China's version of the sub-prime mortgage crisis
Chinese buildings, like American stocks, are essentially a reservoir of national wealth. By buying buildings, Chinese people become shareholders in their cities and enjoy a range of health, education, transport and security amenities that come with urban development. This strategy has been very successful over the past few decades, with rapid urban development, an extremely prosperous upstream and downstream chain of real estate related industries, a large number of people earning lucrative incomes, and the construction of countless magnificent buildings in various cities, making successful China look more developed than the developed world. However, this has also led to a consequence that China has the highest house price to income ratio in the world, with Beijing, Shanghai and Shenzhen long occupying the top positions of the most expensive cities in the world. In 2022, this phenomenon has grown to the point where an average home may require the lifetime income of all members of a family to afford it.
China is not unaware of this.
It refers to three criteria proposed by the Ministry of Housing and Construction for real estate developers' financing from 2021 onwards, in order to prevent the financial risks associated with blindly leveraging up real estate. #realestatedebt #debtratio
A gearing ratio of no more than 70% after excluding pre-receipts.
A net debt ratio of no more than 100%.
The cash to short term debt ratio should not be less than 1..
These "three red lines" imposed significant restrictions on the expansion of real estate debt. At the same time, the recurring epidemic has hit property sales hard, resulting in a sudden depletion of capital in a sector that requires a lot of cash flow. As a result, 2020-2022 saw a large number of property under construction stopping stages.
If this were to happen in the West, real estate developers would go bankrupt, banks would sell off the properties under construction, someone else would buy them at a lower price, finish building them and re-sell them, and the consumer would just pay and buy the house, not caring who built it or whether the seller made or lost money in the business. But in China things are going in the other direction.
This is because the sale of new homes in China generally takes the form of a phase sale.
The term house system, also called pre-sale of commercial properties, is where the pre-seller (usually a real estate agent) pre-sells a house that is under construction and not yet completed to the purchaser, who pays a deposit or purchase price and the pre-sold house is delivered to the purchaser at a determined future date.
In this way, the real estate agent can get the business going without investing a penny of his own money.
The property developer will first obtain a deposit through a bank loan or a private loan and use this money to obtain a land development qualification from the local government. After that, they would mortgage the land development qualification to a bank for a loan, find a builder to produce the plans, build the foundation of the house, and then build a sales office and a few floors to apply for a pre-sale permit. After receiving the pre-sale permit, the property is started to be advertised and officially put up for sale, allowing buyers to pay for the property. Once the property developer has received the purchase price, he can pay off the previous loan and use the purchase price to continue building until the property is completed. The whole process is so interlocking that the property developer can complete the entire development at almost no cost to himself.
Why is such a system adopted? Because of the high capital investment and long lead time in the property development industry.
And in the early stages of urbanisation, developers often have limited capital, and a pre-sale system for phase properties can increase capital turnover and speed up urban construction.
However, there is one major problem with the phased housing system: its risks are mainly borne by home buyers.
Normally, when a pre-sale is completed, the local government gets the land purchase money and taxes, the property developers get the purchase money, and the banks hold many of the home buyers' loans with interest. They all get what they want.
But when real estate rises until it can go no higher and starts to enter a downward cycle, things start to go in the other direction.
Buyers saw the risks involved and were much less willing to buy homes, and the housing companies received far less money than expected, so there wasn't enough money left to complete construction. When they expect to lose money themselves after building the houses, they decide that the advance they have already received will no longer be used for construction either, but will instead draw the money out first, hoping to throw the debt on someone else.
So who exactly will be the ultimate victim? According to Chinese law, the ultimate victim is theoretically the home buyer. Because a housing company can go bankrupt, whereas China has no personal bankruptcy system, the lender must pay off the loan in full.
If a person takes out a loan of ¥5 million to buy a term home, using the home as collateral.
If he makes a repayment of ¥1 million and then breaks his mortgage because he cannot continue to pay, the bank will take his property and put it up for public auction. If the auction proceeds make up the remaining ¥4 million, fine. If it is less than that and only ¥3 million is auctioned off, then the buyer will still have to find a way to make up the ¥1 million difference, or he may be blacklisted on credit.
Worse still, if the house is not yet finished, then they will have to repay the ¥5 million they have borrowed for the house while not being able to live in the house they bought, which means that the risk caused by the housing company and the bank will be doubly borne by them. #mortgagecrisis
Chinese Style Countermeasure
In this case, the purchaser paid the purchase price and fulfilled the purchase contract and should not have been held liable for anything related to it. The reality, however, is that those who are not responsible at all, bear the greatest risk and cost. They did not receive the house that was built, but the decades-long loan had to be repaid to the bank.
When home building stoppages occur in large numbers, home buyers are no longer willing to accept such a clearly unreasonable approach of making the non-responsible party bear all the costs and choose to force a loan stoppage and cut off their payments.
As of today, owners of over 200 unfinished properties across the country have issued a collective statement announcing the mandatory suspension of loans and disconnection of mortgage payments unless construction of the houses is restarted and move-in ready properties are delivered. This is a concentrated outbreak of homebuyer discontent that has never before been seen on such a large scale. It was a Chinese form of rebellion, when faced with an unfair, painful and wrongful situation, people unite and use it to create social influence in the hope of reaching an outcome that is more favourable to them. In the words of one lawyer, one homeowner not paying their mortgage is a legal issue, but what if 10,000 homeowners don't pay their mortgage? That would be a social problem.
If hundreds of homeowners do not pay their mortgages, the bank that provided them with the mortgage loan can of course sue them.
But if all these hundreds of people are sued, will the District Court be too busy? Even if it is, what will the court do if not only one district does this, but all the owners of the unfinished buildings do it? Therefore, the collective suspension of loans and mortgage payments by the owners of unfinished buildings is a crossroads in front of the term housing system. It means that the time has come to change the system of term housing, which was once adapted to the needs of society.
The stoppage of mortgage payments by the owners of the unfinished buildings is a sign of this inflection point.
The beginning of a new phase
Faced with this situation, China's long-standing approach has been to create expectations of rising house prices, to get more people to buy homes, to prop up the bubble and to solve the problems of individual real estate developers in the process of development.
But today this approach is no longer available. In today's economy, buying a home means that a person has to put up a sum of money that will take decades to repay to buy a commodity that carries a very high level of risk, and the bankruptcy of real estate developers has become a large-scale occurrence. With a national urban unemployment rate of 6.1% and a youth unemployment rate of 18.2%, how many people actually have the will and ability to do this? Despite the central government's repeated emphasis on preventing systemic risk, the possibility of systemic risk is increasing, and the trigger point is real estate. Let's keep track of things as they unfold. #realestatebubble
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