Abstract: The financial strain on China’s real estate developers is what stalled the construction projects and promoted homebuyers to go on a mortgage strike, but the cash flow pressure is rooted in the defects of the developer’s business model – their reliance on unconventional financing and colossal “idle assets”. CF40 experts believe that timely delivery of pre-sold apartments is the way out of a potential real estate crisis.
Ⅰ. "GUARANTEED DELIVERY" IS THE SOLUTION TO THE MORTGAGE STRIKE
Recently, some homebuyers announced refusal to continued mortgage payments as a protest against delayed or halted construction of the apartments they had paid for ahead of completion.
What the homebuyers are complaining about are the abandoned constructions instead of the declining housing price or their personal income. Stopping mortgage payments is not an end in itself, but a means to push for the timely delivery of their prepaid homes. Therefore, "guaranteed delivery" is the solution to the strike.
Study based on the calculation under static conditions shows that the scale of potential mortgage defaults associated with the recent strike is controllable. Nevertheless, actions must be taken promptly to help developers finish their constructions and prevent a spread of the mortgage boycott.
So far, decision-makers have taken this issue very seriously. Local governments have already stepped in with various measures to help developers deliver the unfinished projects on time.
The Politburo meeting of the Central Committee held on July 28 pledged to stabilize the real estate market, reiterated the principle that houses are built for living in, not for speculation, asked the local governments to adopt the right policy mix to help meet people’s basic housing demand based on local conditions, and placed the responsibility on local governments to ensure the delivery of stalled residential projects.
On August 12, China Banking and Insurance Regulatory Commission (CBIRC) announced at its press briefing that the CBIRC is studying potential solutions to the money gap to ensure the delivery. Five financial asset management companies are supporting the bailout of distressed developers. Up to now, a total of 26,996 sets of commercial housing have been delivered on schedule, and 55 million yuan of wage arrears owed to migrant workers have been paid.
Local governments are also creating real estate relief funds. On August 5, Zhengzhou issued Zhengzhou Real Estate Relief Fund Establishment and Operation Plan, setting up a special fund of 10 billion yuan that is guided by the government and market-based with multi-level participation.
Ⅱ. PROPERTY DEVELOPERS ARE STRUGGLEING FOR CASH FLOW
The financial strain on real estate developers is what caused the delay in construction.
The cash flow problem is rooted in their defected business model.
1. With land purchase costs rapidly rising, property companies used a large amount of unconventional money in project construction and daily operations. Studies estimate that land acquisition alone has cost nearly 50% of the total sales in recent years. To expand and maintain their operations, real estate companies had to obtain unconventional funds through disguised debts, appropriation of pre-sale funds, off-balance sheet financing, and advance payments by contractors, etc.
2. Developers accumulated a huge amount of "idle assets" that lack cash flow coverage in their previous operations. Some studies found that developers hoarded a lot of land and completed projects when the housing price skyrocketed previously, but some of the inventory failed to bring in cash flow and became idle assets. There are three major sources of idle assets:
(1) Affordable housing built (in addition to regular commercial housing) on land auctioned to developers at a fixed price;
(2) Apartments that developers are required to hold on their own;
(3) Designated industrial real estate built together with commercial housing.
Those idle assets sum up to 19-trillion debts, adding to the interest-paying outflows of real estate developers without bringing in any new inflows.
However, increased defaults in China’s real estate sector since July 2021 have led to regulatory tightening, making it difficult for developers to engage in aforementioned non-conventional financing, which crippled the fragile cash flows under the existing defected business model and spread the liquidity pressure across the industry.
Short-term cash flows in the real estate sector have continued to come under pressure recently, with limited capital inflows and rigid expenditures.
1. In terms of capital inflow, the economic downturn and the unstable expectations of homebuyers have led to a sharp decline in home sales; at the same time, it is still difficult for real estate companies to obtain financing.
2. In terms of capital outflow, developers’ rigid expenditures include:
(1) Taxes and fees related to sales and completed projects;
(2) Payments to contractors for the completion of the pre-sales;
(3) Due repayment of the financing debt accrued during the boom in property development from 2019 to 2021.
The cash crunch and construction halt have been the main cause of the mortgage strike. Therefore, cash flow pressure facing real estate developers should be eased so the cash flow crisis will not further spread to the point of jeopardizing financial and economic stability.
Ⅲ. POLICY RECOMMENDATIONS
1. Help stabilize cash flow for developers that have yet to default in the short term through general control of expenditure and increase in income.
(1) Consider reducing the cash outflow pressure in the short term by tax reduction, exemption, or deferral, as well as the deferral of debt repayment.
(2) Support real estate companies to replace their cross-border debt by issuing domestic bonds to replace overseas bonds, to reduce extra pressure from downgrades and overseas bond defaults.
(3) Implement city-specific policies, relax credit restrictions for reasonable housing needs, reduce the cost of mortgages, and help developers resume sales and repayment.
2. Employ a market-oriented approach and give full play to the coordination role of government for the cash-strapped developers to deliver properties.
Construction suspension is linked to the debts of real estate developers that also involve other stakeholders such as financial institutions, upstream and downstream suppliers, and homebuyers. It is hard to rely on a single industry or its regulatory authority to coordinate the interests of all parties and ensure timely delivery. The government should coordinate the actions of all parties, and apply market-oriented means such as asking a third party to take over the incomplete projects, establishing real estate relief funds, and disposing non-performing assets.
3. Help developers generate cash flow from idle assets.
(1) If the assets can be developed for business purposes, there will need to be a tax and financial system that matches such properties. The government can improve the market-oriented exit mechanism and encourage the participation of policy-based equity funds and private equity in the development of such properties.
(2) If the developers cannot develop their idle assets, they can convert them into quasi-public housing products such as affordable housing, long-term rental housing, and public rental housing.
3. In the mid- to long-term, land supply should be in line with population mobility and the development trend of metropolitan areas; the affordable housing system should be strengthened.
Increasing the supply of residential land in population influx areas and metropolitan areas can match the long-term development of real estate with China's economic development trends. The government should also encourage state-owned enterprises to play a bigger role in the construction of affordable housing, and explore ways to expand the sources of financial support for these projects.
This policy brief was edited by CF40 Research Associate Sheng Zhongming based on the recent CF40 Youth Forum on How to Realize a Virtuous Cycle between the Real Estate Sector and Financial Markets held in July. The views expressed herein are the speakers’ own and do not represent those of CF40 or any other organizations.
