Saturday, February 24, 2024

China’s real estate crisis wiped out unbeatable investments

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When Citic Trust, one of China’s largest investment companies, sought to raise $1.7 billion for real estate development in 2020, it had a clear pitch to investors: “There is no safer investment in China than real estate.”

The trust, the investment arm of state-run financial conglomerate CITIC, calls housing a “balancer of China’s economy” and “an essential valuable investment.” The funds raised will be used for four projects by major development company Sunac China Holdings.

After three years, investors who put money into the CITIC fund had only recovered a fraction of their investment. Three of the fund’s construction projects have been put on hold or have been significantly delayed due to funding issues or poor sales. Sunac has defaulted on its debts and is attempting to restructure its debt.

The unraveling of the Citic Fund provides clues to broader problems facing China’s beleaguered real estate sector. What started as a housing recession has escalated into a full-blown crisis. The finances of local governments that relied on real estate income have become unstable. The shock to China’s financial system caused China’s capital markets to dry up.

Collaboration between governments, financial institutions and businesses has strengthened China’s real estate sector over the years, paving the way for non-stop construction that has propelled real estate to become the largest sector of the economy. But the relationships that once fueled growth are now sinking deeper as problems spread across the economy.

State-backed developer China Nancheng Holdings warned this month that it did not have the funds to pay interest on overseas debt, and investors agreed to restructure the debt to avoid a possible default. Also, major real estate investor Hywin Wealth Management said it had to postpone some redemptions due to the “downturn in the economy.”

Confidence in the investment sector was already wavering. In November, Zhongzhi Enterprise Group, a financial giant that manages $140 billion in assets, told investors that the company was “severely insolvent.” Zhongzhi’s asset management division announced in July that payments to investors began to fall behind, leaving it with a $36 billion funding shortfall.

Meanwhile, China’s central government pledged this month to “proactively and prudently resolve real estate risks” and help companies meet “reasonable financing needs.” The problem has become so big that the Chinese government, which has yet to offer a lifeline to struggling developers, is finally willing to intervene after more than 50 companies have defaulted on loans since 2021. So much so that I thought it was an indication.

“Three years ago, no one would have dreamed of this level of default,” said Andrew Collier, managing director at Hong Kong economic research firm Orient Capital. “That’s pretty amazing.”

Trust companies such as CITIC are part of China’s so-called shadow banking system, which sells investment products to corporations and wealthy individuals. They have few requirements to publicly disclose information about their businesses and manage his $3 trillion in assets as a group.

Real estate developers relied on trust companies to finance and invest in businesses that regulators deemed too risky for traditional banks. The trusts turned the loans into investment products and sold them to Chinese companies and wealthy individuals, promising high returns.

The market was booming when Citic Trust created Junkun Equity Fund and raised $1.7 billion for Sunac to use. With real estate prices soaring, investors will get back their money and a portion of their profits after three years if Sunak’s project progresses and the properties are sold. Returns in his Junkun fund, one of hundreds offered by Citic Trust, could be higher than fixed-income investments, but it was also risky.

Although CITIC did not guarantee how much profit investors would make, it included in its marketing materials a graph of Sunac’s “similar projects” that had produced double-digit returns.

At least, that’s how it was supposed to work.

Serena Chan said she invested a significant portion of her savings, about $420,000, in the fund in 2020 because Citic Trust was a big brand she trusted. Zhang said CITIC’s investment manager almost guaranteed that he would get his principal back and that his annual return would exceed 7.5%.

“At that time, I was pretty confident in real estate,” said Zhang, 38, who lives in the southern Chinese city of Shenzhen. “Housing prices were all going up.”

However, development faced challenges from the beginning. The project combined residential and commercial facilities in his three cities in the south, Chengdu, Guiyang, and Shaoxing, and his single city in central China, Xi’an. And like the rest of the world, China was battling the coronavirus. Pandemic restrictions delayed construction and negatively impacted real estate sales.

Citic Trust said in a statement that it had made “some progress” in “firmly safeguarding the legitimate rights and interests of its customers” and minimizing risks arising from the property market. He declined to comment on the Junkun Fund.

Mr. Sunak did not respond to requests for comment.

Also, around the time the fund was established, policymakers in Beijing, concerned about a housing bubble and reckless speculation, introduced new rules aimed at curbing excessive borrowing by developers. This created funding problems for many developers. In May 2022, Sunac announced that it had defaulted on debt repayments and warned that it would be unable to make payments on other debt.

The impact on investment in Citic was significant. Last year, CITIC Trust was forced to suspend construction on its Chengdu project.

According to a transcript of the press conference reviewed by the New York Times, officials from the CITIC Trust stated at an investor briefing in November that survey results showed that demand would remain weak for several months, and that the situation was affected by the coronavirus lockdown. He said he made such a decision because the situation had become unpredictable. CITIC said it was concerned that sales would not be able to keep up with construction costs.

Preliminary sales are sluggish at a residential and commercial complex project in Shaoxing, a coastal city famous for its locally produced yellow wine.

Citic considered selling the project in January but had trouble finding a buyer as the developer was downsizing, company officials said at a briefing. Then, in July, as sales slowed, CITIC announced that it had decided to look for companies to invest in the project to ease the financial burden.

In the city of Guiyang in southwestern China, Sunac began construction shortly after acquiring land use rights from the city government in May 2020 for approximately $245 million. But the project has had a series of stops and starts, including a one-month hiatus in August due to “general contract financing issues,” according to a management report to investors.

When her investment in Citic matured in October, she received a payment of about $80,000, but it was unclear whether it was interest on the investment or part of the $420,000 principal, she said. Zhang said.

In November, Citic Trust held a briefing session to calm investors seeking explanations for the October payment. Company officials said at the meeting that although there was no “obvious concrete effect” so far, the project still has some value, and expressed hope that the government’s recent policies would help.

A CIT official acknowledged that “the overall market is not good right now,” but asked for patience.

“Everyone will definitely be worried and angry because the money hasn’t arrived. This is normal,” she said. “But please don’t get too angry.”

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