What on Earth Is Happening in China’s Property Market, and How Worried Should We Be?

Homeowners in China are refusing to make mortgage payments on apartments they bought off-plan. What began as a debt problem at Evergrande, one of the country’s flagship developers, is now spreading across the entire property development sector.

As of Wednesday, borrowers have halted payments on more than 100 development projects across over 50 cities. That is nearly four times the 28 projects reported on Monday.

Mistrust is particularly high toward homes sold before completion. The biggest concern is that there is no longer any assurance that developers will actually finish construction as promised.

The total value of mortgages currently being boycotted is expected to reach as much as 2 trillion yuan (around 360 trillion won). Because this suggests that what had been a bad-loan problem largely confined to offshore debt this year could spill over into China’s domestic financial institutions, the Communist Party is reportedly considering unprecedented measures: granting grace periods on mortgage repayments and pushing banks to extend more property loans so that developers can complete their projects.

According to Bloomberg’s China Credit Tracker, stress levels in offshore debt stand at 6, indicating a highly distressed situation.

Yields on Chinese high-yield (junk) dollar bonds are currently around 22 percent, underscoring how little appetite there is to invest in Chinese corporate debt. In fact, offshore bonds totaling 26 billion dollars have already defaulted this year.

Onshore, the stress level is at 2, which looks relatively benign. But that seems to be because conditions are tilted in favor of borrowers. Many financial institutions simply roll over loans that cannot be repaid, creating the appearance that there is no problem.

If there were a bond with a maturity of “forever,” borrowers could avoid default without ever paying the money back—a kind of financial magic trick. That, in essence, is where China’s domestic credit market stands today.

The problems in China’s property market do not stop at financial turmoil and losses.

Property-related industries in China—development, construction, services, and so on—account for roughly 25 percent of GDP. Real estate is the core engine of the Chinese economy.

If the property downturn continues, the damage will not be limited to China’s own related industries and services. It will almost inevitably hit key sectors for Korea as well—chemicals, steel, manufacturing—and drag down demand for a wide range of commodities.

In other words, this is not just China’s problem.

The Russell 2000 (+3.74 percent) and Nasdaq (+3.47 percent) held up relatively well, while the S&P 500 (+2.61 percent) and Dow Jones Industrial Average (+2.05 percent) lagged behind over the week.

As in the previous week, the rebound was led by indexes that had fallen the most, but by Friday much of those weekly gains had been given back.

Judging from market tone—and from the headlines in financial and economic news—it felt like, “Surely the risk of recession is now fully priced in.” But on Friday, the services Purchasing Managers’ Index came in far below expectations, and recession risk was back on the agenda.

One of the most striking divergences in sector performance was between consumer discretionary stocks (+6.84 percent) and communication services (+1.05 percent).

Communication services companies are often lumped in with “tech,” but their real revenue engine is advertising.

Staples tend to sell steadily without heavy advertising, whereas discretionary products are designed to stimulate wants rather than needs, so they rely far more on ad spending.

So when consumer discretionary and communication services move in opposite directions, it suggests one of two things: either one side is “lying,” or the leading industry has already bottomed and is rebounding, while the sector tied to it is only now approaching the bottom.