U.S. Commercial Real Estate Seems Safe From China’s Troubles. That Could Change Fast.

‘Is this a “Lehman situation”? Not yet. But it could be.’


Liquidity problems at two immensely large Chinese companies with real estate holdings are adding to concern that a bubble in Chinese property values could burst and spray the rest of the world with financial contagion.

Some have even speculated that the companies’ liquidity problems constitute a “Lehman moment” for China — a reference to U.S. banking giant Lehman Brothers’ September 2008 bankruptcy filing that sparked the subsequent financial crisis, and whose aftershocks still ripple through decision-making in commercial real estate in the forms of tighter loan underwriting and a general aversion to big risks.

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So far, though, the comparison between now and 2008 doesn’t hold.

The two Chinese companies’ cash shortage hasn’t triggered a crisis like the one that erupted 15 years ago in the United States and that disrupted the global economy, after a wave of home foreclosures flattened the value of subprime mortgage-backed securities that Lehman and other banks held.

“It is not a ‘Lehman moment’ for China. It’s not a financial crisis,” said Beijing-based Alfredo Montufar-Helu, who runs the China Center for Economics and Business of the Conference Board, a nonprofit business research organization headquartered in New York City. “The property sector is in a downturn that is just going to be very hard to come out of, so it’s going to impact economic growth in China. The real estate sector is estimated to account for 25 to 30 percent of total GDP in China.”

Troubles at Country Garden Holdings, one of China’s biggest privately owned developers, and Zhongzhi Enterprise Group, a large conglomerate with real estate interests, are part of a broader slump in Chinese real estate development. That slump has been deepened by 3-year-old regulatory restraints on development financing — debt to cash, to assets and to equity — known as the “three red lines.”

Financial strain at Country Garden Holdings is likely to spread to other companies in China’s finance and real estate sectors as they navigate the country’s sluggish economic recovery from the COVID-19 pandemic.

“Property selling prices, particularly in areas where Country Garden has a high level of exposure, could be under pressure if the company cuts prices to sell its projects to accelerate cash flow to support its liquidity,” debt-rating agency Moody’s Investors Service said in an Aug. 6 report.

At the end of 2022, publicly traded Country Garden owned nearly 2.2 billion square feet (or nearly 50,000 acres) of residential property in China, with 21 percent of its land bank in Guangdong province, another 10 percent in Henan province, and 9 percent in Jiangsu.

“Country Garden’s current situation also will heighten investor concerns about privately owned developers’ financial strength and further undermine their already restrained funding access,” Moody’s reported. “Credit differentiation favoring state-owned developers, which is already underway, will intensify as a result.”

Lenders and bondholders are facing losses on exposure to Country Garden, the debt-rating agency said. At the end of 2022, the company had loans totaling the equivalent of $22.7 billion, and its outstanding debt on senior notes, corporate bonds and convertible bonds totaled the equivalent of $15.2 billion.

But Moody’s also said credit stress at Country Garden will probably have a limited impact on residential mortgage-backed securities in China, because most of these securities are sponsored by banks “that have highly diversified portfolios in terms of geographical and borrower exposure, minimizing the impact from any particular developer.” (Moody’s report did not name any of those banks.)

Shareholders of Country Garden Holdings have already taken a big hit. After the share price fell more than 70 percent this year, shares of Country Garden were set to be delisted from the Hong Kong-based Hang Seng Index on Sept. 4. The embattled company, based in Foshan in the southern China province of Guangdong, missed a deadline for making bond coupon payments.

Beijing-based conglomerate Zhongzhi Enterprise Group told investors on Aug. 16 that the company faces a liquidity crisis and was undergoing a comprehensive audit by a Big Four accounting firm, according to the Reuters news agency.

Based on a video of a Zhongzhi management meeting with investors in the company, Reuters also reported that the conglomerate is planning a “self-rescue” that would center on collecting debts and selling assets. According to Zhongzhi’s website, the conglomerate has business interests in wealth management and financial services as well as real estate management, private equity investment, mergers and acquisitions, and distressed asset management.

The Aug. 16 management meeting with investors followed the failure of a Zhongzhi-controlled trust company, Zhongrong International Trust, to make payments on many of its trust products since late July, Reuters reported.

The news agency also has reported that Zhongrong manages assets totaling $95.6 billion, and that the trust company is part of the Zhongzhi family of “shadow banking” companies that operates outside the traditional restraints of Chinese banking regulations.

Trust companies have been critical conduits for fundraising by real estate developers, and, for years, the national government has tried to promote financial stability by shrinking the amount of shadow banking activity. One result of this crackdown was a reduction in assets held by trust companies to nearly $2.9 trillion in mid-2022, a drop of 20 percent from the 2017 level, Reuters reported.

“It is likely that high-net-worth individuals and some institutional investors that invest in trust products issued by Zhongrong Trust will suffer losses,” according to an Aug. 23 Moody’s report. Banks, insurers and other financial institutions have little exposure to the trust industry, but trust products themselves are rife with real estate risks, the debt rating agency said.

“Most trust plans’ exposures to real estate companies are in loans and equity stakes,” Moody’s reported. “The current distress in the property market could further push up delinquencies in trust assets, after nearly two years of downturns in the property sector. The possibility of more extensive spillovers to the trust sector from the real estate sector is possible.”

Zhongzhi and Country Garden are hardly alone. Other large Chinese real estate companies have stumbled badly in recent years.

China Evergrande Group was once a leading developer that owned more than 1,300 developments in more than 280 cities in China. But Evergrande, which has some assets in the United States, filed for bankruptcy in New York on Aug. 17 after defaulting on debt in 2021.

Shares of struggling Chinese developer Shimao Group Holdings were relisted on July 31 after a 16-month suspension, but the share price dropped 67 percent the first day trading resumed. Three days earlier, on July 28, the company reported a loss of the equivalent of $6.8 billion for the last two years combined.

Chinese real estate developers are still staggering, too, from a one-two punch three years ago: the COVID pandemic outbreak and the “three red lines” policy, announced in August 2020. The so-called red lines refer to limits on three measures of debt leverage (the ratios of debt to cash, debt to assets, and debt to equity) in real estate development financing.

“The real game-changer came with the release of the three red lines debt policy,” said Montufar-Helu. “They put a cap on how much debt these developers can acquire. … So, that just broke it. Developers started having very severe liquidity constraints, leading to more and more defaults, missing coupon payments for their bonds, and so on.”

The start of COVID-19 lockdowns in 2020 essentially coincided with the launch of the red lines policy. At that time, Montufar-Helu said“the real estate market was already cooling. Demand for housing was not as high as before. Part of the reason is that the price was just too high.

“So, the developers started offering discounts on their unsold inventory. And, unfortunately, these drove the prices even further down, and prospective homebuyers didn’t want to buy property. … This is a vicious circle, where prices go down because developers want to sell their inventory, and prospective homebuyers don’t buy.”

The struggles of Chinese developers are playing out against a broader backdrop of economic angst. Government data showed that China had its first month-over-month decline in consumer prices in more than two years in July, and housing sales volume dropped 6.5 percent in the first seven months of the year after plunging nearly 25 percent last year. The New York Times also reported Aug. 21 that the Chinese government stopped releasing jobless data on young adults after the unemployment rate for them reached 21.3 percent in June.

China’s central bank reduced a key interest rate in late August. The People’s Bank of China (BACHF) trimmed its benchmark one-year rate by 0.1 percent and left unchanged its five-year rate, a common basis for pricing mortgages. Whether the tiny interest rate reduction will re-energize the world’s second-largest economy is debatable.

“It’s nothing, in relative terms. They’re fooling themselves if they think it would have any impact, either in China or in the markets here,” Dennis Unkovic, a partner at law firm Meyer, Unkovic & Scott in Pittsburgh, who advises corporate clients on international investments, said in a CNBC interview.

He said the Chinese government has limited means to prevent a drop in real estate values that would push home prices down. “I don’t think there’s much that [Chinese President] Xi Jinping can do in the short run,” Unkovic said in the Aug. 21 interview. “I don’t see anything significant changing in the next 12 months.”

The Conference Board’s Montufar-Helu said weakness in the real estate sector is having a profound impact on the Chinese people in the meantime.

“It’s estimated that 70 percent of households’ wealth is in housing assets. So, you can see that what’s currently happening to the sector, with prices going down, is deteriorating people’s wealth levels,” he said. “There is negative equity, where the price of the mortgage is worth more than your apartment.”

But he maintains that problems afflicting homeowners and big Chinese real estate companies aren’t big enough to topple China’s banking system and trigger a massive financial bailout of broken banks. He cited ample liquidity in Chinese banks, which U.S. banks lacked during the 2008 Global Financial Crisis, and China’s resilience to past collapses of large real estate developers.

“This question of the ‘Lehman moment’ was also raised when Evergrande failed,” said Montufar-Helu. “Evergrande was also one of the largest developers. Shimao was also one of the largest ones. Many developers made headlines two years ago, when all this started. People were asking whether this would lead to a ‘Lehman moment.’ It did not.”

Country Garden, the sales leader among private real estate developers in China, disclosed Aug. 30 a record loss totaling $6.7 billion in the first half of the year, much bigger than its loss in the second half of 2022, and a reversal from a profit in the first half of that year, The Financial Times reported. Country Garden’s revenue grew 39 percent in the first half, boosted by price cuts to sell some of its property projects.

The big developer’s problems may yet spill beyond China’s borders.

BlackRock held $358.5 million of dollar-denominated bonds issued by Country Garden, according to a filing dated Aug 14; and a June 30 filing disclosed Allianz held $301 million of the developer’s bonds. Bloomberg first reported the exposure, and also cited other June 30 filings showing Fidelity International and HSBC were holders, too.

The filings don’t reflect current holdings and may include bonds held on behalf of clients. JPMorgan Chase (JPM) and UBS Group also hold Country Garden dollar bonds, according to filings they made in August.

Two of China’s biggest banks don’t appear to have much exposure to the fallout from Country Garden or Zhongrong’s troubles. Neither Industrial and Commercial Bank of China (ICBC) or Bank of China (BOC) reported any pending losses from exposure to the firms in filings toward the end of August. ICBS reported 1.2 percent annual profit growth in the first half of 2023, and BOC said its first-half profit grew just 0.78 percent, according to Reuters.

BOC officials said in a press conference that the nonperforming loan ratio in Bank of China’s mortgage portfolio increased in the first half from 0.47 percent to 0.49 percent and that the portfolio’s asset quality was “under pressure” but hadn’t deteriorated.

“There’s an old expression that history doesn’t repeat itself, but rhymes. Well, here we are. Does this look a lot like the U.S. back in 2008?” Unkovic, the partner at Meyer, Unkovic & Scott, told Commercial Observer in an interview Aug. 30.

Unkovic said problems facing large Chinese real estate companies could lead to economic catastrophe in China that would reverberate around the world because real estate accounts for as much as 30 percent of the world’s second-largest economy.

“Is this a ‘Lehman situation’? Not yet. But it could be. It depends on where it goes from here,” Unkovic said. “So far, in managing the economy, the Chinese government has not given this a high enough priority. … The Chinese, in their own way, have been trying to fix it since 2020, 2021. But they have been taking mini steps with what is a major problem.”