China’s property woes are spreading beyond Evergrande

Shares in troubled Chinese property giant Evergrande and its property management unit were suspended from trading in Hong Kong on Monday, amid reports that a major transaction is underway.

The suspension came just before it looked as though Evergrande was set to miss yet another payment.

According to the Global Times, China’s state-owned newspaper, Chinese rival Hopson Development plans to buy 51% of Evergrande Property Services. However, there’s not yet been an official confirmation of the deal, and share trading remains suspended.

Subscribe to MoneyWeek

Subscribe to MoneyWeek today and get your first six magazine issues absolutely FREE

Get 6 issues free

Sign up to Money Morning

Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter

Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter

Sign up

So what’s going on?

The Evergrande saga

Evergrande, China’s most heavily indebted property company, has been in the headlines in recent weeks for all the wrong reasons. Its shares have fallen by 80% since the start of the year.

The company, which is struggling under a debt pile of $305bn, missed a $47.5m bond payment last week. Before that, it failed to make an $83.5m coupon payment on some of its outstanding dollar debt. Both have grace periods of 30-days. So it is too early to say whether investors will be stomaching huge losses or not (though the omens are not great).

Now, Bloomberg says, the embattled firm is due to miss a third payment: a dollar bond worth $260m that is guaranteed by Evergrande, called Jumbo Fortune Enterprises. Because the due date is 3 October, it was effectively due on Monday and failure to do so would count as default, as the debt has no grace period.

As a result of all this, the company has been scrabbling to raise cash by selling assets. This is the driver behind the sale of the property unit. Evergrande said in a regulatory statement to the Hong Kong Stock Exchange, that it was suspending its shares “pending the release by the company of an announcement containing inside information about a major transaction.” Although, as of Tuesday, share trading remains suspended with no fresh news on the deal.

Why is Evergrande facing so much trouble and could its demise reverberate beyond China?

Much of the Evergrande’s importance on the global stage has to do with the fragmented nature of China’s property market. Reuters reports: “With liabilities equal to 2% of China’s GDP, Evergrande has sparked concerns its woes could spread through the financial system and reverberate around the world, though worries have eased somewhat after the central bank vowed to protect homebuyers’ interests.”

Calling China’s real estate market huge would be an understatement: it was worth $52trn in 2019, according to Goldman Sachs, and the sector accounts for 29% of Chinese GDP. Yet around 20% of supply – roughly 65 million homes – are underoccupied, reports Business Insider.

There is too much housing and too little overall demand for homes to live in. This gap has been filled by speculators and small investors, but both are now under pressure from regulators who want to dampen house price growth.

“Speculators and investors are being blocked by government policies in cities where they want to buy, and some are increasingly concerned that developers will be unable to complete the units they are promising to build,” reports Foreign Policy.

Real estate is seen as a more reliable investment vehicle than the stockmarket in China – about 70%-80% of household wealth lies in real estate, reports CNBC, underscoring how significant a default by the country’s second-largest property developer would be. So it is unsurprising that China has been asking state-backed firms to snap up Evergrande’s assets, having ruled out the chance of bailing it out.

Should markets worry less now about a default?

Can markets take a breather now that more than half of Evergrande’s property unit could be purchased, bringing in much needed capital for the firm? Perhaps not. Lisa Zhou, Bloomberg’s Intelligence analyst, says that the potential deal “could bring short-term relief” to the liquidity problem and effectively buy the company time to fix its onshore liabilities.

However, the spillover effect into other property developers – many of whom face similar if slightly less acute problems to Evergrande – are already showing up in markets. Chinese developer Sinic Holdings was downgraded by Fitch with concerns over a bond repayment coming up in mid-October. Homebuilder Fantasia saw its bonds collapse in half, after it failed to make a $206m payment.

As my colleague John pointed out last week, it seems unlikely that Evergrande will trigger another “Lehman Brothers” moment – at least, for global financial markets.

But at the same time, stabilising China’s real estate market will take a lot more than just the sale of Evergrande’s property unit – and it has implications for the country’s growth for years to come.