, Evergrande froze its shares on the Hong Kong Stock Exchange, citing a "possible general offer" in the near future, but until 20 October had not unfrozen them nor made announcements about the offer.
On 20 October, they announced that the deal had fallen through and applied to reopen trading on its shares. Except for a stake in a regional bank, as of that date "there has been no material progress on sale of assets of the group" according to Evergrande. In response, shares fell 13.6%.
Financial contagion
Off-shore bondholders hired Kirkland & Ellis and Moelis & Company to advise them ahead of a potential restructuring in September. In the second week of October 2021, they informed the bondholders that they expected an Evergrande default to be "imminent" and that the company had failed to engage with them "meaningfully".
On 28 September 2021, Sunac bought back $34 million of its bonds and denied requesting government assistance. A letter, which the developer claimed was merely a draft, surfaced online arguing that recent regulations in Shaoxing intended to control property prices had left a local project unable to break even.
On 5 October 2021, developer Fantasia Holdings missed a payment on a US$206 million bond that had matured the day before, triggering a default. Just weeks prior, the developer had assured investors it had "no liquidity issue".
On 7 October 2021, Chinese Estates Holdings announced they would go private in order to avoid contagion from a possible Evergrande default.
On 11 October 2021, developer Sinic Holdings Group Co. warned that it was unlikely to be able to pay off a US$250 million bond due on 18 October 2021. At the time of the announcement, Sinic had US$694 million of dollar bonds outstanding.
In the week of 11 October 2021, Modern Land attempted to extend the maturity of a US$250 million bond on Monday and the prices of Sunac and Guangzhou R&F bonds fell sharply.
On 15 October, the Chinese government commented for the first time on the Evergrande situation, blaming the company for its problems and saying that financial contagion was controllable.
On 19 October 2021, Sinic defaulted on US$246 million worth of bonds. The same day, official figures showed real estate output in China was down 1.6% in the third quarter year on year, the first time it has been negative since the start of the pandemic.