China’s Property Sector: An Economic Decline With a Silver Lining

The Chinese high-speed trains that whisk passengers in four to six hours over the 1,300-plus kilometers between Beijing and Shanghai go through a number of lesser-known cities. Danyang, Dingyuan, Chaozhou, Cangzhou, Langfang, and Dezhou, for example, don't carry much name recognition within China, much less outside of it.

Yet cities like these, not the glittering mega-metropolises, illustrate a phenomenon that is only picking up speed in China, and that the central government is feeling increasingly desperate to solve: the collapse of the property sector.

While riding the train, one knows that a station is ahead not just by a decrease in speed and an electronic sign announcing the next stop, but also by the sudden appearance of clusters of high-rises in varying stages of completion on the outskirts of the upcoming location. Almost invariably, little, if any, activity appears to be happening on location.

On one such recent trip, it was a Thursday afternoon during working hours, with perfectly good weather outside. There was no reason for a construction site to be anything but bubbling with workers and equipment, yet in city after city along the route, those sites were deserted.

The property game in China involves some key actors, all of whom play their role in bringing not only housing but also retail, commercial, and industrial properties to a heretofore hungry market.  Among those actors are the developers, the land office, the banks, the buyers, local officials in charge of planning, and everyone remotely connected to the overall development of the city, county, town, or village where new developments are being built. In other words, a great number of people and institutions are involved in the construction and sale of new apartment buildings and other developments, each with their own interests, both personal and professional.

In the end, however, the buyer is the ultimate driver of this market – but was also the least considered player until now. Few anticipated that buyers were all of a sudden going to become cautious, recalcitrant, and downright stubborn in their decisions to defer buying property until a later, hopefully more auspicious, time. Developers in China are defaulting on their bond repayments, and buyers of the developers’ products are proceeding carefully as a result.

In May of this year, real estate agents at a Beijing branch of the well-known company Lian Jia said that business was good and they had plenty of clients. By mid-August, when I could see that no clients ever appeared to be in their offices any time that I walked by (I was staying at the hotel next door), agents said that it was due to the heat. No one wanted to come out, so they were just doing business online.

By mid-September, those same agents, when asked, just shook their heads, clicked their tongues, and walked away.

The Developers and the Buyers

Chinese developers don’t differ that much from their counterparts everywhere. They must juggle the interests of all of the other players in the project. The differences are in the proportion of effort and attention that they must give to each stakeholder.

Paradoxically, the interests of buyers have traditionally been of less concern to the developers than the interests of the banks, local officials, and the Land Bureau. Why? For decades now, several factors have converged to make the buyer the least of the problems with which the developer must deal. Until recently, the buyer was taken as a given. Apartments are pre-sold and often under a mortgage before ground is even broken.

Chinese apartments are generally sold as shells. It is the owner’s responsibility to finish the apartment, from floor to ceiling. A buyer receives a concrete interior, and then hires an interior builder to turn the space into a home. It is at this level that the buyer begins to get some attention. Interior building companies compete fiercely for the projects built and sold by the developer.

Along with the developers themselves, the companies that finish out the properties are suffering, as well. Buyers are reluctant to contract an interior builder when they don’t know if there is going to be a product to finish out in the first place.

The Banks and the National Government

Developers don’t generally self-finance; that is where the banks come in. Banks also provide the finance for individual buyers to purchase the apartment (unless they have the cash, which they often do).

The level of developer default is now considered so critical that national resources and policy pronouncements are weighing in.

In November 2022, China’s central bank, the powerful People’s Bank of China (PBoC), which is responsible for the regulation of financial institutions, laid out a program to provide loans at no interest to six state-owned commercial banks, in order to supplement the completion of thousands of property projects throughout China. Two hundred billion renminbi ($27 billion) was made available.

The program had one caveat, however. In order to receive the interest-free loan from the central bank, the local commercial bank had to guarantee that it would not only loan out that same amount to a developer in trouble, but that it would also match that amount from its own coffers.

Apparently that was not an enticing offer. According to the U.K.'s Financial Times, as of mid-September “less than 1 percent of the funds have been disbursed to banks.”

This indicates that where China’s central bank, ostensibly in charge of monetary policy, failed to understand both the scope and depth of the property problem, local banks did not. By not taking up the PBoC’s offer (and, even more interestingly, not being forced to by the sheer political power of the central bank), local banks have demonstrated that they have a command of the situation within their lending regions that the central bank in Beijing does not. These banks are deciding that there is no point in throwing good money after bad.

It may not make economic sense for individual banks to provide new loans to the developers, but this issue is as much or even more of a political problem as it is an economic one. Most sources say that China’s property sector makes up more than 25 percent of the entire economic activity of the country. And now sales are plunging, leaving developers without funds to finish projects.

Unfinished projects put those homebuyers who have already paid a significant amount toward their new property into a dilemma. Do they continue to pay, in hopes that the developer’s current account will be sufficiently replenished to finish the project? Or do they, as is more frequently happening, just stop paying?

In some ways, the response by everyday homebuyers has been unequivocal. They have begun boycotting by refusing to pay the mortgages on homes that may never be completed. For Beijing, that is now a political problem.

Aggravating the Property Crisis: Absent and Conflicting Data

The situation is aggravated by the real estate activity of China’s shadow banking system, which provides financing outside of the officially regulated financial system. Some estimates of its size reach into the trillions of U.S. dollars. Since so many of the transactions that occur within this system are essentially off the books, it is difficult to gauge the exposure to which both the shadow bankers and their clients – often the developers – are subject.

In addition, it is difficult to reconcile some of China’s official statistics that relate to property ownership. On the one hand, China boasts that it has one of the highest rates of home ownership in the world, at close to 90 percent. However, at the same time, statistics put China’s migrant population at close to 300 million, or over 21 percent of the overall population. A conversation with nearly any Chinese migrant, working far from home in major cities such as Shanghai or Beijing, will reveal that the migrant is working toward buying or building a home back in his hometown, but he usually doesn’t have one yet. His parents may have a family home, but it is not his home.

The statistics contradict themselves and underpin a crucial misunderstanding. If nine out of 10 Chinese already own their home – and another 20-plus percent even own a second home – then why are developers still building? In other words, why does the glut that is causing the property crisis exist at all?

A Silver Lining

This crisis has a potential silver lining. The situation reflects a reality that most knew was bound to arrive sooner or later: The property market had to correct. It has been over-inflated almost since its infancy in the 1990s. The chance to bring the market back to a position of normality, in which the real value of properties begins to settle in and settle down, is long overdue.

It already is causing pain for many, and will continue to do so. But that discomfort can lead to a level of market maturity that is far healthier in the long run than the avaricious drive that has created the current situation. If the central government does not interfere to the contrary, banks will, in their own interest, become far more conservative and clinical in their lending practices. Although that trend has already begun, a complete reshuffling of the property sector will only amplify the need for banks to make loans based on financial criteria, and not political pressure at either the local or national level.

As already noted, the measures introduced by the PBoC have not been taken up at the local level, and there seems to be no negative consequences for the banks who quietly decline the offer. That is a telltale sign that economics is prevailing over political dictates.

There are other indicators in the Chinese economy right now, albeit anecdotal, but telltale in their own way, that point to healthy consumerism that perhaps is not being tracked. I argued in an earlier piece in these pages that the health of the Chinese economy could be largely tracked by the discretionary spending on luxury items, one of them being jewelry. Indeed, that market died for a while. It's back now.

Reliable sources in Beijing report that purchases of South Sea pearl necklaces by mainland Chinese women are back to, and in some cases exceeding, pre-pandemic levels. Jewelers in the Beijing markets are selling multiple necklaces a week at 30,000 yuan apiece, and some have reported sales of 100,000-200,000 yuan per necklace. That is not a sign of a dying consumer market.

In early August, I witnessed busloads of shoppers from outlying areas coming into Lujiazui in Pudong, home to one of Shanghai’s ritziest, most expensive malls, and featuring top-line designer brands – the real thing – such as Gucci, Bally, Ferragamo, Chanel, Dior, and so on.  The buses – actually comfortable coaches – were full to the brim of eager buyers, and as soon as the coach doors opened, the stores filled up.

Over a period of two hours, I watched as many as 200 women enter shops with some of the most expensive clothing and accessories in the world, and come out with bags brimming with goods. I believe that most of those shopping tours catered to rural women, which made the phenomenon even more telling. There was no shortage of discretionary spending among them, and they knew exactly what they had come for.

There is the other side of the coin, as well. The working poor are still the backbone of many aspects of the service economy in China. Taxi drivers drive 14-16 hours a day. Hotel housekeepers are paid per room they clean, at a rate of 10 yuan per room, equivalent at today's rate to less than $1.50.

The housekeepers, unlike previously when those jobs were held by younger women, are now typically in their 40s, with families in the suburbs whom they are able to see once or twice a month. While on the job, they live in crowded dormitory-like housing off-site from the hotel. They hope to clean 16 rooms a day, giving them a daily wage of $22. Many of the women with whom I talked over a period of several months said that their goal was to earn enough money to help to buy a home for their grown child and his or her young family.

Nonetheless, for all of the doom and gloom created by the property crisis and supposedly deflated consumer spending, there are indicators that not all is lost. Needed corrections are occurring. Some are still well enough off to buy the personal luxuries they crave. And the opportunity to restructure the property sector and rebuild it from the ashes of the current failures is there for the taking.

In the meantime, some will spend, and some will put their savings under the mattress. Either way, the Chinese economy is likely to prosper in the long run as long as the policymakers allow people to do what they feel is best for themselves.