“Housing is for Living, Not for Speculation” An Update On The Global Property Market.
As of September 2021 1.4 million homes have been paid for and are yet to be delivered.
Founded in 1996 Evergrande pioneered development of cities, at the time one third of China lived in cities, in 2020 this was 63.9%, a near doubling! The company’s growth burgeoned with the powerful growth of china for the last 20 years with the company fuelling growth through developments of predominantly residential cities. The company often forward funded developments, taking deposits for properties, or contractual sales to fulfil this created a liability for the company with liabilities at September 2021 exceeding $300Bn.
Evergrande’s solvency has long been questioned, since around 2010 the first questions of solvency came up, with more concrete criticisms arriving as early as 2016. The company’s debt fuelled growth allowed the plates to continue spinning for some time, taking out new financing to fuel new developments, to pay out and service previous debts. In 2016 analysts inspected 40 projects across 16 cities, all under development, all requiring expensive short term debt. Certainly 10%+ this long term financing strategy and growth was not sustainable long term mode, at the same time accounts identified circa 400,000 car parking spaces, valued at $7.5Bn. The true value of these assets was questionable but the leverage was what peaked analysts questions, this value was equivalent to the company’s entire equity base.
We speculate the aggressive growth fuelled by expensive debt appeared to be fuelled by a speculative boom in housing and land auctioning from local government, with local government receiving 1/3 of revenues through land sales, what was meant to be a secondary source of income.
What caused the music to stop? “Housing is for Living, not speculation”
China’s political motive of ‘common prosperity’ put real estate in the firing line, the political landscape wanted to make housing more accessible, this was made difficult by families using property as a speculative wealth generating tool as an alternative to the casino public equity markets of china. So long as deposits could be taken, and finance received to deliver future apartment blocks these developers were taking future earnings today with units to be fulfilled.
The crisis began with 3 red lines being imposed by government, constraints on borrowing based on the company’s cash and equity positions. Again, the aim to prevent housing being used for speculative gains. To curtail developers thresholds were imposed on debt : equity, net debt to equity, and gross debts to assets. To curtail speculation from buyers, mortgage lending was tightened. In June 2021 Evergrande failed all 3 tests resulting in a failed attempt to further refinance. Projects (and future income) ground to a halt.
(1) Sale of projects to developers in a position to fulfil
(2) Sale of equity to raise capital (nationalisation?)
(3) Default on debt and restructure
At this stage it is not clear how things will play out over the next 4 – 6 weeks, September 23rd Circa $80M interest payment was missed (as of Friday 24th still missing) there is a 30 day grace period for Evergrande to make this up but any attempts to service this debt will undoubtably lead to further the same difficulties in days or weeks time. The debate is whether Evergrande is too big to fail or not. The bonds expected to default carry an 8.75% coupon against a par value of $1, currently they are being traded in the bond markets at circa 24 cents on the dollar (a staggering 33% return). As investors speculate on the default of Evergrande it is expected that retail investors, homebuyers, and domestic Banks in china will be prioritised over any debt funds trading this speculative debt.
Evergrande is not an isolated case, R&F, another Chinese property development company has recently a rasied $2.5Bn in loans from Executives of the company, and sale of a project to shore up cash reserves. Its been found that 10 other Chinese development companies have $290bn of liabilities of contractual sales to fulfil. These regulatory capital controls could affect many foreign markets.
Another factor of note is a slowing birth-rate in China, down 20% in 2020 from 2019. The cohort of women aged 22-35 will also drop 30% over the next decade, accelerating this decline and with it the demand for housing.
What can be learned for UK Housing and Buy to Let investors:
The challenge is arising out of a liquidity crisis brought about by tightening of credit. We saw this move in 2008 with buy-to-let portfolios being moved down from an 85% gearing to 75% being the threshold which banks wanted to see. Could our portfolios withstand a further restriction in gearing from 75% to 65%?
The UK is poised for a unique boon over the next 10 years, the demographic of 18 year olds will grow 25% over the next decade from 700,000 today to 900,000. This is a rare phenomenon in modern developed nations and not typical of western society (see Germany’s population decline and labor shortage challenges). The cause of this boon is felt from the baby boomers of 1950-60’s having children born around the 1980’s. This increase in the number of children (women) coming to child bearing age between 2000-2010, a period of sustained wage growth outpacing inflation, meant that the noughties were a particularly good time, economically, to have a family.
The context of this growth versus wider Europe is an anticipated increase of 18 years on the continent of 2% by 2030.
What does this mean for the UK?
Demand for schooling will be high.
Public Service demand will be high.
Increased labor availability at the low skill end of industry, particularly hospitality and leisure.
University demand will grow.
Housing and shared accommodation demand will grow.