Collateral damage, the borrowing of billions of dollars, an irrational GDP ratio and a potential negative, global economic domino effect are factors tied into the fall of China’s Evergrande Group real estate company.
Evergrande Group is a real estate company founded by Hui Ka Yan in Guangzhou, China that is now based in Shenzhen, China and is currently on the brink of collapse. It is the second-largest property developer in the world and owns over 1,300 residential projects in more than 280 cities. It does not only have revenue invested in real estate but also in electric cars, insurance companies, bottled water and even the world’s largest soccer school, Guangzhou FC. Despite its multiple investments, the real estate market is Evergrande’s largest collateral as the housing market in China is worth $52 trillion, accounting for more than 25% of its GDP. This is a large GDP percentage, considering China is the second largest economy in the world, following the U.S. economy.
The U.S.’s GDP in housing is only 15%, so more than a quarter of China’s GDP coming from real estate is significant. The high GDP revenue in China coming from real estate, and Evergrande being the largest real estate company in China, has now entered dangerous territory as the company has announced in September that they are $300 billion in debt and are behind in payments to both domestic and foreign investors.
In 2018, China’s Central Bank flagged Evergrande as a risk to its economy. The reason for this flagging is because Evergrande has funded most of its projects by borrowing money, and China has a Three Red Line System which is a strike policy for the government to limit the borrowing of companies. The three strikes are ensuring a liability to asset of less than 70%, a net gearing ratio of less than 100% and a cash short term debt ratio of 1%. Evergrande broke all three strikes and was no longer allowed to borrow money, leading to the crisis it is in now.
In September, Evergrande warned its investors of monetary issues and stopped its flat sales and paying its employees, investors and suppliers. After the announcement, Chinese employees have been protesting at their Shenzhen headquarters demanding to be paid. Investors such as American credit agency, Fitch, has cut their ties with Evergrande for missed payments.
The Chinese government has yet to get involved and is seemingly reluctant to financially assist Evergrande in its debt as it goes against President Xi Jinping’s initiative for common prosperity and an equitable society. Assisting a single company will mainly be beneficial to rich tycoons, especially the CEO Hui Ka Yan, not China as a whole. If the damage stays centralized and does not further spill into the rest of the economy, the government will not get involved.
The Evergrande situation is looking like an economic disaster for not just China but also for the international economy. This mess could have been prevented if it were not for China’s overly ambitious goal to beat other world economies with such a mismanaged real estate industry. The previously-mentioned Three Red Line System in China is a poor system to manage companies and assess their irresponsibility. If China believed Evergrande was a risk back in 2018 before it breached all three strikes, it should have not been allowed to further borrow money. Its debt back in 2018 was already large and dangerous.
The Chinese government is partially to blame for Evergrande being allowed to put a larger toll on the housing market. The Three Red Line System in China needs to be reassessed. A single company should not be allowed to accumulate enough debt to have the international economic community in a panic. China’s real estate industry is also extremely dangerous and mismanaged and mainly benefits the wealthy and disadvantages common citizens. The property to income ratio is at a ridiculous 45. This means most property in China cannot be bought by just a singular family, but the wealth of around two to three generations is usually invested into property.
Rental yields in China are also around 1-2%, which is very low and prompts many investors into buying properties to get payment from numerous renters. Expectation of future growth is what fuels China’s housing market and its price growth. This large hold of the economy invested in a single market is dangerous. Evergrande proves such a fact as many investors and employees are out of jobs and citizens are in debt or out of homes because of Evergrande’s failed promises and initiatives.
China should reevaluate its economic system and try and spread out its GDP in other industries to ensure safer economic growth and prosperity for not only its own nation, but the economy of other countries dependent on them.