Evergrande Group has been an integral part of the recent rise and rise of China [see photo]. This entity is massive because it has major holdings in real estate inside China. Allegedly, it carries $US 308 Billion of debt with some held by Chinese nationals and some held by Foreigners. This debt burden is the result of massive over-reach within a layered system of economic transformation and growth. So let me peel back some of the layers of this system.
The story begins with the fact that social cohesion throughout China is based around the family. The family unit is at the centre of all social traditions and expectations. And even though the CCP runs the topdown management of China it does not control the family assets being accrued, or lost, by its citizens. Over recent decades the family expectations have centred around home ownership. Indeed due to the highly skewed demographics of the one-child policy any young male with a property portfolio has little trouble finding a partner. The expectation is that a young man's home ownership credentials will underpin his future prosperity given the rise and rise of home prices.
Evergrande Group was one of the leaders in property development with an expansive vision of what the total home market could become. They purchased land and developed high rise properties. This was a viable business strategy within China because only the government can own land inside the country. This means that all land is leasehold with limits on its tenure for any particular use. Thus buildings can rise, or implode, in line with the demand for total dwellings within a Province. However the well known, and understood, bug in this schema is the recurring need for the CCP to create employment in the construction industry. The CCP pushes fiscal funds into the Provinces to stimulate employment growth but not to reach dwelling targets. And this means there has long been a built-in bias towards over-building. For decades past this has not proven to be a major problem because Chinese nationals have snapped-up this overhang as investments. Apartments are traded much like stocks and shares, or commodities, not like traditional real estate assets. And while prices kept rising the system kept ticking over.
Enter the Covid-19 pandemic, new outbreaks of unemployment, and unrelenting pressure on family budgets. These new economic pressures put the squeeze on investment liquidity within the real estate marketplace. Not surprisingly therefore the Evergrande Group was maintaining its cashflow, and liquidity, by selling "off-the-plan" rights to dwellings that did not, and may never, exist. They were selling "options" on future dwellings. Again this was fine so long as the expectation was that the price for such "options" could only ever go up and up and up. In this overhyped market these "options" were always readily tradable much as shares are on the New York Stock Exchange. But... What would happen if the prices of the actual commodity, the dwellings, began to fall? We are about to see what happens.
One expectations is that the debts of Evergrande Group will be covered by the CCP in the manner that the 2008 sub-mortgage crisis was handled when the US. Congress voted that taxpayers money should be used to bail out the Wall Street hedge funds and banks to save the whole financial system from collapse. But the CCP is not going to bailout Evergrande. Well it is not going to bailout the Foreign leans on property. Instead it might demand that internal banking system bailout locals who have leans on their property. Exactly how one problem with two solutions will work is not yet clear so we will have to wait and see.
Why is Evergrande an important issue for you, your children, and your grandchildren? I am not sure it is that important, however... Investment funds around the world are currently buying up single-front homes in one of the largest land grabs ever seen. They will use this land to build apartments. These apartments will become part of the "build back better" programme that seems to be politically linked to global Climate Change initiatives and social justice policies. So you might expect to see more and more Evergrande Group clones take charge of the real estate in your neighbourhood. Will this be a good thing?
Richard.
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