China’s Beloved Property Market Returns as a Problem It Wants to Ignore

The Real Estate Climate Index is a composite indicator that reflects the current state and development trends of China’s property market.

The period when this Real Estate Climate Index was at its lowest was January 2020,

when Covid deaths were rising and the United States announced additional retaliatory tariffs on August 5, 2019, reigniting the US-China trade war.

At that time, China’s job market was in its worst shape. Nearly half of all workers saw their wages cut or frozen, and the middle class’s sense of economic deterioration led to reduced consumption.

Their mortgage principal and interest payments exceeded their living expenses, and falling home prices only added to the burden.

China is an economy driven by property investment.

As growth slowed, concerns about a property bubble intensified.

Fast forward to 2022: investment in China’s property development has been steadily declining.

In essence, nothing has changed. China is still an economy driven by property investment, and in that kind of economy, property investment is now shrinking.

Across China, protests have broken out and borrowers are refusing to make their mortgage payments.

That is because they were paying principal and interest on homes they had never once lived in.

These are units sold off-plan, before construction was completed.

Chinese property developers buy land, take out bank loans, and then start building.

At that point, they pre-sell units to homebuyers to raise funds, and those funds are used to acquire yet more land.

This unchecked proliferation of projects has pushed back completion timelines.

Borrowers are repaying principal and interest on homes they have never lived in, and have taken out loans using those same never-lived-in homes as collateral—leaving them servicing debt with no actual home to show for it.

If China’s property market collapses, the first casualties will be the developers, who will come under severe stress and go bankrupt.

That much is obvious. But there are second-order problems as well.

One key issue is that the volume of residential mortgages is more than twice as large as developers’ own borrowings.

It brings to mind the subprime mortgage crisis, when lenders were handing out home loans in the name of anyone and everyone—even the family dog—until the whole thing blew up.

The fallout can spread to banks, asset managers—indeed, to every corner of the financial system touched by credit.

In China, where property is the engine of economic growth, a credit blow-up built on real estate could be extremely difficult to recover from.

There is a wide range of measures Beijing could, in theory, deploy to revive the economy, and we will return to that topic if and when the current problems fully crystallize.

We also need to consider the impact on steel producers.

Construction in China accounts for 55% of the country’s steel demand.

If that 55% slice of demand shrinks rapidly, Chinese steelmakers will look overseas.

China is both the world’s largest steel producer and its largest steel exporter.

But a decline in domestic Chinese steel demand does not automatically translate into higher demand abroad.

In the process, many steelmakers could end up going bankrupt.

When the United States faced its own steel crisis in 1984, Washington adopted policies to protect the domestic steel industry, including voluntary export restraints.

But those measures pushed up prices for steel-consuming industries, which in turn reduced employment and fueled inflation.

China will be well aware that if it tries to protect its own steel sector by restricting exports and forcing more steel into the domestic market, as the US did in 1984, it will trigger the same set of economic problems.

Beijing is trying to support the sector by investing in infrastructure and stimulating the economy,

but ultimately, to keep its steelmakers alive, it needs to see the completion of the property projects now under development.

The problem is that developers’ financial conditions are deteriorating.

The weakening of the renminbi against the dollar is toxic for developers.

Among Chinese property companies, China is the single largest issuer of dollar-denominated bonds,

and the depreciation of the renminbi makes it more expensive for them to refinance that debt.

As developers go bankrupt one after another, construction will slow further, and the more it slows, the more steelmakers will be left waiting on the sidelines.

To survive, steel producers will face a stark choice between restructuring and cutting output, or going under.

As demand falls (because of a shaky property market) and supply also contracts (because producers go bust), employment will shrink and the economy will slip into a recessionary cycle.

Because so much of this system is built on credit, the downturn could unfold faster than many expect, starting with the developers.

Yet even if China goes through this painful adjustment, it will not magically create homes for buyers who already paid for properties that do not exist.

That is how serious the problem is. It brings us back to the Real Estate Climate Index after 2020.

Looking at the index after 2020, it can appear as though the crisis has been overcome.

That is not the case. Back in 2020, the government stepped in to rein in developers’ excessive leverage.

We are simply facing the same problem all over again.