China is facing housing market disaster

The dangerous bubble which for years has been brewing in China’s housing market is bursting, changing the country’s economy in a way that’s still hard to predict, even for economists.

The property sector has almost single-handedly driven the country’s explosive growth in the past few decades, but as the mess created by years of risky investments unravels, only the tight control of the Chinese Communist Party (CCP) has prevented an absolute, overnight catastrophe.

Yet, despite the efforts of the CCP, China’s housing crisis is far from over. Earlier this month, Country Garden—China’s biggest private property developer—narrowly avoided defaulting on its huge debt. Among an ongoing downturn of the once thriving property sector, the entire Chinese economy is struggling, causing global concerns.

According to data, China’s property sector is the single largest asset class in the world, as Adem Tumerkan, editor at Speculators Anonymous, told Newsweek. “It’s estimated to be worth over $60 trillion—far more than China’s bond and equity markets combined,” he said.

“When I was still at UBS a few years ago, we used to call it the most important sector in the world,” economist George Magnus, once chief economist of UBS and now an associate at the China Centre at the University of Oxford in the U.K., told Newsweek. “Most people kind of accept that even allowing for a bit of double counting and dubious inclusions, it’s probably about a quarter of [China’s] GDP.”

This is a huge slice of GDP when compared with other large economies. Not only this sector is massively important for China, but it’s also closely tied to the personal finances and savings of Chinese households, as “Chinese people don’t really invest in equities or financial assets,” Magnus said, and the property sector has become “a form of saving for the urban middle class.”

About 70 percent of household wealth in China is tied to the real estate sector, “a massive amount,” according to Tumerkan. “It really emphasizes how dangerous falling home prices can be on household balance sheets and confidence,” he said.

And prices have been falling for a while now, despite the CCP’s efforts to introduce policy stimulus measures. According to the latest data reported by Bloomberg, new-home prices in 70 Chinese cities tumbled by 0.3 percent in September compared to the previous month, when they had fallen by 0.29 percent. It was the steepest month-on-month decline since October 2022.

The slump in home sales and property investment is dragging down China’s entire economic outlook. But how did the country get to this point?

How Did China Get Into This Mess?

In the 1990s, China made its first moves to turn what used to be a housing welfare system—where the only way you could get housing was if you were a party member or if you did something that was beneficial to the CCP—into “a genuine property market as we would know it,” Magnus said.

That led China’s property market to expand very rapidly starting from the 2000s onward, partially driven by the growing urban population and the government’s support.

“In the very early years it was commercially viable,” Magnus said. “But then a few years ago people started talking about ghost cities, and those were the very first observations that a lot of unnecessary building was going on or that construction was going faster than the capacity of the economy to absorb it.”

To support the sector, the government regularly intervened in the 2000s and 2010s when the economy “was weak or going towards a down cycle,” Magnus explained, “but when the economy was strong, they never came in to quieten things down.”

This type of intervention, which never dampened the sector but only boosted during hard times, led to widespread optimism among builders, local authorities and investors in China believing prices would only go up, an idea which Magnus described as “a fantasy.”

Households were asked to invest in the building of their homes as well as new properties for other people, in what Magnus called “sort of a Ponzi scheme.” In 2019 and 2020, he said, 90 percent of properties sold in China were sold on this presale model, allowing developers to borrow a lot of money from Chinese households.

Reality came crashing down on the property’s sector “fantasy” when the Chinese government realized that some of the country’s biggest developers, like Evergrande and Country Garden, were growing huge debts and fueling an asset bubble by promoting a risky type of investment based on the “presale model.”

In the fall of 2020, the Chinese government cracked down on this kind of investments, putting restrictions on the amount of debt developers could collect. Banks went even further, cutting off financing for developers.

“It was the thing that burst the bubble, because that’s when people realized that the model of the property developers was broken,” Magnus said.

“Then developers started to run into financial difficulties,” he added. “They couldn’t complete or even start some of the properties. Last year, there were hundreds of thousands of mortgage owners who refused to pay their mortgages because they had no confidence that the properties that they’d bought would ever get built.

“And so the government was quite concerned about this, as you can imagine, because the real thing you really don’t want to do is to anger the middle class when it comes to housing.”

Evergrande—then China’s second-biggest developer and now the poster child of the property crisis—defaulted on its massive debt in 2021 and filed for bankruptcy protection in the U.S. in August this year. Country Garden currently has $11 billion in debt and $6 billion in onshore loans and is raising fears among analysts that it might default soon.

What Does This Mean For the Country?

Magnus thinks that the bursting of China’s housing bubble will likely represent a crisis in China, sinking consumers’ confidence and negatively affecting employment.

Especially in smaller cities, where most of the oversupply currently is and where most of the price depreciation is taking place, Chinese banks—or some banks, at least—may have big problems because of non-performing loans, Magnus told Newsweek, the longer this crisis goes on.

The Chinese government has taken a lot of measures in August and September to try to stabilize things in the country’s property sector, “and today we had economic data out for the third quarter, which were, if you believe the numbers, a little bit better,” Magnus said.

“Sales value and sales volumes have kind of picked themselves up a little bit off the bottom, but construction is still deep in the mud,” he added. “The medium-term trend, I think, in the market is not good.”

China’s property market is now heading towards an inevitable shrinkage, Magnus said, “which is going to go on for quite some time.”

What Will Be the Impact on the Rest of the World?

The consequences on the global economy are even more uncertain.

“China is the second largest economy in the world. So if the bubble further deflates, it’s hard to see it not having ripple effects globally,” Tumerkan told Newsweek.

“China made up much of global growth post-2008, creating a locomotive effect. But now as China is dealing with an inevitable slow down, this raises concerns for the global economy,” he continued.

“For starters, if Chinese demand is weak, they will turn to exports for growth while having less imports. But I don’t believe foreign countries will be ecstatic about Chinese imports crowding out their own manufacturing. Thus trade tensions could rise.

“Country Garden and Evergrande together carry roughly $500 billion in liabilities—billions. This is more than many countries’ entire public debt. Someone, somewhere, will be forced to absorb those losses. Which could lead to further black swan events,” Tumerkan said.

Scott Kenney, senior adviser and Trustee Chair in Chinese Business and Economics at the Center for Strategic and International Studies (CSIS) in Washington, D.C., thinks that the impact on the global economy would be limited.

“The consequences for the rest of the world are somewhat ameliorated by the fact that China has a closed capital account and that most of the real estate investment is through Chinese entities, not foreign entities,” he told Newsweek. “Despite how huge China’s real estate sector is, it’s having a much more limited effect on the rest of the world’s economy.”

The fundamental questions, Kenney said, are how China decides to manage its “bad debt”—whether it does so in a way that’s well-balanced or in a way that creates more problems—and how can the country find new drivers of growth to replace real estate.

“That’s why they’re investing so much in high tech and hope that electric vehicles, green tech, A.I., Telecom, commercial aircraft, and semiconductors will spur a new generation of growth that isn’t based on infrastructure development,” said Kenney.

“All of that translates more likely into slower growth over the next decade, whether the Chinese want it or not. Not only is the economic challenge difficult, but the political economy of China and the views of its leadership create huge obstacles to them pursuing this transition in a measured, successful way that generates domestic and international confidence.”