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IWen seemingly healthy Chinese real estate developers are being dragged into the Evergrande mess.
The financial crisis of China’s biggest property developer has spread to those companies investment-grade loanWalling firms like Country Garden Holdings Co., the country’s largest builder. Are investors overreacting?
Maybe not. As China Evergrande Group nearly defaulted on its debt, local governments across the country are keeping a close eye on regulations governing residential real estate development, in many cases how much cash builders need to keep for ongoing projects. , there are strict requirements for this. As regulators delve into developers’ holdings, investors are realizing how little they know about the finances of these businesses.
The crux of the problem is that apartments in China often sell out long before they are completed. For construction projects, developers take property loans from banks, which account for 40% of the total project cost for large commercial lenders. For the remainder, local governments often allow developers to put apartments on the market when construction is still in its early stages.
For pre-sold units, consumers pay the full price of their homes, with the lump sum transferred to escrow accounts. In theory, developers only tap those holdings to pay construction bills, or when they have delivered apartments to consumers. But in practice, developers often treat that pot of money as free cash that is used for things like loan repayment.
Evergrande’s trouble has curtailed practice. As the giant developer struggles to deliver 1.6 million paid-up homes to buyers, local governments want to say more about how escrow accounts are used.
Rules vary from city to city. In Beijing, developers are only required to set aside 10% of cash in escrow accounts. But smaller cities are less generous, demanding a cash buffer of up to 40%. This has left developers operating in smaller markets without access to money, which they hoped to use to pay off their debt.
The amount of cash set aside may be substantial. For example, Chongqing-based Jinke Properties Group told investors that as of September, half of its 30 billion yuan ($7 billion) in cash was in escrow accounts, according to Datewire. Shanghai-based Cifi Holdings Group Co. said that as of June, about 30% of its cash was in escrow.
Country Garden, whose debt Moody’s Investors Service Inc. gives its lowest investment grade, is in a particularly difficult position. More than 70% of its real estate portfolio is in small cities in China. Then how will the developer repay his loan? The question will soon become urgent: Country Garden has $1 billion in convertible bonds that investors can redeem in December, as well as $1.3 billion in bonds next year.
The bond route is getting darker because of the asymmetric information. We don’t know how much off-balance-sheet debt is, or how much cash developers can deploy to repay investors. Investors are appropriately skittish. To stop the sell-off, maybe some honesty is in order?—bloomberg
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