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The lenders in the Chinese housing market are mostly Chinese citizens. In modern China, rather than buying a house, you buy a promise of a house, then the house

The lenders in the Chinese housing market are mostly Chinese citizens. In modern China, rather than buying a house, you buy a promise of a house, then the house builder builds it for you. The house builders though have these huge debts, and they've been using money from new purchases to construct their backlog of homes. The $90bn outstanding is $90bn in outstanding housing construction, not just abstract debts to banks which could be written off or bailed out. Citizens will need to continue paying their mortgages on houses that don't (and won't) exist, which will cause some civil disquiet. Construction companies are going to have a shortfall of $90bn worth of work in their pipelines, which will mean mass layoffs. Entire large towns will go unbuilt. Evergrande isn't the only one in this situation, it looks like a handful of large house-builders also have these uncompleted backlogs being paid for with new orders. The collapse of one might prompt the collapse of the others. As house-buyers become less confident that their house will ever exist, they'll stop buying new stock. When they stop buying new stock, the other house-builders collapse under the burden of their backlog of construction projects.

tremon 3y ago
That sounds suspiciously like a pyramid scheme: the only thing financing the current construction are payments to new construction. How did they get into this situation? By continuously selling under cost, or perhaps by siphoning off profits?
- NhanH 3y ago
  Land price keeps increasing caused this problem. You can just imagine land price to increase 50% YoY (hypothetical number) and you will understand the situation. Basically you can not have enough cash on hand to purchase the next piece of land for your development, but you want to always plan for the next step.
  - benterix 3y ago
    The first time it happens, you can call it a mistake. But second, third? Is int't it obvious that, seeing this trend, you should calculate the risk and factor in the land cost increase when pricing your offer?
    - NhanH 3y ago
      It's a different issue than what you are imaging. It's not that they sell the property for less than the relevant land cost, it's that the increase is too steep that they can't buy and build the next one without pre-selling the lot, the company just doesn't have enough cash.
      - jjoonathan 3y ago
        The magnitude of land speculation profits is not dictated by physics. If companies weren't able to pay what they did, the speculators (local governments in this case?) would live with less. Developers compete with each other, so they will always take as much leverage as allowed, but the rules are adjustable by lenders. Lenders compete too, but they usually wind up backed by a central bank or other political entity, and that's the point at which changes can actually be made. Of course, there is no guarantee these changes won't create problems (Three Red Lines were a decade too late) but they can be made.
    - jjoonathan 3y ago
      Try doing that and someone who does take the leverage will simply outbid you for the land.
- reisse 3y ago
  The way OP described it, yes, it sounds like a ponzi, but in reality it's more like crowdfunding. First, the developer takes credit from a bank and uses own money to buy a land. Then, in order to start construction, the developer sells what is basically an obligation to build real estate and transfer the rights to buyer. These obligations are obviously cheaper than the expected price of real estate in the future, and also cheaper than already-constructed real estate now. The developer does not sell all the future real estate at once, because as the time goes by, and construction comes closer to a finish, the obligations become more expensive - it sells only the amount necessary to fund the next step of construction. After the construction is finished, developer sells leftover real estate with a markup big enough to finance its next project. When the housing market is good, this scheme brings real estate costs down, because you can buy cheaper "not-yet-build" flats or houses, and the developer can seek funding without overpaying on the bank loans. But if the housing market tanks, the development freezes, and the first buyers take a loss. I don't know about China, but in some countries such obligations are mandatory insured from the default, so people can get at least some of their money back. In others buyers are left with a piece of land with unfinished building.
bombcar 3y ago
This sounds ponzi schemic.
- bobthepanda 3y ago
  That’s because it is. China lacks a safe financial system that the ordinary person can invest in, the way that an American can park funds in an index fund and expect a reasonable rate of return. (The Shanghai and Hong Kong indices are not as healthy as the general economy.) It also lacks generous pension schemes like those in Europe. So part of the reason this is so bad is because most Chinese citizens put their nest eggs in real estate, and now the bubble has popped.
  - hnfong 3y ago
    If you think the S&P500 and NASDAQ in recent years merely gives a "reasonable rate of return" you'll realize that there really aren't any other economies with a "safe financial system". Most markets don't have that level of growth. The Chinese predisposition to invest in real property is much more cultural (and irrational) than what you suggest. The Chinese stock market is actually much more rational in this regard as for quite a while you could buy Chinese real estate stocks with pennies on the dollar, price to book ratios much less than one. Traders know the real estate bubble is going to burst sooner or later and the stock market priced this in. The real estate market which mostly consists of individual buyers didn't quite get the memo until recently. Speaking personally, in Chinese circles, the social pressure buy an expensive apartment is honestly overwhelming, and it's not because people knew that the property market was a good investment, it was just something they thought a respectable person should do once they earned some money. Family members without any financial literacy kept thinking I was an idiot for holding FAANG stocks instead of buying an apartment. AFAICT I'm the only person in my social circle (including people who should have known better) that has avoided the recent property slump (in Hong Kong) by steadfastly refusing to enter the property market at its height a couple years ago. It's nice to not have people nagging me about it now.
    - bobthepanda 3y ago

tremon 3y ago

That sounds suspiciously like a pyramid scheme: the only thing financing the current construction are payments to new construction. How did they get into this situation? By continuously selling under cost, or perhaps by siphoning off profits?

NhanH 3y ago
Land price keeps increasing caused this problem. You can just imagine land price to increase 50% YoY (hypothetical number) and you will understand the situation. Basically you can not have enough cash on hand to purchase the next piece of land for your development, but you want to always plan for the next step.
- benterix 3y ago
  The first time it happens, you can call it a mistake. But second, third? Is int't it obvious that, seeing this trend, you should calculate the risk and factor in the land cost increase when pricing your offer?
  - NhanH 3y ago
    It's a different issue than what you are imaging. It's not that they sell the property for less than the relevant land cost, it's that the increase is too steep that they can't buy and build the next one without pre-selling the lot, the company just doesn't have enough cash.
    - jjoonathan 3y ago
      The magnitude of land speculation profits is not dictated by physics. If companies weren't able to pay what they did, the speculators (local governments in this case?) would live with less. Developers compete with each other, so they will always take as much leverage as allowed, but the rules are adjustable by lenders. Lenders compete too, but they usually wind up backed by a central bank or other political entity, and that's the point at which changes can actually be made. Of course, there is no guarantee these changes won't create problems (Three Red Lines were a decade too late) but they can be made.
  - jjoonathan 3y ago
    Try doing that and someone who does take the leverage will simply outbid you for the land.
reisse 3y ago
The way OP described it, yes, it sounds like a ponzi, but in reality it's more like crowdfunding. First, the developer takes credit from a bank and uses own money to buy a land. Then, in order to start construction, the developer sells what is basically an obligation to build real estate and transfer the rights to buyer. These obligations are obviously cheaper than the expected price of real estate in the future, and also cheaper than already-constructed real estate now. The developer does not sell all the future real estate at once, because as the time goes by, and construction comes closer to a finish, the obligations become more expensive - it sells only the amount necessary to fund the next step of construction. After the construction is finished, developer sells leftover real estate with a markup big enough to finance its next project. When the housing market is good, this scheme brings real estate costs down, because you can buy cheaper "not-yet-build" flats or houses, and the developer can seek funding without overpaying on the bank loans. But if the housing market tanks, the development freezes, and the first buyers take a loss. I don't know about China, but in some countries such obligations are mandatory insured from the default, so people can get at least some of their money back. In others buyers are left with a piece of land with unfinished building.

bombcar 3y ago

This sounds ponzi schemic.

bobthepanda 3y ago
That’s because it is. China lacks a safe financial system that the ordinary person can invest in, the way that an American can park funds in an index fund and expect a reasonable rate of return. (The Shanghai and Hong Kong indices are not as healthy as the general economy.) It also lacks generous pension schemes like those in Europe. So part of the reason this is so bad is because most Chinese citizens put their nest eggs in real estate, and now the bubble has popped.
- hnfong 3y ago
  If you think the S&P500 and NASDAQ in recent years merely gives a "reasonable rate of return" you'll realize that there really aren't any other economies with a "safe financial system". Most markets don't have that level of growth. The Chinese predisposition to invest in real property is much more cultural (and irrational) than what you suggest. The Chinese stock market is actually much more rational in this regard as for quite a while you could buy Chinese real estate stocks with pennies on the dollar, price to book ratios much less than one. Traders know the real estate bubble is going to burst sooner or later and the stock market priced this in. The real estate market which mostly consists of individual buyers didn't quite get the memo until recently. Speaking personally, in Chinese circles, the social pressure buy an expensive apartment is honestly overwhelming, and it's not because people knew that the property market was a good investment, it was just something they thought a respectable person should do once they earned some money. Family members without any financial literacy kept thinking I was an idiot for holding FAANG stocks instead of buying an apartment. AFAICT I'm the only person in my social circle (including people who should have known better) that has avoided the recent property slump (in Hong Kong) by steadfastly refusing to enter the property market at its height a couple years ago. It's nice to not have people nagging me about it now.
  - bobthepanda 3y ago