Real Estate Crisis in China: Causes and Effects on the Global Economy

China’s debt-fuelled growth hit the brakes in recent years, as its real estate sector prices tumbled. While the country’s economy shows few signs of recovery, here’s an article explaining how China’s housing bubble started to pop and why its real estate crisis might have a disastrous impact on global financial markets.

The bubble inflates

Following decades of economic expansion, China’s real estate market started inflating rapidly, with land values tripling during the 2005–2009 period. This boom, mainly driven by urban expansion and fiscal reforms, caused local governments to increase their reliance on infrastructure projects for revenue.

Thus, local authorities began selling land use rights to fund further development, creating a cycle where rising land values became crucial for local financial stability. Furthermore, with the lack of possibility to invest in many overseas financial assets, Chinese citizens also started finding investment in domestic real estate more appealing, believing it was a ‘risk-free’ investment.

The 2008 global financial crisis only deepened this dependency, as in an attempt to counter the overseas crash of the US real estate market, China invested heavily in infrastructure, further tying its financial health to the rising value of land.

After the crisis, the Xi-Jinping Era began, doubling China’s GDP in ten years and modernizing the country to levels unseen before. Unfortunately, it was an ill, debt-driven growth, which managed only to postpone the effects of the 2008 crisis. 

The rise and fall of Evergrande

It all began with a shining star in the Chinese real estate industry. Founded in 1996, in the 7 years following its IPO in 2009 Evergrande Group multiplied eightfold its stock value, outpacing the Hang-Seng Index by a 30% growth rate. 

Being the second largest real estate company in China, by the end of December 2020 it had 120k employees and a market capitalization of 197.3 billion USD. To make a comparison, in order to understand the sheer size of the company, the GDP of a small country like the Netherlands that year amounted to 909.79 billion.

Like every other developer in China, Evergrande habitually sold unbuilt properties to finance the completion of projects already promised to previous buyers, creating a cycle where new investments funded old obligations. This Ponzi-like scheme, alongside factors like central bank interventions, fueled the economy for years. However, it was inherently unstable, relying on continuous inflows of new investors to cover existing debts, exacerbating the problem over time.

In 2021, Evergrande’s mounting debt, estimated in the hundreds of billions, triggered a crisis in China’s property sector. This financial instability was a key factor behind the significant drop in many global stock market indices in September 2021, as investors reacted to fears of a broader economic fallout from the property giant’s collapse.

By the end of December 2021, Evergrande’s stock price tumbled from 14.9 dollars a share to 1.59, losing 176.3 billion in capitalization.

After admitting a 66.3 billion USD loss for 2021 and a 17.4 billion USD loss for 2022, the group finally filed for bankruptcy on August 17, 2023. The lack of a clear restructuring plan caused the Hong Kong court to order the company liquidated in January 2024, also shining some light on the overstated almost half its size Evergrande revenues for 2019 and 2020.

The bubble bursts

Amidst Evergrande’s solvency problems and later liquidation, property sales and new residential building development continued falling after 2021. 

A sudden drop in demand for new residential buildings during the Covid contributed to the already meager picture of falling new-house sale prices. The Covid pandemic, coping with other more long-lasting factors, such as the consequences of the disastrous demographic ‘one-child policy’, also hit the brakes on population growth, thus weakening the population’s need for new residences, bringing other developers to heel.

As a result, many Chinese real estate firms faced $125 billion in bond defaults between 2020 and 2023, culminating with another dreadnought of the industry – Country Garden Holdings & Co. – to default on its 15 billion USD overseas obligations in October 2023, in an attempt to avoid a first local default.

Global consequences

The collapse of China’s real estate bubble has far-reaching global implications, extending beyond its property sector into broader economic and financial systems. As major developers like Evergrande defaulted, the resulting loss of consumer confidence has stifled spending, a key driver of China’s economic growth. The crisis has also heavily impacted the construction industry, leading to job insecurity and cautious behavior from homebuyers.

Global financial markets have reacted with volatility. Shares of Chinese property developers have experienced sharp fluctuations as news of government interventions, like state purchases of unsold homes, spurred initial optimism. 

However, after hopes of a quick post-pandemic recovery faded and the real estate bubble continued to deflate, Chinese stock indices continued their rout. Moreover, other problems hit the Сhinese economy, like rampant youth unemployment, industrial overproduction failing to meet local and global demand, and, more recently, political challenges and deflation.

While at first many, such as the former Fed chair Janet Yellen, downplayed the likelihood of severe global spillovers from the East, they were quickly reminded that China remains the top 2 world consumer of fuel and one of the top 2 goods importers, making its demand dynamics key for many countries. China is also a leading constructor of solar panels, wind turbines, and other transition-friendly products, as well as electrical and electronic machinery and equipment, clothing, textiles, and footwear, all of which are pretty important trade goods.

China’s deep financial ties to the global economy made its real estate bubble burst heavily concerning to every national economy. If China’s production and consumption dynamics slow, other countries might be damaged by it, receding into a recession.

What awaits China

It is clear that China’s future as a world superpower hinges on its ability to stabilize its struggling real estate sector while addressing deeper, systemic issues like its aging and not increasing population and cautious consumer sentiment. 

The current real estate crisis highlights the unsustainability of debt-fueled growth models, necessitating reforms that could pave the way for a more balanced economic strategy. 

As the Chinese government contemplates regulatory changes and long-term economic shifts, its success in reviving property sales will serve as a key indicator of the nation’s capacity to adapt and recover. Navigating these complex challenges will ultimately determine China’s economic resilience and future trajectory.

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