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Why the Fate of Troubled Property Developer Evergrande Group Is Posing a Huge Headache for China

The logo of Chinese property developer Evergrande is seen on top of a skyscraper on Oct. 5, 2019, in Shenzhen, China

Alex Tai/SOPA Images/LightRocket via Getty Images

When Chinese home-buyer Zhiwei decided to purchase a luxury apartment at a development named Australia Villas back in 1997, it was billed as the apex of affluence.

Located outside Chinas southern megacity Guangzhou, the sprawling complex was to have 292 buildings, including a gymnasium, spa, cinemas, and a private school. Boutiques and restaurants would dot its 2,000 acres, sales staff said. Impressed, Zhiwei stumped up $21,000a huge sum 24 years ago, when the averageannual disposable incomein China wasless than $650.

But things quickly went awry. The developer went bust in 2001 leaving most homes unfinished. Buyers with means swallowed the loss, but those without anywhere else to go, like Zhiwei, were forced to move into the concrete shells of their unfinished homes, living without gas, electricity and, in some cases, even windows.

The whole area is thick with weeds, you can sometimes see snakes slithering on the sidewalk, and outdoors we are savaged by swarms of mosquitoes, says Zhiwei, who asked to use a pseudonym for fear of jeopardizing ongoing negotiations with the developer and local government. As the houses are unfinished, we cant even get [approval] to sell them.

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Two decades on, many people still live amid the vine-entangled, mildewed structures, planting vegetable gardens and rearing chickens on what were supposed to be ornamental lawns. More than 2,000 homeowners like Zhiwei are still waiting compensation. After fighting for our rights for more than 20 years, many owners are getting old, and even the youngest have been retired for several years, she says.

And yet this cautionary tale has had no impact Chinas gangbusters real estate market, which today remains the worlds biggest. In the year ending June 2020, about $1.4 trillion was invested in Chinese housing, even allowing for a fleeting dip due to the pandemic. That dwarfs the $900 billion invested in real estate at the peak of the U.S. property boom of the 2000s. Today, real estate makes up 29% Chinas GDP.

But alarm bells rang this week, with the news that the worlds most indebted real estate developer, Evergrande, is struggling to make loan payments on its more than $300 billion in liabilitiesa sum roughly equivalent to the public debt of Portugal. On Tuesday the firm, based in the southern city of Shenzhen, said it was under tremendous pressure and warned there was no guarantee that it would be able to meet its financial obligations.

That was crushing news for the roughly 1.5 million people who have put deposits on Evergrande homes that have yet to be built.

Police officers survey people gathering at the Evergrande headquarters in Shenzhen, China on Sept. 16, 2021, as the Chinese property giant said it was facing unprecedented difficulties but denied rumors that it was about to go under.

What impact could Evergrande have on Chinas financial system?

Fearing a fate like Zhiweis, scores of furious protesters besieged Evergrandes headquarters this week in a show of public discontent not usually tolerated under Chinas strongman, President Xi Jinping. Some even shared photos online of the family graves of Evergrande founder Hui Ka Yan, located at his ancestral home in the central province of Henan, exhorting people to go and vandalize them.

Analysts are concerned. Evergrandes collapse would be the biggest test that Chinas financial system has faced in years, Mark Williams, chief Asia economist at Capital Economics, wrote in a Sept. 9 briefing note.

Not only would a collapse be catastrophic for investor confidence, it would also reflect poorly on the ruling Chinese Communist Party (CCP). Under President Xi Jinping, the CCP has sought to rein in excessive wealth, reduce market risks and lower income inequality through a new campaign for common prosperity. But Evergrandeone of Chinas largest corporationsis a problem that has worsened under Xis watch.

The burning question is whether he will allow Evergrande to fail, potentially unleashing ripples of financial turmoil and further protests. At the very least, Financial issues at the group are likely to cause contagion effect in the banking sector, Angus Lam, a senior economist at IHS Markit, tells TIME by email.

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Yue Yuejin, research director for the E-House China research institute, says that unless there is social unrest simply bailing out the enterprise wholesale will not happen. But there may be possible interventions such as the introduction of strategic investors or active coordination of asset sales.

Its precipitous fall for Evergrande, which until recently was Chinas second largest developer with nearly 900 completed commercial, residential and infrastructure projects. It had grown extremely bloated, swelling to some 200,000 staff as it made a bizarre array of loss-making forays into bottled water, electric vehicles and other sectors. It also investedhundreds of millions of dollarsin its own soccer team.

Hui, who founded the firm in 1997, was listed as Chinas third-richest man by Forbes last year, but his wealth has plummeted in recent months. Evergrandes shares have nosedived 81% since the beginning of the year, with the current crisis prompted after a series ofdowngrades of its bonds.

On Monday, shares of Evergrandes electric car unitplungedas much as 26% in Hong Kong after canceling plans for a secondary listing in Shanghai, taking their decline this year to some 94%. The subsidiary has lost more than $84 billion in market cap from its April peak when it was valued at even more than Ford despite never producing a single vehicle.

Investors are growing increasingly jittery that a collapse could spread to other property developers, revealing systemic vulnerabilities. Each year, China builds about 15 million new homesover five times those in America and Europe combinedyet a quarter of the current stock already lies empty, with forests of unoccupied tower blocks ringing many second and third-tier cities. In 2021, Chinese developers were exposed to more than $100 billion in bond repayments, while 10% of outstanding bank loans to non-financial clients globally have been made in Chinas property sector. According tocourt filings, 228 real estate firms went bust in China during the first half of 2020 alone.

YICHANG, CHINA - SEPTEMBER 14: The construction site of an Evergrande housing complex is pictured on September 14, 2021 in Yichang, Hubei Province, China.

Is Evergrandes collapse inevitable?

The crisis does not stand to be anything like as bad as Americas 2008 sub-prime mortgage crisis. A key feature of Chinas property market is that many buyers pay the full price upfront rather than relying on mortgages. Of course, buyers may now be much less likely to trust real estate firms with such large sums, but defaults shouldnt lead to the snowballing effect that the U.S. experienced.

There are also some positives when it comes to Chinas housing market. Whereas affluent Chinese once wanted to invest overseas, they now see China as a safer bet than foreign nations still in the grip of the coronavirus. Demand for new homes in good locations is so high prospective buyers must enter lotteries for the right to purchase one, with odds at some sought-after developments as low as 1 in 60. Social attitudes also place a strong emphasis on home ownership, with 81% of Chinese believing that buying a home is amust before marriage.

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But the next few days will be critical. Evergrande has alreadymissed quarterly debt interest paymentsanda $83 million bond interest payment and has various suppliers waiting. Instead of cash, a $34 million debt to a paint supplier is reportedly being repaid by apartments in housing complexes that wont be finished until 2024. Such wheeling and dealing is hardly sustainable. On Monday, Bloomberg reported that tens of thousands of Chinese households risk being sucked into the unraveling after the embattled developer missed payments on investment funds sold through shadow banks. Evergrande always had a reputation for creative financing, says Dinny McMahon, an analyst on Chinas real estate market for the Trivium China analysis group.

Many ordinary Chinese are now wondering if they will pay the price. Around 78% of the wealth of urban Chinese is in residential property, versus just 35% for Americans, who prefer to invest in financial instruments and pensions. Were Chinese home prices to drop significantly in the wake of the Evergrande affair, it would shrink the primary assets of the worlds largest middle class, sending shudders around the globe.

Says McMahon: Hedge funds a decade ago were telling me its only a matter of time before Evergrande topples over.

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