The fuss around Evergrande seems to be dying down, so now seems as good a time as any to reflect on what happened and try to put it all in perspective.

The catalyst for Evergrande’s woes was China’s ‘three red lines’ policy. This is aimed at a forced de-leveraging to improve the health of the real estate sector, levels of debt having been a concern for years. The red lines are: liability to asset ratio of less than 70%, net gearing ratio of less than 100% and cash to short term debt ratios of more than 1x. Breaching all three means that permissible debt growth allowed in a year falls to zero. 

The issue for Evergrande is one of sheer scale, because it is indeed a very large developer, ‘the biggest in the world’, heavily leveraged and thus viewed by some as systemically important and as such too big to fail. It’s worth noting that it’s just one developer out of 50 other developers in China which are bigger than the biggest developer in the United States. Arguably then, there is a lot to be worried about. So, as a market observer, are you worried about the impact of government policy on what is a clearly gargantuan property market in China or are you secretly quite happy that the authorities have imposed a regulatory clamp-down to bring greater order to the property market? 

Let’s have a look at what some of the experts have to say. 

Real Estate Foresight conducts market research and risk monitoring of the China property market. In a recent report, it said that growth of sales value for the 20 major developers is around 15% up year-on-year, whereas Evergrande’s sales volume is over 20% down, perhaps as one would expect, given its struggles, but the point is this: Evergrande is an outlier and does not represent the norm among its peers. It’s also worth bearing in mind that its projects are distributed across many cities, rather than concentrated in a few, which should lessen the negative impact of disposals.

In addition, the property market in China is not behaving in a way that is particularly out of kilter with its usual cycles. Sequential month-on-month price growth of new homes decelerated in September and has turned negative for secondary homes in 70 major cities. This decline fits the narrative of some observers that China property is a ‘bust’, but ignores new home price growth of +3.8% year-on-year, which on this longer-term view, shows that the market is still just moderating. Arguably, not much to worry about then. 

September data showed a continued clear drop in land sales/acquisitions, with average land prices clearly up. Lower future land supply should serve as a buffer against any major down-cycle. 

The sheer size of the property market in China and the fact that some (very large) developers are saddled with debt would suggest that some more of them will be ‘caught out’ by the three red-lines policy. The implication of this is that we can reasonably expect more bad news. The trick will be not to fly into a panic. 

The conclusions of this analysis are: 

The Evergrande impact on the housing markets should be fully controllable, given limited land supply, the administrative nature of tightening and the distribution of Evergrande’s projects across many cities.

National sales volumes and average house prices are likely to look flat and a controlled down-cycle is underway.

A more orderly market for new homes seems the likely outcome, with more controlled margins, administrative controls with opportunities in cities where structural changes are taking place.

One question also worth exploring is whether the Chinese economy is in trouble. 

In a recent research briefing, Oxford Economics talks about a cyclical slowdown being amplified by the tightening of real estate sector regulatory and credit policies mentioned above. Their baseline is that China’s property downturn will be significant but contained, due to a low stock of unsold housing, room for policy easing, continuing urbanisation and significant income growth. It’s worth noting that their long-term GDP growth forecast for China out to 2027 is around 5% per annum, which is a very impressive growth rate for such a large economy. While stating expectations of a medium-term gradual retrenchment of the property sector, Oxford Economics also points out that a relatively benign outlook is far from guaranteed, given multiple risks – disorderly collapse of a large developer, say, followed by contagion in the property sector – which would see GDP fall to 3% in end of 2022 versus 5.3% in the baseline. This is viewed as a medium probability outcome, which personally I do not buy into. 

Putting all of this together, my view is that we are already past ‘peak Evergrande’ and any news now will revolve around an orderly disposal of assets amid an overall subdued property market downturn. 

Which brings me to Stephen Roach, faculty member at Yale University and former Morgan Stanley chief economist, who has some interesting views.

In a recent South China Morning Post article, he was quoted as saying that the new emphasis on redistribution plus re-regulation strikes at the heart of the reform that has underpinned China’s growth. The Evergrande crisis will pass, he said, but a regulatory clampdown amid a push to redistribute wealth could rewind the Chinese miracle. Interesting indeed.

Judging from this, Evergrande could simply be viewed in due course as a side note in history. Therefore, what we really need to understand is the ‘common prosperity’ campaign which is aimed at redistributing China wealth more evenly across the economy. The risk is whether this can be achieved in a way which is not heavy handed, as this might undermine the free-wheeling business environment which has helped big firms such as Tencent and Alibaba power China’s economic rise. 

Now that’s something worth watching.