September was the cruelest month for the colossal Chinese real estate developer Evergrande Property Services Group, and the ripples of its failure are echoing around the world. Although many people were content thinking that Evergrande is simply “too big to fail,” there has been no such assurance from the Chinese government, and there are a myriad of investors, companies, and world markets that are watching nervously to see what transpires. It seems that Evergrande has bitten off more than it can chew, and now it is time to pay the piper. At the final hour, Evergrande has hatched a plan that will do some good. Shares were halted Monday, amid reports that Hopson Development Holdings was going to buy 51% of the company’s property services unit for $5 billion dollars. But this might be too little too late to save the real estate empire from toppling and to send ripples throughout the world.
The Struggle is Real (Estate)
Evergrande was established in 1996 by Hui Ka Yan, and in that time has compiled over $300 billion in debt. In the last 25 years, Evergrande has accrued more debt than any other developer in the world. The debt was amassed during the rapid growth of China’s property boom, but currently the bills are coming due. Now people around the world are watching, some with their life savings at stake, to see how this will play out.
“As Evergrande teeters on the edge of default, collapse would have grave consequences for hundreds of thousands of property buyers and retail customers,” said CNBC Senior Correspondent Emily Tan.
Evergrande is embroiled in over 1300 residential projects in over 280 cities, with some new owners already paying mortgage on projects that have currently been halted. According to CNBC, more than a quarter of China’s economy and people are paying for homes that haven’t been built yet. This is devastating for individual investors and their families, as well as the businesses that are on the hook because of their work with Evergrande.
The world is taking notice. The Wall Street Journal reports, “At least 23 lawsuits involving commercial bills—a form of IOU among Chinese businesses—have been filed this year against Evergrande’s subsidiaries in Anhui province, where Lu’an is located, according to a Journal search on Tianyancha, a corporate database in China.” These lawsuits include construction companies, concrete companies, and manufacturers of cable and paint.
“Its creditors include buyers of 1.4 million apartments that Evergrande presold and promised to build but hasn’t yet completed, estimates research firm Capital Economics. Evergrande also borrowed from banks and foreign investors.”
How Did This Happen?
The failure of Evergrande and its ability to wrack up so much debt has been a perfect storm. Because Chinese leaders do not have much power to tax, they get approximately a third of their revenue from the sale of land. Additionally, if cities annex land from local farmers, the farmers can then buy apartments for a discount. The city of Lu’an, in particular, has been hit hard. Because Beijing and Shanghai did not have much available land, Evergrande spent a lot of time and money building in Lu’an: money they did not have, as it turns out.
As if they were not already struggling, in 2017, Evergrande entered the theme-park business, and the 15 projects they put in motion across China totaled more than $100 billion in investments. Now both theme parks and apartment complexes sit empty and unfinished across the country.
Evergrande sold real estate to a wide variety of buyers: corporate employees and farmers who wanted to move to urban areas. These investors were sure that real estate value would rise, and they would be protected by Beijing.
But by September, Evergrande was trying to protect its customers and missed an interest payment to overseas bondholders. And now the whole world watches and worries.
A sharp deceleration in China’s property market could “exacerbate and amplify downward pressure” on the job market and China’s overall economy, Goldman Sachs economists warned in a recent note. By some estimates, real-estate-related activity now accounts for nearly one-third of China’s economy.
The Ramifications of Piles of Debt
Evergrande had been barely holding it together for the past several years, but in 2020, China started cracking down on bank debt. This was unwelcome news for a real estate developer that had been living on the edge. “As China cracks down, new-home construction has slowed and housing prices are falling in many places. Local governments’ land-sales revenues fell by 17.5% in August from a year ago, according to Rhodium Group.”
The crisis is being compared to the Lehman Brothers failure in 2008, and China and the world are expecting a “systemic spillover to other parts of the country.”
Without a forthcoming full scale bailout from China’s government, Evergrande is making some strides to calm the crisis. Early this week both Hopson and Evergrande suspended their stocks, pending the transaction that would have Hopson buying 51% or Evergrande’s property-services unit, giving them a majority holding.
According to Reuters, “Selling an asset means they are still trying to raise cash to pay the bills,” said OCBC analyst Ezien Hoo. “Looks like the property management unit is the easiest to dispose in the grand scheme of things.”
Investors and bankers suffering from the fallout of the Evergrande debacle are one thing, but for farmers and ordinary citizens who have spent their life savings to get a new house or apartment to no avail, the crisis is personal. The world will look with nervous anticipation as the events unfold in China. Without a large-scale bailout from the Chinese government, investors want to know if the Hopson deal will help get Evergrande back on track, or if real estate developers across the globe will continue to feel the reverberations of the mountains of debt.