This article is from the Australian Property Journal archive
HOMEBUYERS in China have taken the market by surprise, refusing to make mortgage payments, estimated at around US$300 billion (approx. A$430 billion), worried that the properties they bought from distressed developers will not be completed.
Unlike other real estate markets, homeowners in China must start making mortgage payments before they take possession and construction has started. This policy was a convenient funding arrangement for property developers.
Oxford Economics lead economist Tommy Wu said the speed at which the mortgage boycott has grown has taken many by surprise.
What started as a protest in one project in late June has rapidly spread to over 300 projects in more than 90 cities by mid-July.
“Mortgage boycotts, driven by deteriorating sentiment toward property, are therefore a very serious threat to the financial position of the sector. Indeed, just as the property market appeared to start stabilizing in June amid pent-up demand and policy easing, housing sales have fallen sharply again in July,” he said.
Presales account for 90% of new home sales in China and one-third of developers’ source of funding, Wu said the fall in housing sales will pose a very serious threat to developers’ financial position.
“It’s not entirely clear how many homebuyers have stopped paying their mortgage. While some estimates suggest that as much as RMB2tn (US$300bn) worth of mortgages (5% of outstanding mortgages) could be affected, banks disclosed a much smaller exposure of RMB2.1bn (0.01% of outstanding mortgages),” he added.
Wu said although the boycotts are a worrying development, they do not pose a substantial risk to trigger a crisis.
“Banking and housing authorities, together with local governments, have stepped in to contain the fallout of the mortgage boycott.
“We expect stronger, but targeted, policy easing will be rolled out in H2 to support real estate construction and infrastructure spending. While this will provide a short-term boost to the economy, it is not ideal for China’s longer-term growth as the government and the financial sector are being forced to help sustain an unproductive (and failing) real estate industry,”
Wu said while more homebuyers may stop paying their mortgages on unfinished homes as a means of protest, most will likely continue to repay their mortgages, as non-payment will hurt their social credit score and lower their “trustworthiness”.
China’s social credit system rates the ‘trustworthiness’ of individuals and businesses. There are consequences for citizens with a low social credit rating, they could be banned from travelling on train or planes, have reduced employment prospects, won’t be able to apply for a loan, and children from ‘untrustworthy’ families can be banned from attending certain schools or universities.
Having said that, Wu noted that the loss of confidence in property developers is deeply concerning.
“The boycotts reflect the loss of confidence among Chinese homebuyers about property developers, and potential homebuyers could lose interest in home purchases – something that is difficult to reverse in the near term.
“Although the mortgage boycott by itself is unlikely to hurt banks much, the loss of confidence about developers will exacerbate the real estate downturn and add to financial stability and growth concerns down the road. Potential homebuyers will likely remain wary about developers’ abilities to deliver homes as many of them will remain under financial stress, perhaps for the next couple of years or longer. As such, housing sales look set to remain weak for an extended period.”
“Moreover, the decline in house prices will unlikely be reversed significantly any time soon. This will create negative household wealth effects and dampen consumption at a time when the prospects for employment and income are weak, and Covid risks and restrictions continue to undermine consumer sentiment. Also, as real estate contributes to almost a quarter of GDP in China (including upstream and downstream industries), the large economic footprint means that a prolonged real estate downturn will have a major impact on the economy,”
“We think defaults by high-profile property developers, including Evergrande, remain the biggest risk to the real estate and financial sectors.
“Market concerns about developers’ default risks are reflected in the rise in offshore dollar junk bond yields, in which most of the volatilities over the past year or so have been driven by movements in property developers’ bonds. The nonperforming loans ratio for real estate financing by onshore Chinese banks also climbed. While defaults on onshore bonds have declined this year thanks to monetary easing and debt reprieves (deals with creditors), this is simply kicking the can down the road.
“Clear restructuring plans for distressed developers and their debt should help, but they usually take a long time. The possible delay in the delivery of Evergrande’s restructuring plan, which was scheduled for the end of July, illustrates the difficulties.
“The chance of a vicious cycle – declining housing sales and prices, mounting developers’ distress, and deteriorating local government finances – developing is concerning from growth and financial stability perspectives,”
Wu said should the mortgage boycott worsen rapidly, he expects authorities act in a more forceful manner, as some 70% of households’ wealth is tied up in property. For instance, takeover of projects by local governments or state-owned enterprises and giving a grace period on mortgage payments (though this option will create moral hazard, incentivising homeowners choose to stop mortgage payments) are possible.
The government of Zhengzhou, the city with the highest mortgage payment boycott, has set up a fund specifically for helping developers to complete projects. It has also been reported that a fund will be set up by the central government via one of the big four Chinese banks to provide funding for selected developers.
Meanwhile a few local governments have urged banks to tighten controls of real estate presale escrow accounts, so that funds should be spent on construction only.
“Overall, we believe real estate policy easing will continue to prioritise the completion of existing housing projects and help developers in a stronger financial position to purchase assets from troubled developers, including project mergers and acquisitions. We also think the authorities will likely keep most of the significant curbs in place, including the “three red lines” policy on developers’ financing.
“Nonetheless, the stakes are high. So far, the problem seems manageable, but developers’ funding could worsen sharply and pose a significant downside risk to the economy and could threaten China’s financial stability.” Wu concluded.
