[Global Focus] 'Bubble Management King' Evergrande, The True Face of China's Real Estate Economy

1998 Chinese Government Abandoned Housing Allocation Policy... Evergrande Group's Real Estate Boom Drives Rapid Growth
Real Estate Accounts for Up to 30% of China's GDP... Real Estate Downturn to Impact Chinese Economy
Japan's Nihon Keizai Warns of China's Economic Slowdown "China's Real Estate Bubble More Severe Than Japan's Past"

[Asia Economy Reporter Park Byung-hee] "I sincerely wanted to leave that village."

Xu Jiayin, chairman of China's Evergrande Group, said this in a speech in 2018. That village was his hometown in Henan Province, where he was born in 1958. In his childhood, he was extremely poor. His father was a warehouse worker, and his mother passed away eight months after giving birth to Xu. "When I was in school, all I could eat were sweet potatoes and steamed buns."

Hating poverty, Xu moved to Shenzhen in his early 30s, a symbol of China's reform and opening-up, and rode the wave of China's real estate boom to become the richest man in China. Evergrande Group, founded by him in 1997, rapidly grew to become the real estate company with the highest sales in China by 2016, less than 20 years after its establishment. However, Xu's reckless business model of building houses with borrowed money from banks backfired, plunging Evergrande Group into the worst liquidity crisis. Concerns that this debt-driven issue exposes the dark side of China's economy have spread, shaking the global financial markets.

Evergrande Grew Alongside China's Real Estate Policies

In 1992, 34-year-old Xu Jiayin headed to Shenzhen. It was right after Deng Xiaoping's southern tour to reinforce reforms. From January 18 for about a month that year, Deng visited Wuhan, Shenzhen, Zhuhai, Shanghai, and other cities, repeatedly emphasizing the importance of reform and opening-up policies. After the Tiananmen Square incident in 1989, China's reform and opening-up policies had stalled but were reignited that year. More than 100,000 mid-level managers from state-owned enterprises started businesses. Xu Jiayin also quit his job to test his fate in Shenzhen. Shenzhen had been designated as China's first special economic zone for reform in 1980 during Deng Xiaoping's chairmanship.

Xu founded Evergrande Group, a real estate development company, in 1997. The following year, changes in China's housing policies brought an unprecedented boom to the real estate market. From the second half of 1998, the Chinese government abandoned the previous allocation policy where it supplied housing and began to let the market dictate housing. Individual home purchases increased, and banks competed to increase housing loans. Land prices soared, and real estate development guaranteed solid profits. Borrowing from banks was not a problem. Building and selling houses allowed repayment of loans with huge profits remaining. 1998 is regarded as the inaugural year of China's rapid real estate market growth. Evergrande Group grew rapidly riding this boom.

When Xu founded Evergrande Group, only one-third of China's population lived in cities. Since then, the urban population has increased by 480 million, and now two-thirds of China's population live in cities.

Real Estate Accounts for Over 70% of China's Wealth

Because real estate investment guaranteed solid returns, leveraged investments like Evergrande's were rampant. The real estate sector's share in China's economy grew, inflating the bubble accordingly.

Real estate is estimated to account for at least 15% and up to 30% of China's Gross Domestic Product (GDP). The share of construction and real estate in China's employment market was 8% in 2002, rose to 18% in 2013, maintained 18% until 2018, and slightly decreased to 16% in 2019.

Most importantly, real estate accounts for over 70% of China's wealth. According to Goldman Sachs, as of 2019, about 90% of urban residents own homes, and the housing market value reaches $52 trillion. This is twice the $26 trillion U.S. housing market.

In the U.S., the bond market ($44 trillion) and stock market ($34 trillion) are larger than the housing market. However, in China, the housing market is overwhelmingly dominant. The bond and stock markets are only $12 trillion and $8 trillion, respectively.

Because real estate holds an absolute share in China's wealth, GDP, and employment, a downturn in the real estate market would severely impact the overall Chinese economy. Experts believe that Evergrande's default will not spread into a global financial crisis like the Lehman Brothers collapse but will seriously damage China's economy.

This is why the Chinese government has not taken significant action regarding Evergrande's crisis but is working behind the scenes to prevent the crisis from spreading to the real estate market or the broader economy.

Is China Facing Its Own 'Lost 00 Years'?

On the 27th, Japan's Nihon Keizai Shimbun warned that China's current real estate bubble surpasses the bubble economy level of Japan's 1980s real estate boom, cautioning about the possibility of an economic downturn in China.

Japan achieved economic growth rates in the 10% range during the 1960s and maintained growth rates of 4-5% in the 1970s and 1980s, rising to become the world's second-largest economy. However, after the bubble economy burst in the early 1990s, Japan has experienced a 'lost 30 years' of no growth up to the present.

Nihon Keizai Shimbun's analysis indicates that China's current real estate bubble is more severe than Japan's past bubble. In fact, apartment prices in Shenzhen are 57 times the average annual salary of Chinese workers. In Beijing, apartment prices are 55 times the average salary. At the end of Japan's bubble economy in 1990, Tokyo apartment prices were 18 times the average salary. China's current private debt-to-GDP ratio is 220%, higher than Japan's 218% right after its bubble economy. The proportion of real estate loans in total loans is 27%, also higher than Japan's 21-22% during its bubble economy.

As of the end of 1989, Japan's Nikkei 225 index rose 5.9 times over 10 years. However, China's Shanghai Composite Index has only increased 1.5 times in the past decade. Investment funds concentrated in real estate have led to relatively sluggish stock price growth.

Gan Li, a Chinese financial expert and economics professor at Texas A&M University in the U.S., said, "In China, housing is considered a safer asset than stocks or overseas assets, so speculative demand has continued to increase."

'$8 Billion Dividend'?The Future of Xu Jiayin

Experts believe the Chinese government is likely to restructure Evergrande by splitting it into three or four companies or nationalizing it. Xu, who amassed enormous wealth through sprawling management, appears to have fallen out of favor with Chinese President Xi Jinping. The way Xu increased his wealth contradicts the government's recent emphasis on 'common prosperity' and living well together.

Chairman Xu Jiayin of Evergrande Group
Photo by AFP Yonhap News

The U.S. economic weekly Forbes estimated Xu's wealth at $11.5 billion, reporting on the 23rd that $8 billion of this came from cash dividends. Evergrande has paid dividends every year except 2016 since its listing on the Hong Kong Stock Exchange in 2009. Xu holds 77% of Evergrande's shares. Evergrande's cash dividends inevitably increased Xu's personal wealth. While dividends continued, Evergrande's debt steadily increased. Debt was $7.7 billion in 2009 when it went public and rose to $302 billion in 2020. While the company deteriorated, Xu kept increasing dividends, growing his personal wealth.

Currently, protests by individual investors and consumers demanding their money back from Evergrande are ongoing across China. Bloomberg reported that about 1.5 million homebuyers have contracts with Evergrande but are waiting for completion. To compensate for their losses, the Chinese government is likely to target Xu Jiayin's personal assets.