Solid fundamentals, tight regulations, sales pickup shield indebted property industry from default risks

China's real estate industry may be staring at what some may label as a monstrous financial problem.

According to estimates of the Evergrande Research Institute, real estate developers in China will need to repay debts of 6.1 trillion yuan ($887.4 billion) this year and 5.9 trillion yuan in 2020.

What's causing concern in some, not all, financial circles is that both these figures are more than double that last year (2.9 trillion yuan).

Such staggering indebtedness may ring alarm bells anywhere else in the world, but in China, there's no panic, only cautious optimism, experts said.

How come? Any financial risks that may arise from high leverage of China's real estate industry would be kept under control as the fundamentals of the property market remain rock solid and the necessary financing regulations are in place, they said.

Supervision over new forms of leveraging channels, however, should be strengthened, they said.

Leverage refers to the amount of debt a firm uses to finance assets. In the context of a property firm, high leverage would mean its projects have more debt, mostly in the form of bank loans, than equity.

When a property firm borrows heavily to build new projects, but is unable to repay in time due to poor financials, or paucity of buyers, or sluggish sales, or other market forces, it will likely default. That is a potential financial landmine as it could spark systemic risks, given the pivotal role of commercial banks in a financial system.

Financial risks of the real estate sector are also reflected in the rapidly rising mortgages of Chinese families. From 2008 to 2018, China's outstanding amount of residential mortgages surged from 3 trillion yuan to 25.8 trillion yuan, pushing up the household debt-to-GDP ratio to 53.2 percent by the end of last year, according to the People's Bank of China, the central bank, and the Chinese Academy of Social Sciences.

But related risks are still controllable as the ratio is still below the global average level of more than 60 percent and far below the approximately 95 percent in the United States on the eve of 2008 subprime mortgage crisis, analysts said, adding that it is still necessary to rein in the growing residential mortgage burden.

Since the beginning of this year, increasing indebtedness of the real estate industry has caused concern among top regulators.

Guo Shuqing, the People's Bank of China's Party secretary and head of the China Banking and Insurance Regulatory Commission, told a forum last month: "We must face the problem of the financialization of real estate in some places."

Excessive financing of the real estate industry not only strains credit resources that could be channeled into other industries but encourages speculative investment in properties, blowing the property bubble larger, Guo said.

His comments marked at least the fifth time this year that top regulators underlined financial risks of the real estate sector in the public domain.

"Financial risks of the real estate sector should be kept a close eye on as developers' defaults on loans, if they happen on a large scale, could dent commercial banks' financial stability," said Pan Xuefeng, an economics researcher with the University of International Business and Economics in Beijing.

Chinese real estate developers had relied on high leverage, mainly in terms of loans, to expand their businesses for years, with their debt-to-asset ratio stabilizing at about 80 percent in recent years, said Pan.

"Default risks would emerge on expectation of falling property prices, which would weigh on property sales and thus developers' solvency."

Default risks may intensify as the amount of due debts is expected to peak this year and the next.

Repayment pressure forced some developers, mainly small and medium-sized ones, to sell assets and even declare bankruptcy.

Meanwhile, debt defaults made the Anhui province-based Zhonghong Holding Co Ltd the first real estate enterprise to be delisted from the A-share market last year.

"It cannot be discounted that some small and medium-sized developers that typically face fewer channels and higher costs of financing, will default as financing conditions tighten to curb speculation," said Edwin Chen, a real estate analyst with UBS Securities. "But I don't consider it a systemic risk."

Chen highlighted healthier fundamentals of the real estate sector compared with several years ago. They, he said, will help shield the sector from financial risks.

"Property inventory has declined and sales have quickened. The market has a relatively satisfactory liquidity condition, which means that the developers facing repayment pressure could tide over difficulties by selling assets to others."

"Listed property firms' financial stability has improved," Chen said, adding that strong industry players with higher efficiency and anti-risk capacity are expected to squeeze out or acquire weaker competitors, ushering the real estate industry into a high-quality development stage.