Real Estate Gold


This article published in Bloomberg should give us pause, because it’s not only in China where real estate leverage has become too big to fail. (And our POTUS is a real estate magnate.) In the aftermath of the financial crisis of 2008, real estate portfolios were not allowed to fail and Fed credits were used to protect excessive investment. Now we have a stark divide in the fundamental values of real estate versus the inflated prices of a product that is tax-subsidized and priced solely on the margin. As a speculative trading asset rather than basic shelter, housing has now become the tail that wags the dog of our lives. This is pretty insane, and plants us back in the age of land feudalism.

The problem, which is not only a US problem but a global one, is excess cheap credit that has led to a generational credit-debt bubble in the private and public sectors. It promotes the imbalance between China and the rest of the world and drives inequality world-wide. It reflects coordinated central bank policy under the leadership of the US Federal Reserve that was made possible by the untethering of fiat currencies – giving governments world-wide discretion over the value of their currencies.  We’ve tried to grow faster than our productivity warrants. It has greatly increased systemic risk, price volatility, and uncertainty over price signals. For example, what is a house really worth? $100K of materials or $5 million based on the marginal value of land? Or how much somebody can borrow against it?

Ultimately, the value of scarce land will have to be taxed accordingly, an idea put forth by Henry George more than a century ago.

Evergrande Is Too Big to Fail Thanks to Its Huge Land Holdings

China’s Most Indebted Firm Is Too Big to Fail

This property developer is borrowing even more to expand into unlikely projects, such as electric vehicles. But there’s a method to the madness.

There’s a lot working against China’s most indebted property firm. China Evergrande Group is sitting on $113.7 billion in debt and its core profit fell 45% in the first half of the year. Real-estate growth is slowing, with banks under orders to curb home loans. President Xi Jinping’s refrain that houses are for living in, not speculation, has been cropping up more frequently. 

Time to rein things in, right? Not Evergrande. The company, whose portfolio already includes theme parks and a football club, now wants to become the world’s biggest electric-vehicle maker in the next three to five years. It’s burning through precious cash – 160 billion yuan ($22 billion) – to build factories in Guangzhou. 

Investors are voting on this folly with their feet. The company’s shares have fallen 30% this year, making Evergrande the worst performer among Hong Kong-listed Chinese developers. The property firm’s borrowing costs are among the highest in the offshore dollar market and its bonds are tumbling.  

For anyone gawking at Evergrande’s improbably ballooning debt load, just waiting for the doomsday clock to strike midnight, there’s a valuable lesson: This firm is too big to fail. Evergrande is one of China’s biggest developers – with projects in 226 cities – and its billionaire founder, Hui Ka Yan, is the country’s third-richest man. With property accounting for about a quarter of China’s gross domestic product, any instability in the sector has proven too much for Beijing to stomach. Time and again, the government has reluctantly reopened the credit spigots to boost a flagging real-estate market. Just look at 2008, 2011 and 2014. [As we have in the US, leading to a big gap between those who own real estate and those who rent or would like to buy.]

Crucially, Evergrande has China’s largest land reserve, with 276 million square meters (905 million square feet) of gross floor area, according to Citigroup Inc. While the developer has a lot of exposure to China’s smaller cities, where growth is slowing rapidly, it also dominates redevelopment in big, rich cities such as Shenzhen, where profit margins are robust. 

Land is scarce in Shenzhen, and urban renewal – demolishing old, low-density buildings to make way for high-rise apartments – is widely seen as the answer to the city’s growing population. These projects also give Evergrande access to cheap lots, which helps keep its land costs among the lowest of its peers, according to Toni Ho, an analyst at RHB Securities. If the protests in Hong Kong accelerate China’s plans to make Shenzhen the the next “global cosmopolis,” according to state-run Xinhua News Agency, Evergrande could be in a plum position.

The company’s diversification into electric cars is sure to bleed money for years, and competition is getting stiffer. During his visit to China last week, Elon Musk managed to score a tax break for Tesla Inc. But carrying out one of Xi’s signature projects has its perks: For example, clean-car manufacturers can get land much more cheaply from local governments than real-estate developers. That helps explain why a host of firms including Country Garden Holdings Co. and Agile Group Holdings Ltd. are jumping in.

Being in Beijing’s favor and securing low-cost inputs is no bad thing for a cash-strapped developer like Evergrande. Maybe there’s a method to the madness of its wild spending.

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