China's real estate uncertainties persist, fueling market anxiety

BEIJING — Wild swings in Chinese real estate stocks and bonds are keeping investors on edge — these news headlines could cause troubles in the sector to spill into the rest of the economy, says S&P Global Ratings.

While the plunge in Evergrande’s shares has abated, the volatility in other Chinese real estate companies has continued this month.

On Thursday, Kaisa shares briefly popped 20% after news it could stave off default. On the same day, a Shanghai-traded bond from developer Shimao plunged 30%, reminiscent of a sharp sell-off in the company’s bonds earlier this month.

“Headlines can hit sentiment and drive contagion,” Charles Chang, senior director and Greater China country lead for corporate ratings at S&P Global Ratings, said in a report earlier this month.

The risk Chang laid out is that news reports about defaults, or even the potential for default, could scare away Chinese homebuyers. And that drying up of demand would put developers out of business, along with the construction companies and other suppliers that work with them.

The consensus among economists is that the real estate slump is contained, since it’s driven by a top-down government decision to limit reliance on debt in the property industry. The People’s Bank of China summed up this view in mid-October, calling Evergrande a unique case, and affirming the overall health of the property sector.

But investors have grown increasingly worried about how Beijing’s crackdown would actually play out. News of the default of a far smaller developer, Fantasia, and growing financing troubles among other developers, began to exacerbate a sharp sell-off.

The Markit iBoxx index for China high yield real estate bonds is clinging to monthly gains after a volatile few weeks — including a drop of nearly 18% in October and an almost 11% fall in September.

“It’s a really trying time for investors right now, probably more for bond investors than equity investors, because what we’re really watching is a policy transition unfolding in real time,” Jennifer James, portfolio manager and lead emerging markets analyst of Janus Henderson Investors, told CNBC earlier this month.

Even worse for foreign institutional investors, typically more comfortable with detailed messaging from companies and policymakers, China’s system tends to rely more on broad government statements and cautious corporate disclosures.

This lack of clarity has been a longstanding issue with investing in China-related assets.

Rather than companies making announcements during the worst of the sell-off earlier this month, James said she often learned about how they were doing through news reports, days or weeks later. These include meetings with the government.

“I’m not quite certain the regulators and authorities understand the damage this does to the offshore market, because a lot of investors won’t return,” said James.

The lack of clarity exacerbated the situation, research institute Rhodium Group pointed out in a note on Tuesday.

“The most significant policy signal was a non-signal: the absence of a clear decision on what concrete action to take to resolve Evergrande’s situation and stem contagion in the property sector,” said analysts at Rhodium Group.

“Officials underestimated the severity of contagion and systemic concern, made confusing pledges to prevent a full reckoning, and ultimately claimed that the initial policy disciplines that precipitated the property stress had been misinterpreted,” it said.

“If the government intended to build confidence in the direction of financial reform, the outcome has been the exact opposite,” they said.

For investors left in the dark, the ensuing anxiety meant they’d rather sell than stay invested.

“The problem is when you have a market impact that has gone far beyond what anyone would have reasonably expected at the beginning of October, you have to start asking, ‘What is the macro impact?'” Jim Veneau, head of fixed income, Asia at AXA Investment Managers, told CNBC earlier this month.

The potential macroeconomic consequences can be significant.

Real estate and industries related to it account for about a quarter of China’s economy.

Property accounts for the bulk of household wealth.

According to S&P, residential land accounts for 85% of local governments’ revenue from selling land.

Land sales to developers provide critical revenue for local governments since they can’t generate enough revenue from taxes to pay for all their expenses, according to Rhodium Group.

But developers will not want to buy as much land now, since negative investor sentiment makes it harder for the real estate companies to get financing. The business cycle for Chinese real estate companies relies heavily on sufficient financing for making sure consumers get the apartments they paid for ahead of completion.

In contrast with other industries, Chinese developers relied far more on the offshore bond market that gave them access to foreign investors.

But that channel of financing began to dry up as negative sentiment around the real estate companies increased on the back of concerns that Evergrande — which owes more than $300 billion — might default.

The number of Chinese real estate high-yield bond deals plummeted in October to just two deals, worth a total of $352 million, according to Dealogic. That’s down from $1.62 billion for 9 deals in September, and a high of 29 deals worth $8.5 billion in January, the data showed.

Those tight financing conditions reflect a relatively challenging environment for property developers to get capital on the mainland as well.

“A lot of easy things can happen through messaging,” James said. “Someone can come out and say: This is a very important part of our economy and we will always be supportive.”

But one of the latest messages from the People’s Bank of China was that the real estate market remains healthy overall.

As a result, Ting Lu, chief China economist at Nomura, is not expecting a change in the property curbs to come until at least the spring.

— CNBC’s Weizhen Tan contributed to this report.