Real estate has always been the engine of China’s economic growth, and a wave of loan suspensions caused by unfinished buildings is hitting Chinese property developers and the country’s real estate market hard. However, analysts pointed out that the real threat to China’s economy is not the wave of loan cessation but that the cessation has led to people’s loss of confidence, driving down home sales and further impacting the Chinese economy.

German mathematician David Hilbert once imagined a hotel with an infinite number of rooms. He noted that even if “all the rooms” are occupied, the hotel can accommodate new guests just by requiring each guest to move to the next room. A guest moves into a second guest’s room to make room for the new guest. The second guest moves into the third guest’s room, and so on. Since the number of rooms is infinite, this sequential process never ends.

Real estate developers in China seem to have followed a similar process for years. They would pre-sell homes long before construction began. The funds raised for the construction of these apartments should have been placed in escrow and reserved for the construction, just as every room in Hilbert’s hotel should have been reserved for existing guests. But property developers use the funds for other purposes, such as buying new land. When it came time to pay for the construction, they would pre-sell more unconstructed apartments and use the money to complete the previous build. Just as Hilbert’s hotels put every guest in a room next door, Chinese property developers use the money from the next presale to build the apartment from the previous presale. This approach can continue as long as there are always new buyers.

According to The Epoch Times, in 2020, Chinese authorities started cracking down on the excessive leverage of real estate developers. This triggered a liquidity crunch, with many developers breaking the capital chain and losing funds to complete housing projects. Many real estate projects continue to extend the construction period or become “unfinished buildings.”

Chinese developers are now ‘out of room’

An Economist article said that, unfortunately, Chinese developers are now “running out of room.” Sales were down 22% in the past 12 months through June compared to the previous 12 months. Presales are falling even faster. Many developers do not have enough cash to continue building apartments they had pre-sold to homebuyers. Developers in China have pre-sold more than 6 billion square meters of property in the past three years, but they have completed less than half the number of apartment buildings. Homebuyers could do nothing about these unfinished properties. After all, they had already paid.

But they still have to make the mortgage payments, even though they handed all the down payment to the property developer. In recent months, angry homebuyers have threatened to stop making mortgage payments if developers don’t resume and complete the construction of the apartments they bought. According to Bloomberg, the wave of stopping mortgage payments has spread to more than 320 real estate projects in nearly 100 cities. More than 40 of these projects are located in Zhengzhou, the capital of Henan province.

How widespread will this “loan suspension wave” spread? The CCP system obviously limits it. Homebuyers refusing to make loan suspension payments may be put on the CCP’s social credit blacklist, making it difficult for them to get new loans. Rating agency S&P Global noted that most people cannot declare bankruptcy in mainland China because “their debts will never be forgiven.”

Unwillingness to buy new houses will pose a greater threat to China’s economy

Standard & Poor’s believes that in the worst-case scenario, about 24 trillion yuan ($3.5 trillion) of home loans could become nonperforming loans. That’s 1.3% of total bank lending, enough to jeopardize some small lenders but not enough to pose a systemic threat to the banking system.

The real crisis caused by the “borrowing moratorium” is that Chinese households no longer believe that pre-purchased houses will be delivered. This loss of confidence was not limited to protesters who stopped paying. It also manifests in a decline in home presales, especially for struggling property developers. An unwillingness to buy new houses will pose a greater threat to China’s economy than the “borrowing tide.” Weak sales will further weigh on developers’ top line, leading to delays in more and larger construction works, adding to a sense of disillusionment.

How can we break this vicious cycle? In Henan, two state-owned enterprises (a developer and a “bad bank”) have set up a relief fund to acquire bad projects and ensure completion. Andrew Batson of the research firm Gavekal Dragonomics said local governments in China lack the funds to restore confidence.

On July 27, Esther Liu, director of S&P Global Ratings, said in an interview with CNBC that the “tire of loan stops” by owners of unfinished properties is causing people to lose confidence in the real estate market, the “recovery” of the real estate sector has been delayed to next year instead of this year.

With property sales falling, more developers could be in financial distress, she said, warning, “If the situation is not contained, the drag could even spill over to other developers who are operating in a relatively healthy way.”

Credit strategist Kenneth Ho wrote: “For us, the ongoing pressure on China’s real estate sector, coupled with uncertainty related to epidemic prevention measures, points to an even more uncertain outlook for the Chinese economy.”

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