The Confounding Dynamic of Regulating China’s Real Estate Market

The Confounding Dynamic of Regulating China’s Real Estate Market
A man works at a construction site of a residential skyscraper in Shanghai on Nov. 29, 2016. (Johannes Eisele/AFP via Getty Images)
Fan Yu
News Analysis
After a brief market decline, the Chinese real estate market is back in a familiar place.
Prices are surging and regulators are fretting, but in the end, the push and pull between stimulating the broader economy versus reining in an overheating real estate market always ends the same way—stimulus wins.
It's a movie that has played out multiple times in the past 10 to 15 years. But this time, in 2020 and heading into 2021, there are some new cracks forming in the broader Chinese financial markets that could destabilize China's real estate market.
The latest private survey data released Dec. 1 from the China Index Academy showed that average new home prices in 100 cities rose 0.3 percent in November sequentially, down modestly from the 0.4 percent growth in October, according to a Reuters report.
Annually, November average real estate prices are up 3.6 percent year over year, despite the CCP virus ravaging China’s economy earlier in the year.
But China’s hot property market has elicited a new round of warnings from Beijing regulators.
China Banking and Insurance Regulatory Commission Chairman Guo Shuqing recently warned in an article published Dec. 1 that the real estate market is the biggest current “gray rhino” risk facing China. “Gray rhino” describes an obvious and known risk that is deliberately or unsuspectingly ignored. 
The latest warning follows Guo's previous commentary published in August that China’s real estate bubble has been exacerbated by speculation. That's despite rules introduced in 2019 such as “One City, One Policy” to tailor real estate caps in specific markets and limiting the amount of inter-city capital flowing into certain markets.
Shortly after Guo’s August comments, Beijing piloted the so-called Three Red Lines policy to rein in excessive borrowing at China’s property developers, to constrict their financing channels by putting minimum debt covenants in place before new loans can be requested.

Threading the Needle

On a macro level, China’s economy is set to grow 2 percent this year. This is the widely reported headline number, of which most analysts are skeptical. But that 2 percent headline number can't be fabricated without tangible growth from China’s real estate market.
Real estate has been one of the most stable investments available to Chinese residents over the last decade. And the majority of household wealth among Chinese people is tied up in the real estate market.
The Chinese Communist Party (CCP) has been very careful in trying to rein in excessive speculation, yet are keen to not pop the bubble. But even the mild regulatory pushback enacted by Beijing has caused havoc among property developers, the backbone of China’s real estate sector. 
Highly indebted property developers have been skirting disaster all year. Last month, Guangdong’s provincial government stepped in to buy out a major strategic investor of China Evergrande Group after the investor demanded an exit and Evergrande didn’t have the cash.
There had been rumors circulating the months prior of Evergrande’s possible insolvency. As of Dec. 4, Evergrande’s $1.45 billion April 2022 bond yielded 15.9 percent at the last traded price, underscoring the company’s increasing default risk.
The “Three Red Lines” policy—which marks thresholds around the three metrics of liabilities to assets, net debt to equity, and cash to short-term debt—have hampered Chinese property developers’ ability to access new capital, further putting strains on their finances.
To raise fresh funding while being shut out of the debt market, developers have been rushing to divest their lucrative property management arms. Developer Sunac China in November listed its management arm Sunac Services in Hong Kong, raising approximately HKD$8 billion (about USD$1 billion). Two weeks ago, Evergrande also filed paperwork to launch an initial public offering for its property management subsidiary, with goals of raising as much as $2 billion in proceeds.
But that’s just a temporary cash infusion. Property management subsidiaries provided stable and predictable cash flow that help service debt. In the future, it could be even more difficult for property developers to meet their debt covenant criteria without their property management businesses.
CCP leader Xi Jinping’s “dual circulation” economic strategy aims to develop domestic industries. If it proves successful, capital inevitably will be funneled back into the real estate sector to support manufacturing, logistics, and of course, residential properties.
There’s little recourse. The CCP is stuck supporting highly indebted property developers, knowing that it can't afford to truly rein in the real estate market. Any semblance of economic growth, and hence its legitimacy, depends on it. 
Fan Yu is an expert in finance and economics and has contributed analyses on China's economy since 2015.