The Falling of a Chinese Giant

China’s second-largest real estate developer, the Evergrande Group, is facing impending bankruptcy. Could this be another “Lehman moment” with the epicenter in China and ripple effects that would quickly spread across the entire world? In today’s special edition newsletter, we will give you details about the situation concerning Evergrande and what repercussions, if any, there would be for our real estate market in the U.S.

Since President Nixon’s famous visit to the People’s Republic of China in 1971, the country has opened to the West in its own unique way. While their economic system has evolved to follow capitalist principles, its political system has remained firmly committed to communist ideals. The Chinese President and General Secretary of the Communist Party, Xi Jinping, is undeniably the most powerful and influential figure in China.
 
In this unusual market environment, Chinese businessmen have been able to build some of the world’s largest companies. In the year 2021, the Global Fortune 500 list featured 135 Chinese companies, which is 13 companies more than that of the U.S.
 
The Evergrande Groupe is number 122 on the list. It primarily engages in the business of property development in China with a focus on residential properties, although property investment, property management, and property construction are also under their prevue.
 
This mega-company is in big, big trouble. Since 2018, when earnings peaked, It has seen a steady decline. In 2020 earnings were only 22% of earnings in 2018, based on the company’s annual earnings reports. According to Reuters, 2021 half-year earnings were reported to be only 39% of 2020’s half-year earnings due to a significant drop in home selling prices and increased costs.
 
Moreover, Evergrande is debt-laden and has already missed important payment deadlines. The company has amassed about $300 billion in liabilities and in June it missed its first interest payment. The outlook became such that in mid-September it warned investors of a default risk. Two well-known external advisors were hired to examine the firm’s financial options.
 
The stock price of Evergrande reacted sharply to the news with daily losses in the double digits. The chart “Stock Price of Evergrande Group” depicts a rapid decline of the group’s stock price since June 2021, when it became public that the company had missed its first interest payments. At that time, shares were valued at $43. Since then, the stock price has seen a steady decline that amounted to a loss in the share price of 95%, or $41 a share. On September 20th, the stock price reached a new low of $2.08.

Likely, the company has not yet hit rock bottom. Many Chinese investors are very upset. On September 14th, a group of private investors stormed the company’s headquarters in Shenzhen, China, and allegedly took a few executives hostage.
 
Epicenter in China, Effects Around the World
If the fall of Evergrande ends in bankruptcy, the effect will be felt in China and around the world. In the Chinese residential real estate market, it is standard practice that new homebuyers pre-pay real estate developers, such as Evergrande. Construction on a new property will not commence unless a property is fully funded.
 
Given the current financial troubles of Evergrande, construction of unfinished properties, with enough floor space to cover three-fourths of Manhattan, grinds to a halt. According to Bloomberg News, over a million homebuyers are now in a precarious situation: owing debt on real estate that will not be completed.
 
Further, the $300 billion that Evergrande carries as liabilities on its books are spread across 128 banks and 120 non-financial institutions across the world, all of whom will have to settle for pennies on the dollar in case of bankruptcy, if they would receive anything at all. Consequently, the global banking industry will be among the first to be hit, along with new Chinese homeowners.
 
Moreover, funding for Chinese companies would become more expensive, making it difficult for them to earn a profit and continue operating. According to Bank of America, Evergrande is the largest high-yield dollar bond issuer in China, accounting for more than 16% of outstanding notes. Should Evergrande collapse, the default rate on bonds would rise significantly, making it prohibitively expensive for Chinese firms to access funding.
 
Chinese economic output, which is about two-thirds of the U.S.’s output, would decrease significantly under these conditions.  The real estate market, including its supply chain, accounts for more than 25% of Chinese GDP, according to Bloomberg News. Evergrande’s bankruptcy would lead to a slowdown in property construction over the next several years, reduce overall economic output, and demand for commodities. Unsurprisingly, the news about Evergrande’s trouble has sent the stocks of other Chinese developers and suppliers plummeting.
 
Furthermore, household wealth in China would go down, leading to a reduction in consumer spending. Today, real estate accounts for 40% of household assets in China. Undeniably, the fallout from Evergrande would decrease the overall wealth of Chinese people, further battering the hopes and dreams of achieving prosperity. With a lack of consumer spending, the Chinese economy would shrink. By earning less in foreign profits, American and other Western firms doing business in China will most likely see a reduction in stock prices as their profit forecasts are not met.  

Too Big To Fail?
The financial situation of Evergrande is so dire that only a bailout from the Chinese government can save the company. Xi Jinping has the last word on this topic, but will he save the company to protect China’s economy?
 
On Friday, September 17th, author and editor of the Chinese government-owned Global Times, Hu Xijin, indicated that government intervention would be unlikely. His comments can be interpreted as a way for the government to prepare the public for the looming bankruptcy of Evergrande. Of course, the final decision about whether we will have a Chinese “Lehman moment” is with Xi Jinping and the ruling Communist Party.
 
Effect on the U.S. Real Estate Market
As outlined above, banks in the U.S. will suffer from the default of Evergrande. The impact will be felt by borrowers as lending institutions will engage in risk averse lending in order to mitigate further loss of profit. In particular, we expect that banks will eventually treat residential real estate properties the same way as commercial property. Capitalization rates of properties will become a key criterium. Bars to qualify for news loans will be raised. Only real estate properties that offer a good price to rent or loan payment ratio will be financed under affordable conditions.
 
As an investor, we would like to assist you in finding properties that offer good price to rent ratios and will deliver a solid and stable return regardless of the economic situation.
 
We encourage you to become a first trust deed investor now, before the effects of an Evergrande bankruptcy have spread throughout the global economy, sending stock markets into a decline, and wiping out significant amounts of wealth. You can mitigate any potential loss in market shares by investing in the U.S. housing market and collect a stable and solid return along the way. Become a first trust deed lender now.
 
If you are interested in making an investment, please contact our representatives to learn more about first trust deed lending.