China's Real Estate Malaise Is Deepening But Doesn't Look Contagious

China’s real estate market entered a newly worrying phase in the past few months, but it bears no resemblance to and has little connection with the industry’s challenges stateside.

Two of the country’s largest private developers, China Evergrande Group and Country Garden Holdings, are back in the news with fresh debt troubles while home prices keep declining and the Chinese real estate market shows reliable signs of oversupply.

But there is little realistic path to those problems having a material impact on U.S. commercial real estate, experts say.

“You have two very different financial supervision systems,” said Collin Lau, founder and CEO of Hong Kong-based real estate and asset management firm BEI Group and former head of real estate for China’s sovereign wealth fund. “I don’t see any close correlation between the U.S. and the Chinese systems, so why would the Chinese real estate debt market spill over to the U.S.? I cannot tell.”

China didn't set up the same post-2008 guardrails against overleveraging that U.S. regulators did, allowing dozens of private developers to borrow excessively at the corporate level until regulators capped the amount of real estate exposure banks were allowed to have in mid-2021, Nuveen Global Chief Investment Officer and Head of Asia Pacific Real Estate Louise Kavanagh said.

Within months, Evergrande was on the brink of collapse. Within two years, dozens of companies defaulted on debt, both domestic and foreign, The Wall Street Journal reports.

By last autumn, the Chinese government had implemented financial mitigation measures like lowering interest rates, allowing for loan extensions and clearing a path for healthier companies to acquire struggling competitors.

Nine months on, the moves seem to have demonstrated that China has the capacity to keep its debt from becoming an international crisis. But it may not be able to turn around its domestic real estate industry — and, by extension, its economy, the WSJ reported.

“The government is focused on containing rising indebtedness, which is the reason why they have currently been holding back from unleashing further stimulus to drive growth,” Kavanagh said.

Country Garden is negotiating with its bondholders on a maturity extension for a $535M bond that comes due Sept. 1, Bloomberg reported. Evergrande filed for Chapter 15 bankruptcy in New York on Aug. 17 to formalize a debt reorganization plan, and by Friday, it was preparing to relaunch trading of its shares for the first time since March 2022.

Even if both companies fail to work out their debt situations, China’s track record and public statements indicate that state-owned companies will probably absorb their business, Lau said. 

“What we are looking at is the government setting up to allow some companies to die,” he said.

“They’ll be looking for the system to correct itself, and because they are counting on huge savings and the wealth of the country, which has a lot of state-owned assets, there’s little question over whether the country can raise the money.”

The country’s largest four banks are state-owned, demonstrating how direct the relationship is between government fiscal policy and the financial market, Kavanagh said. Since China owned $859B of U.S. Treasury debt as of January, it can absorb the foreign debt of dozens more private companies without damaging its place in the global credit system, Lau and Kavanagh said.

“Since 2021, we haven’t seen any evidence that Chinese real estate issues spilled over into the U.S.,” Lau said. “So the question is whether anything would be different now.”

Rather than China, it is the U.S. real estate market in a much different position than it was in 2021, staring down over a year of interest rate hikes punctuated by the regional bank crisis in the spring.

One line of logic could be that financing is already too scarce for commercial real estate in the U.S. to take any external disruption in stride. 

But one aggravating factor in China’s credit troubles is also a mitigating factor for U.S. exposure to those struggles. China’s clampdown on foreign investing seven years ago made it a smaller presence in U.S. property, and growing political tension between China and the U.S. over the past handful of years has done the same to U.S. investment in China, Lau said. 

The distinction between the two countries’ problems is neatly demonstrated by their regulated interest rates: China is pushing its rates down, while the U.S. is pushing its rates up.

“If China had no choice but to raise interest rates, it could give the [U.S.] economy trouble,” Lau said. “But if they’re polarizing, I can’t imagine what would spill over.”