CHINA’S REAL ESTATE PROPERTY CRISIS

2022: The outlook for China's developers appears bleak amid looming debt maturities, falling home sales, and uncertainty over the proposed property tax

Home sales are likely to drop between 5 and 10 percent this year, according to forecasts by analysts, rating companies

China Evergrande, which has the dubious distinction of being the world's most indebted real estate developer, is gripped by a solvency crisis that began more than a year ago. And the crisis affects not just Evergrande. A growing number of Chinese property developers are facing financial strain, while property sales and home prices in China are falling sharply. The Chinese government, worried that an engine of growth is losing steam, is struggling to keep the property sector afloat. Yet China's rescue measures are mostly short-term solutions to a larger long-term problem. In fact, Evergrande is a leading indicator that China's model of property-led growth is unsustainable and needs to change.

A government working group and a risk committee, made up of mostly senior executives from Chinese state-owned enterprises, have been set up recently to deal with the crisis at Evergrande. It remains unclear how the government will sort out the Evergrande problem, but it could follow the model of HNA Group, another heavily indebted private conglomerate that the government eventually took over. If that happens, debt restructuring will inflict losses on investors as the company splits into several smaller independent entities.

Evergrande is hardly the only real estate problem facing China. If, as expected, property sales and home prices keep dropping this year, China's economic growth will be imperiled. Property and related industries account for 25 to 30 percent of China's GDP. Banks will be saddled with significantly more nonperforming loans on their books, since 27 percent of all loans Chinese banks hold are related to property, including mortgages. The shadow banking sector, which includes trust companies and is an important funding source for Chinese developers, will be hurt as well.

The problems extend to local governments, which on average receive nearly 40 percent of their total fiscal revenue from land sale proceeds. With land sales more difficult, coupled with the impending decline in revenues related to those sales, local governments may have to cut public services. Worsening fiscal conditions of local governments can in turn lead to more defaults by local government financing vehicles whose debt is usually collateralized by land parcels.

Equally worrying would be the potential political fallout. Nearly 60 percent of the total assets owned by urban Chinese households is property. That share is even higher for lower-income households. As a result, a sharp property price decline could trigger social unrest, something the Chinese government would want to avoid at all costs.

Beijing faces a classic dilemma between the need to rescue the debt-loaded property sector while avoiding a moral hazard, the belief among property developers that the government will hold them harmless despite their reckless behavior. China's leadership has signaled its goal of stabilizing the property market in 2022. The central bank has cut the reserve requirement ratio and the benchmark one-year loan prime rate. Many believe these cuts are just the first steps. Greater fiscal stimulus, including a renewed focus on infrastructure investment, is also on the horizon.

LOCAL GOVERNMENTS RELY TOO HEAVILY ON CHINA'S PROPERTY BUBBLE
The Chinese housing boom is fueled by financing from local governments, whose budgets rely on proceeds from land sales and taxes related to property development.

Skyrocketing real estate-related loans, including mortgages, are weighing on the economy, squeezing the financial resources allocated to more productive sectors other than property. From the end of 2011 to the end of September 2021, the share of property-related loans, including mortgages, in the total loan balance has increased from less than 20 percent to more than 27 percent, according to the People's Bank of China. At the same time, the total mortgage balance as a share of property-related loan balance increased from two-thirds to more than 70 percent.

All these factors make it clear that China must change its property-led growth model. Local governments addicted to land sales for income have to look for alternative sources of fiscal revenue. One source could be a nationwide property tax on homeownership, a solution that China is now in the process of introducing. But whether such taxes can wean local governments off of land transfer fees is uncertain.