Evergrande and China’s real estate turbulence

By: J. David Chapman/September 30, 2021

I had the opportunity to be a guest on the KRMG radio show Senior Class, hosted by Rusty McMurray, this week. The topic was the turmoil in the Chinese economy. Long thought of as a shining star in terms of global economies, China is now facing a test of its financial system. China has become very dependent on housing for growth. Real estate has been the target for stimulus after the global financial crisis.

Sound familiar? Nearly every country has leaned on real estate to pull its economy out of financial recession; however, none did so as much as China. Real estate products and services account for 29% of GDP in China. Ireland and Spain may have come close to those levels, but the U.S. at its peak was at 15%.

The whole Chinese growth model is dependent on producing real estate. This has been the strategy for years. It is now estimated that in order to get real estate from 29% GDP to a more reasonable 15% or less, the economy would fall to 2% growth or less. This growth level would be extremely painful for the Chinese economy.

An unsustainable situation was allowed/encouraged by the government with cheap money. Developers added incentives to convince homeowners to purchase homes. Builders were pre-selling homes and using the deposited money to build new homes. Recently, the Chinese government has issued a policy that no longer allows the practice.

One company, Evergrande, employs 200,000 people and is indirectly generating 3.8 million jobs in China. The company has debt of $300 billion and is now considered insolvent. Its stock, traded on the Hong Kong Stock Exchange, fell more than 11% and the company has lost more than 80% of its market value. Moody and Fitch warned that the company has a “high risk of default.”

There is significant worry that the company’s failure could cause a global ripple, as Lehman did in 2007. The real estate and development issues come as retail sales are slowing, led by slowing car sales. Industrial production has slackened and heavy government spending on projects is keeping the economy afloat. I believe Beijing will carefully manage the problem and a global impact is unlikely. It will certainly cause market turbulence in China and those countries reliant upon selling products in the Chinese market may see friction in the coming months as this unsustainable government spending slows.

J. David Chapman is a professor of finance and real estate at the University of Central Oklahoma (jchapman7@uco.edu).