|Patrick Lenain, assistant director at the Organisation for Economic Co-operation and Development |
Rapid real estate development has increasingly fuelled China’s economic growth in the past decade. Overtaking infrastructure and industry, the housing construction sector has led the growth of investment, with funding coming from debt issued both in domestic and foreign markets.
Chinese property developers have increasingly tapped the dollar market, adding to their high leverage an unhedged foreign currency risk exposure. The financial difficulties of Evergrande – a massive property developer – may signal the end of this boom, with financial repercussions that could spread beyond China.
The great urban transformation of China meant that millions of new apartments had to be built for the fast-growing city population. The demand was so strong that apartments found buyers before being built. The real estate boom brought large financial gains to many stakeholders: homeowners and residential investors enjoyed fast increases in house prices; municipalities raised local revenue by leasing vacant land; bondholders obtained higher yields than in low-interest mature markets; homebuilders were filling up their order books; and the central government could witness fast GDP growth fuelled by the property sector.
However, the Chinese property boom has triggered growing concerns. Worried by skyrocketing housing prices and a growing stock of units held vacant by speculative investors, China’s Party Congress adopted in 2017 the principle of “housing is for living in and not for speculation”. Home prices exceeded 18 annual incomes in 2020 on average in the country. They were even higher in cities such as Shenzhen (57 times the average annual income) and Beijing (55 times) according to the Rushi Advanced Institute of Finance.
The new principle adopted by the Party Congress has been increasingly enforced, with regulators cracking down on speculators, black-market intermediaries, illegal developers, and deceptive advertisements.
As excesses in real estate were worked off, the leadership signalled its willingness to focus economic growth away from property development to more sustainable drivers such as environmental protection, technological innovation, and fair access to education.
Nonetheless, the outbreak of COVID-19 and its disruptive effects in early 2020 was a sharply negative shock for the real estate sector, triggering a surge of defaults and bankruptcy filings. With growing inventories of unsold housing, the financial health of property developers became a rising concern due to its high leverage and reliance on both formal and shadow banking in both domestic and foreign markets. Worried by excessive leverage, China’s regulators introduced restrictions on debt accumulation by property developers. Three “red line” principles imposed limits on ratios of debt-to-assets, debt-to-equity, and cash-to-short term debt.
When it failed to meet some of these ratios, Evergrande was banned from issuing more debt and has since then faced liquidity difficulties, making markets worried that it could miss interest payments on its bond holdings.
With $305 billion in debt outstanding, many properties under management, 200,000 persons directly employed and many more indirectly, Evergrande has large ramifications throughout the Chinese economy. Apart from bondholders, ordinary households also face financial risks, such as people who have invested in wealth management products issued by the firm, and families who have paid for homes that have not yet been completed.
It is unclear whether Evergrande’s financial difficulties will remain isolated, or if they will spread further. While Western financial markets have remained largely unshaken so far, yields on riskier Asian dollar bonds have seen a spike in yields, signalling nervousness of investors about emerging-market Asian borrowers with lower credit ratings and footprints in the real estate sector. Meanwhile, Evergrande has been working with creditors to avoid a default, and talks have taken place with local authorities, raising hopes that a financial contagion will be avoided.
A successful resolution of this crisis will be important for Vietnam, which has strong and rising exposure to China.
Vietnam and China are close trading partners. Foreign direct investment from China has increased rapidly, especially in manufacturing, and is similar to Japan’s and second only to South Korea’s. China’s banks have opened branches in Vietnam, thus strengthening financial linkages. This rising economic integration makes economic development in China important to Vietnam.
An important question is “could it happen here?” In other words, could the downfall of a massive real estate developer also occur in Vietnam, as it is happening in China, with associated financial difficulties for investors and homebuyers? Vietnam is following socioeconomic trends seen in China in the past. This includes fast demographic growth, with the population projected to increase from 96.5 million in 2019 to 120 million in 2050.
A fast-rising population will demand adequate housing, especially the growing middle class expecting better accommodation. Urbanisation is projected to follow a similar trend as in China: the large rural population will continue to migrate to the big cities, where it will find better-paid jobs and amenities that are more enjoyable.
The Vietnamese government has long sought to avoid the type of spiralling land and house prices seen in China. Essential to the model of inclusive growth adopted by the country, successive decrees have emphasised the need for affordable housing, including social projects for industrial workers and their families, as well as price controls and zoning regulations for land use.
However, a dual market for land prevails, with different prices: while provincial authorities prefer low land prices to attract foreign investors, private property developers bid up the same land plots to build condominium projects for the rising number of high-income homebuyers.
Such a dual market creates distortions in urban planning and is a source of social discontent for families unable to get access to affordable housing. Land conversion for speculative purposes can lack transparency and come under scrutiny by the authorities. Like in China, real estate development in the large cities of Hanoi and Ho Chi Minh are highly lucrative activities which attract the interest of investors. Without proper financial supervision and financial literacy, the rush to real estate speculation has led in a few cases to the failure to deliver adequate social housing, as seen in past developments of new urban areas.
An adequate policy framework combining urban planning, land zoning, property taxation, and infrastructure development can secure the country’s future housing development and provide the rising number of working migrants and middle-class families with the accommodation that they are looking for. Land use planning needs also to take into account environmental priorities and seek to contribute to lower carbon emissions thanks to green city development that reduces energy needs and mitigates the environmental footprint of real estate projects.
Properly supervised and regulated, private property developers can play a key role, without causing the type of financial tremours seen with Evergrande. Vietnamese private joint-stock companies are already excelling in the task of real estate development. Vietnam’s conglomerate Vingroup – one of the world’s 2,000 largest corporations– is active in the real estate market through its subsidiary Vinhomes, a company involved in the construction and management of offices, commercial buildings, houses, apartments, and villas for sale, lease, or rent. Both companies suffered drops in the equity and corporate bond markets when market sentiment shifted, but this was temporary and they regained their footing when fears of contagion rapidly dissipated.
Drawing lessons from China’s present difficulties will help Vietnam charter a course where economic growth, urbanisation, property development, social housing, and financial stability complement each other. By avoiding excessive risk taking, often fuelled by the moral hazard created by bailouts, the housing and commercial property market can be steered in a direction that serves the interest of future homeowners and consumers.