Great Pyramid of China – Real Estate – Kommersant


The attention of investors and bankers all this week is riveted on China, where the Evergrande Group, the company with the largest debt in the world, is in a desperate struggle for survival. In the event of his bankruptcy, financial institutions in many countries will lose billions of dollars, the Chinese real estate market will be in a deep crisis, and at least 200 thousand people will find themselves unemployed overnight.

Construction for the ages

Evergrande was founded in 1996 by entrepreneur Xu Jiaying. It is headquartered in Shenzhen, registered in the Cayman Islands, and traded on the Hong Kong stock exchange. In just three years, Evergrande, a newcomer to the real estate market, has managed to become one of the ten largest developers in the country.

Initially, the company was engaged in affordable housing projects, implementing various government programs. In 2000, the construction of real estate for sale, including luxury ones, was added to the creation of endless “anthills” throughout China. At the same time, large investors from all over the world began to invest in it, including leading banks such as Deutsche Bank and Merrill Lynch.

In 2009, the company raised $ 722 million during the IPO.

Since then, Evergrande has become a real business empire that now deals not only with housing, but also with hotels, offices, shopping centers, car manufacturing, batteries, electric car charging stations, medical research, insurance and much more. Mr. Xu himself became the richest man in China, and also entered the People’s Political Consultative Council of China (an advisory body to the government).

Evergrande founder Xu Jiayin

Photo: Reuters

By 2020, the holding already employed more than 200 thousand people, and its revenues climbed up to 500 billion yuan ($ 77.4 billion). The Evergrande Group seemed invulnerable and synonymous with success.

At the end of 2020, the company had contracts for $ 119.5 billion. According to this indicator, it ranks first in China. The total amount of its assets is about $ 350 billion.

Ghost town holding dream

Last year, according to media reports, the developer notified the authorities that the execution of debt obligations, scheduled for January 2021, could lead to a serious liquidity shortage. As a result, having hardly found buyers for the newly issued shares and a small part of its assets, the company made payments. But this was the first wake-up call that the Evergrande empire was seriously flawed.

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The problem for China’s biggest developer is how quickly it became so successful.

Recall that initially the company was engaged in the construction of only budget real estate. And Chinese legislation clearly defines that a developer can sell such housing at a price no more than 5% higher than the cost of construction. The margin on such projects is minimal, and it is simply impossible to become a construction giant in such a short time with the help of mass housing.

This was not the case with Evergrande: the company simply actively borrowed money to cover as many projects as possible. Including under another large-scale government program – this time the mass relocation of people from rural areas to cities.

If in 1995 the share of the urban population of China was 29%, then ten years later it was already 43%, and by 2019 this figure exceeded 60%.

Aggressive urbanization has become an ideal environment for the rapid growth of Evergrande. The business strategy based on the state program worked flawlessly.

The developer bought rural land from the regional authorities, receiving loans for this from local bank branches. There have never been any problems with this. The conversion of rural land into urban areas increased the price of land tenfold, so local authorities willingly helped developers. Often without taking into account the real movement of the population.

As a result, dozens of ghost towns have appeared across the country, where, instead of millions of people, only a few thousand live. How many of these empty apartments are now on the balance sheet of Evergrande, it is impossible to say for sure. The company itself does not disclose this information.

Each unsold home means that the company will have less money left for the new project. Consequently, she has to take out additional loans or look for other ways to raise capital.

For 20 years, all this worked out, but suddenly the COVID-19 pandemic happened.

Evergrande tries to pay off suppliers of building materials with empty apartments

Evergrande tries to pay off suppliers of building materials with empty apartments

Фото: Carlos Garcia Rawlins/File Photo, Reuters

Virus against construction fever

The residential real estate market in China still cannot move away from the effects of the pandemic. If in the first half of 2019 the growth of the segment reached 10%, then in December 2020 it was already only 3.8%, and by the summer of this year it had recovered only to the level of 4.5%.

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Another negative factor was the rise in prices for construction materials, which, as noted by Fitch, put significant pressure on the country’s engineering and construction companies.

Finally, during this difficult period, the Chinese government reminded itself of itself, which decided to strengthen the discipline of local businesses by cutting off loans from highly indebted builders. Thus, the authorities deprived Evergrande of a key element in its business model, although in all previous years most of the loans were issued to the company with the permission or even direct instructions of the authorities.

And Evergrande, predictably, went into a fever. Sales are falling. According to the latest reports:

  • in June, they amounted to 71.63 billion yuan ($ 11 billion),
  • in July – 43.78 billion yuan ($ 6.8 billion),
  • and in August – 38.08 billion yuan ($ 5.9 billion).

It will only get worse in the future, the company itself admits. There is no longer any confidence in the developer either from buyers or from creditors. The same statements say that already two subsidiaries of the Evergrande Group have not fulfilled their debt obligations on time.

On September 23, the parent company had to pay “only” $ 35.9 million on coupons for bonds in yuan. The funds were found at the last moment.

But Evergrande was unable to pay on dollar bills worth $ 83.5 million on time.

If, after 30 days, the debt obligations are not fulfilled, there will be a default.

At the same time, the total debt of the group already exceeds $ 305 billion. And all of its assets, we recall, are estimated at $ 350 billion. Perhaps $ 200 billion of them are illiquid 1.4 million unfinished apartments.

The company has already made numerous attempts to raise cash. She issued shares, asked her own employees to lend her money at a high interest rate, tried to sell the car business and other non-core assets. She even tried to pay the suppliers of building materials with apartments.

The result of all these actions is disappointing. The panic is so great that no one believes the company anymore.

To save or not to save

The only escape route is government intervention. The Communist Party is closely monitoring what is happening, sending warnings to municipal authorities and banks about future problems, and publicly urging the company to deal with its debts, threatening “harsh punishment.”

That is, he does whatever he wants, but does not help with money.

More recently, Xi Jinping publicly warned businesses that they should be responsible for their own activities. Therefore, from a political point of view, saving Evergrande at public expense would not be the right move.

But from an economic point of view, everything is more complicated.

The collapse of the developer could affect a significant part of the Chinese economy, which is highly dependent on the construction industry.

In recent years, it has accounted for 20-25% of the country’s GDP, and together with related production – all 30%.

In addition, the fate of hundreds of thousands of people is at stake. It’s not just about the company’s employees, who are more than 200 thousand people. The company indirectly creates about 3.4 million jobs in China. And then there are hundreds of thousands of people waiting for their houses to be completed.

Considering that about 70% of the savings of Chinese families are made in the form of investments in real estate, the collapse of prices in the housing market after the collapse of a key developer will seriously hit the entire economy.

Looking at what is happening, experts are at a loss as to how the story with Evergrande might end. Some media outlets have even dubbed it the Chinese Lehman Brothers, an American investment bank whose problems in 2008 became the apogee of the global financial crisis. Fortunately, Evergrande’s operations are not on the same scale as Lehman Brothers.

In any case, experts say, the last word in this matter will remain with the Chinese Communist Party and the government. If the PRC authorities decide that the delay threatens the entire construction industry with a crisis, they will not have to wait long for decisive action on their part.

Kirill Sarkhanyants

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