Frothiness in the Chinese Real Estate Market Is a Warning Sign

Market sentiment check

Chinese tech stocks have been selling off since the news came out that Didi (NYSE:DIDI) was removed from Chinese app stores. The real estate in China has been no exception, and the Chinese government is also imposing changes in the sector. With all this negative news, and further regulations investors are fleeing from Chinese stocks all together. 

The fear and prejudice against Chinese equities is such that no matter what news comes out, Chinese equities will go down. Even the most recent news, that the CCP is imposing new taxes on the rich to reduce inequality, has been the latest of this string of bad news. The reality is that in the US, the same is happening but investors choose to perceive it differently. There is no selloff in US equities, but the Biden administration is also going to try to push an additional tax on the rich. Afterall someone has to pay for the new $1 Trillion infrastructure bill that was just passed. It is highly unlikely that the Biden administration backs up on its intention to increase the taxes for the wealthy. In fact that would be a political suicide that would not be well received among democrat voters.

How does this relate to Chinese equities?

Investors are pricing the risk in China, completely different than in the US and Europe. China is an authoritarian regime, and Xi Jinping acts as he pleases. However this should not be a concern for investors in Chineses equities, as long as you understand what the CCP is trying to achieve. The sense of community, and culture are entirely different from Europe and the US. 

For that reason the CCP will intervene as much as it can, to make sure the Chinese economy works for its people. The idea that China is a communist country is ludicrous. Although the party might be labeled Communist, the reality is far from it. Bearing communist in the name, has not had any effect on reality. China is a totalitarian capitalist regime, and the CCP will go to any extent to protect their authority, and make sure their economy works for its people.

Chinese real estate market 

China is among the hottest real estate markets in the world, and it is also the largest. There are several reasons that explain this. One of them is the fact that there are not as many investment options in China, as there are in Europe and the US. For that reason, Chinese tend to see real estate as a great investment vehicle.

Due to the overdependence of the Chinese economy on the real estate market, it is not a very attractive sector. Some would call it bubbly, and some say the implosion is just around the corner. The government is trying to tackle the problem by setting maximum prices on second hand homes. It is too soon to say how this new policy will affect the average housing prices. So far what we have seen is a reduction in the number of transactions, in part due to the banks. In an effort to reduce speculative behavior in the Chinese housing market, banks have raised mortgage rates. Also the delays in the mortgage approval have affected the market and it is as much as 108 days in some cities.

Evergrande could be the pin that bursts the Chinese real estate bubble?

The level of speculation currently in the Chinese real estate market is worrisome. Especially when we consider that even the CCP acknowledges it. Evergrande (HKSE:3333) is among the largest real estate developers in China. With over $300B in debt, it is one of the companies worldwide with the largest debt. Concerns over Evergrande’s liquidity have been rising over the past few months. Its bonds have continuously declined in value. With some of the trading at a 53% discount to par. The market is pricing a default, and traders have piled into the Evergrande bond short trade

The recent news is even more concerning, with a supplier suing Evergrande for an overdue payment. There are also reports that Evergrande has managed to reach a new agreement with creditors to extend its loans.

This is nothing new for Evergrande. Following the debacle of the Chinese real estate bubble during 2010, some were expecting Evergrande to implode. It did not happen, and to a certain extent it is hard to tell if the government will intervene in such a situation.

Conclusion

On one hand, the real estate market could be about to implode. On another hand, it will be important to see to which extent the government will actually intervene. In a situation like Evergrande defaulting, and going bankrupt, Chinese creditors will be wiped out. The situation could create sheer panic, and induce real estate owners into selling their properties. It is certainly something to keep our eyes on in the future. Take this into consideration when investing in Chinese equities, especially those directly related to real estate.

Image source: World

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