Evergrande: the end of China's property boom
The rapid expansion of China's property sector was powered by a great migration from the farms to the cities - and built on cheap credit. The FT tells the story of Evergrande, the most indebted property developer in the world, which now stands on the brink of collapse. It's a story that changes the outlook for China's position as the locomotive of global economic growth. But is this China's Lehman Brothers moment?
Produced, directed and edited by Daniel Garrahan. Filmed by Petros Gioumpasis, James Goldman and Karsten Hohmann. Graphics by Russell Birkett. Additional illustration by Dreamstime. Additional material from Bloomberg, Getty and Reuters.
You can enable subtitles (captions) in the video player
This is the story of a huge change in the Chinese economy.
A story about hubris, about excess, but above anything else, it's a story about debts.
Eye-watering amounts of leverage.
The rapid expansion of China's property sector on cheap credit.
The meteoric rise of a company founded by one man who ultimately thought that he could do anything as long as he borrowed enough money.
This is a story of the failure of one of China's, and also the world's, largest real estate developers.
A property developer that came out of absolutely nowhere and within 10 years had $150bn of assets.
The most indebted property company in the world, Evergrande Group.
If Evergrande really goes under it would definitely become China's biggest ever bankruptcy case.
This story goes to the heart of China's position as the prime locomotive of global economic growth.
For decades the property sector has essentially anchored China's economy.
You can't underestimate how important the property sector is to China.
A third of China's economic output is in property.
For other countries, say US or UK, the ratio would fall below 20 per cent.
The reason for that is quite simply one of the most remarkable things that's ever happened in human history. A great migration of people from the countryside to the cities of China.
Hundreds of millions of sons, and particularly daughters, of Chinese farmers, who moved from the farm where they were earning really the same as they were earning 1,000 years ago in Chinese history. Absolute subsistence wages. They travelled four or five hours to the local city, and there they began working in the big factories, the workshop of the world.
In the 1990s, when Evergrande was launched, about a third of Chinese people lived in cities.
China's urban population grew from around 415m in 1998, when the housing reform began, to more than 900m as of the end of last year.
Now there are more people living in cities than there are in the countryside.
Before 1998 every Chinese urban citizen would get a flat for free from the government.
People who lived in government apartments were allowed to buy those apartments at really a peppercorn amount.
Chinese banks began issuing mortgage loans and also development loans to property companies.
Every single person that moves from the countryside in China to a city needs to live in an apartment. And someone's got to build those apartments.
Construction workers, who mostly work for property companies, account for more than 10 per cent of China's total workforce. Land sales, which will then feed into real estate, account for almost a third of local government fiscal revenue.
It created the perfect conditions for the world's biggest ever property boom.
Evergrande was founded in 1997 by Hui Ka Yan. It was absolutely at the right time.
Hui Ka Yan was really good at spotting that opportunity and capitalising on this trend.
Developers like Evergrande, and there are dozens and dozens of them, built China's cities, in many cases almost from scratch to accommodate this massive historic flow of people.
Owning your own home after a period of no property rights, I guess, is a massive aspiration of the middle class.
A middle class that now numbers well over 400m people. This was the absolute crucible of China's economic boom over the last two decades. Hui Ka Yan, he just rode it. He just rode it from the very beginning. He began building all kinds of projects in Guangzhou.
It's why it was able to just borrow so heavily. So it started from nothing. Within 10 years it had $150bn on its balance sheets.
From 2004 to 2020 Evergrande's total revenue grew at an annualised rate of 44 per cent, the fastest growing companies you would ever see in China.
He's really been a poster boy for how much money you can make out of Chinese real estate.
Hui spotted the opportunity making small shoebox apartments. Instantly became a big success.
In 2017 he shot to fame by heading up the China rich list, clocked $42.5bn. It's quite a departure from his humble origins.
People who've met him say he's an extremely charismatic person, an extraordinary salesman.
He likes to hire people from top tier universities in the west to be his personal secretary, to make him look like a westernised boss.
He also was very good at cultivating political connections. You need those connections in order to get access to more credit. He cultivated very good connections with Joseph Lau, a notorious Hong Kong tycoon, whose company had lots of investment in Evergrande. He was also part of the delegation for when Xi Jinping visited Great Britain in 2015. You don't just randomly get invited to join those sort of delegations. So it definitely made the effort to make those political connections.
The chairman of Evergrande's had a massive taste for luxury.
He has lived this lifestyle associated with newly minted Chinese billionaires. He's got a luxury house on the Peak.
He had a superyacht. He was quite a generous gift giver.
He loved to mix with some of the most important people in China, in Hong Kong, even from the UK.
In 2015 when his soccer team, Guangzhou Evergrande, had won the Asia Premiership, he had Prince Andrew, Jack Ma over at his hotel, popping champagne. One of the ways in which he sort of ingratiating himself with some of these tycoons was that he had these card nights.
The folly of his ambition is no better seen than in this huge sprawling plot in Hong Kong called Project Castle, where he intended to build this Palace of Versailles-style mansion in one of the most overdeveloped places in the world. Ten years on it's a muddy plot of land. Evergrande went from nothing to being this huge developer with over 1,000 projects in over 200 cities across mainland China.
Over two trillion renminbi of assets on its balance sheet. It's a business model that lends itself to very rapid expansion. Real estate developers in China are buying land from local governments.
Local governments are a key economic actor in China. They are the people who decide whether or not to build an industrial park over here, a factory over there, real estate development somewhere.
So these developers buy their land, build apartments on the land, and they sell the apartments to customers before they've built them.
The homebuyers need to make in advanced payment. Evergrande has allocated the funds to other areas, which, in turn, has cost the projects to be stalled, which would then anger these homebuyers.
This arms race between multiple developers encourages them to move as quickly as possible. Once you inject that into it, the whole thing speeds up. The Chinese government has tried to control and constrain it, limiting the use of onshore debt to buy land. It's one reason that offshore debt, international bond markets, became so attractive. But Evergrande took advantage of seemingly limitless demand from global investors for Chinese real estate debt.
It just seemed so clear that it was going to become too big to finance.
The last two decades in China have really seen an unprecedented period of economic growth, driven by the property boom. But now a lot of people are thinking that China is running out of road.
The growth rate of urban population has been above 3 per cent or 4 per cent. The rate last year has dropped.
So that era of very strong demand in the cities for migrant workers is largely over.
The ratio of empty apartments in China could range between 10 per cent and as high as 40 per cent, or even 50 per cent in some small cities.
There are enough empty homes in China right now to house about 90m people, greater than the population of Germany or the UK.
Newer developments were built quite quickly without a lot of consideration for the logistics.
I've travelled to many parts of China, where you go to a suburb and suddenly you see this forest of apartment blocks.
Carry on for five, 10 minutes in your taxi, and you're still going through apartment block after apartment block with nobody in them.
I visited one of the most famous ghost cities, Ordos, in the middle of the desert, very far away from anything. It was quite strange, because it's not like there's necessarily jobs there.
Housing affordability in China is among the worst in the world. It would take more than 50 years of median household income in Beijing to buy an average apartment. The ratio is around 15 years in London and 10 years in New York. Policymakers, led by President Xi, wouldn't allow that to happen.
They realised that you can't keep on building property which is often unsold by using debt that property companies ultimately will not be able to repay.
Developers always had a way to take on more debt, which prompted the three red lines policy.
In about August 2020 everyone was talking about the three red lines.
Three debt ratios Chinese developers must follow to gain access to bank lending.
First one is a liability to asset ratio of less than 70 per cent, which is essentially a way of avoiding too many liabilities. Evergrande has over $300bn of liabilities. The second one is a net gearing ratio of less than 100 per cent. That's essentially a way of measuring debt compared to equity. And the third ratio is a cash to short-term debt ratio of more than one, which just means you've got more cash than you've got short-term debt.
A vast majority of Chinese major developers were not able to meet that requirement. They lost access to credit.
It has changed the mindset of lenders in China not to lend too much to Evergrande and other property developers.
At the same time the government advised banks to quietly slow down the issuance of mortgage loans. Evergrande can't sell apartments. It also can't borrow from banks. How could it pay off the loans? And that's where the problem is.
These three red lines have created pretty much a sudden stop in terms of using debt to fund debt payments.
A huge part of the appeal of investing in any Chinese company is the belief that the government is going to bail out any prominent player if things go wrong. This is still a country controlled by the Communist party.
China saw, with shock, the western economies almost collapse during and after the 2008 financial crisis created by a massive debt bubble. It just couldn't afford to shoulder that type of risk itself.
The government is taking a particularly negative view on excessive leverage. Evergrande is the poster child for excessive leverage.
The Chinese property market is a bit like a game of Jenga.
The wealth management investors, offshore bondholders, banks. You've got the local governments that sells land to Evergrande who need it for financing. You've got the central government that's trying to control leverage in the economy, trying to control the economy. You've got ordinary citizens who are buying homes from Evergrande and other developers. You've got construction workers who rely on Evergrande for their income. A whole supply chain of companies, not only within China, but outside of China, that are providing the goods and services to build apartments.
Some of these blocks have been pulled out entirely, making the tower sort of teeter and list to one side. One of the first blocks, which has not been pulled out entirely, has been consumer demand. The really big one that was pulled out entirely, and made the tower list, was the three red lines, the ability of property developers to borrow in many different forms.
It's not so much just that Evergrande is a tower that's ready to crumble. In many ways it already has crumbled. But the Chinese property machine hasn't completely crumbled. This is really, in many ways, only just beginning.
We've got bank lending, a Jenga block that's still in the tower, and commercial paper issuance still in the tower. These are areas where property developers would be fundamentally vulnerable. If those Jenga blocks were to be pulled out it really would bring the whole tower crashing down, and it would bring the Chinese property market to its knees, many more bankruptcies among property developers all over the country.
What we might be seeing here are just the kind of teething pains of what happens when the most powerful economic forces in the world begin to unravel. If that's true then this is all the tip of the iceberg, and we're not looking at one Jenga tower collapsing. We're looking at a whole forest of towers. In the summer it really looked like it was going to default. Hundreds of ongoing residential projects, in hundreds of cities across China, suddenly ground to a halt.
In September 2021 there was a hugely crucial moment.
Evergrande missed payments on wealth management products. The wealth management market in China is where ordinary people can put their savings, and the money is usually going into real estate, often to companies like Evergrande. And these people, who had invested, hadn't got their money back. They descended on the headquarters of Evergrande in Shenzhen.
We don't know where to get our money. And now we go to Shenzhen government, and nobody help us.
This was the point at which it went from it might be a crisis to, well, it probably is a crisis. About a week later they just didn't pay an interest payment on one of their dollar bonds.
It's the first time that a Chinese property developer of this size has defaulted on its offshore debts. And the entire bond market for the Chinese property sector collapses.
These are some of the world's biggest investment banks, investment funds. When it comes to investing in Evergrande bonds everybody expects to take a massive haircut.
Other property companies in China are going to really struggle to raise any financing at all on offshore markets.
People no longer trust Chinese companies that say we're issuing bonds offshore, we expect to honour them. That's all completely changed.
The offshore bondholders ploughed $20bn into this company on the basis that everyone believed that China just would never let its property sector fall, would never let its construction sector fall.
Some people might panic over what it meant for the entire global financial system.
There's a lot of talk about how Evergrande may be restructured, potentially allowed to go bankrupt.
The scale of Evergrande's borrowing is so vast. $300bn is 2 per cent of GDP. So the idea that there could be any failure of a restructuring, and the whole thing could go into a complete liquidation, one, would go on for likely a decade, and, two, would have unimaginable consequences on China's property sector and its economy.
Evergrande will probably fail in some form.
It would be the biggest bankruptcy ever in China's history.
Investors around the world have been incredibly spooked by Evergrande.
It led to this sort of domino effect. In the wake of Evergrande we've had so many different defaults and companies getting into serious financial strife, companies which have international investors who issued international bonds.
There are comparisons that are being made between the Lehman Brothers collapse, which triggered the financial crisis in the US of 2008.
The big question everyone's been waiting for is when's the next financial crisis. The most indebted property developer in China defaults on its debt, it sounds like there we are. We've got our crisis.
We just don't know how big the ripples will be, which is why there's so much uncertainty and worry in global markets.
The question now remains whether the collapse of Evergrande will spread over to China's financial industry in general.
There are obvious similarities. The Evergrande story is a story about massive unmanageable debts.
I don't think we're going to see a financial market meltdown in China of the type that we saw in the aftermath of the Lehman crisis.
The Chinese government will do everything to contain the fallout. That is a really key difference between that and 2008.
The situation with the Chinese crisis is very, very different. Everyone knew this stuff was risky. These are high yield bonds.
So many people had called this as a disaster waiting to happen that it seems crazy that the offshore bondholders did put so much cash into the company. Massive investors from BlackRock to Goldman Sachs to HSBC, their funds invested in these bonds. They ploughed billions of dollars into an already overheated market because they believed that China would never let its construction or its property sector fall. Turned out to be nonsense.
Whether or not they're able to effectively restructure does reflect whether or not, in the future, investors will have that confidence.
One of the big unanswered questions in the collapse of Evergrande is, where were its auditors? Where were PwC? They had a Big Four audit firm auditing them for years, signing off their accounts, signing off the figures that management had presented to them. And then, suddenly, halfway through 2021, Evergrande tells its investors that it might not be able to meet its financial obligations. The audit regulator in Hong Kong has already launched an investigation into PwC's work.
Evergrande has become this symbol of this critical juncture in China's economic story.
It changes the outlook for China as the world's locomotive of economic growth.
Building bridges, building houses, building entire cities has been such a profound driver of growth, not just for China, but for the entire global economy.
It is a very big moment for a rethinking by Chinese policymakers of the reliance on property to fuel economic growth.
According to the IMF, China's contribution to global GDP growth, between 2013 and 2018, was more than double the contribution made by the United States in the same period. A small fluctuation, a few percentage points, in China can have an impact all over the world. And it is a few percentage points that Evergrande is now chilling the Chinese economy by.
It's difficult to overstate the spell that Evergrande helped cast over property in China. It's been a byword for a property sector that couldn't fail, prices that were always going to rise.
Thousands of ordinary Chinese citizens have made investments in the company and bought its homes, but it remains to be seen how many of them will get the homes that they have been promised and, in many cases, paid upfront for, in full.
It doesn't look good to have people running around in extreme wealth at the same time when you're trying to reassure the middle class that you're looking after their interests. It is a monumental fall from grace.
I think it's lost trust. I think it's lost its credibility.
We see it time and again across China at the moment, billionaires stripped of the luxury lifestyles that they lead.
The Evergrande fallout is a pivotal moment for China's economic model.
It might be seen as the inflection point where China's growth model shifted from one thing to something completely different.
Greener growth investment in green industries, an economy that's more stable, that's less susceptible to external shocks.
Evergrande matters because China matters. And Evergrande has become this symbol of this critical juncture in China's economic story.
We've had two decades of go-go growth, created largely by the booming property sector, and now this really marks the end of that boom.
You can't just grow the economy by borrowing, borrowing, and borrowing.