The rise and fall of the real estate industry in China has revealed profound differences between the mainland’s financial, legal, and political systems and those of other parts of the world, triggering doubts about future financing channels.
In 2011, Evergrande issued over $1 billion worth of U.S. dollar bonds to overseas investors. This document provided the most comprehensive insight into Evergrande’s financing mechanism, bearing the logos of Western investment banking giants such as Bank of America, Deutsche Bank, and Citibank, as well as the state-owned China Construction Bank International.
More importantly, they promised an interest rate of up to 9.25% – an extremely attractive return in a post-financial crisis world where interest rates were close to zero.
With this wave of Chinese real estate USD bond issuances, Western financial institutions – essentially representing Western depositors – poured billions of dollars into the seemingly “blooming” Chinese real estate sector.
These bonds were endorsed by Wall Street elites, then issued through Hong Kong – with its Westernized legal system and investor protection – serving as a financial bridge between China and the world at that time.
As the Chinese real estate market transitioned from prosperity to downturn, this investment channel proved to be a “substandard” project, unable to provide any security guarantee related to debt instruments.
By the end of 2021, Evergrande ceased interest payments to overseas investors, marking the first clear sign of serious problems in the Chinese real estate model.
Overseas investors found these bonds now worthless. Lawyers and restructuring experts are attempting to negotiate for some rights on behalf of investors, while speculators hope to recover some returns through bankruptcy proceedings in Hong Kong.
In 2024, three years after Evergrande first defaulted on payments to overseas investors, the Chinese real estate industry continues to struggle. Beijing refuses to offer public assistance to the real estate sector, instead promising local governments will buy unsold homes. Many of these projects remain unfinished, with some controlled by provincial officials rather than being funded by overseas investors.
According to a report from Mainland China’s Shen Yin Wan Guo Securities Research Institute’s macro team, since 2021, the total area of unsold off-plan properties in China has exceeded 2 billion square meters. The most conservative estimate puts the current funding required for building settlement buildings at around 7.6 trillion yuan, with a funding gap of around 3 to 4 trillion yuan.
Goldman Sachs estimates that by the end of 2023, China’s inventory of available residential properties is worth 13.5 trillion yuan, with an additional 5 trillion yuan needed for completion due to some constructions being unfinished. The bursting of the real estate bubble has led to a housing backlog worth 30 trillion yuan in China.
The rise and fall of the Chinese real estate industry reveals profound differences between the mainland’s financial, legal, and political systems as compared to other regions of the world.
A key figure involved in the earliest listing of mainland companies in Hong Kong told the Financial Times, “They are essentially a village (assets)”. He was referring to a speculative wave of state-owned enterprises listed in Hong Kong in the 1990s. Investors were well aware of the assets and liabilities risks of these enterprises.
Within the same decade, China essentially created a private real estate market, becoming a key driver of economic growth.
Foreign investors coveted this booming market while struggling with a lack of direct investment opportunities.
Due to stringent capital controls on businesses by the Chinese Communist Party, which hindered direct overseas investment, many Chinese real estate companies then introduced offshore structures with tacit approval from authorities, a common structure seen in many other emerging markets.
Bonds were sold to international investors by specialized offshore entities set up by China (often in the British Virgin Islands). These entities primarily directed the raised funds into China in the form of equity investments in subsidiary companies – relying on dividends from these subsidiary companies to meet obligations to their own investors.
Lawrence Lu, a director at Standard & Poor’s in Hong Kong, stated during an interview with the Financial Times that this “structural subservience” in China could severely limit bondholders’ claims on subsidiary assets in case of debt defaults.
In Western markets, funds raised from the market have no inherent difference, regardless of their sources – $100 from one source is equivalent to $100 from another. However, once Chinese companies raise funds from overseas investors, they use it for project equity, surpassing the initial investors or stakeholders’ supervision or understanding.
“Once they (referring to Chinese companies) raise funds, they use it for project company equity. We do not know where the funds flow.” Lu said.
These offshore tools provided funding for companies under Evergrande. A chart in Evergrande’s documents delineated dozens of subsidiary companies, distinguishing between mainland and overseas subsidiaries.
While overseas funding isn’t Evergrande’s sole financing source, it did kickstart projects and attracted upfront payments from Chinese domestic homebuyers, which Evergrande then reinvested elsewhere.
A court in Hong Kong issued a winding-up order against Evergrande’s Hong Kong entity. However, the legal significance of this order is limited unless recognized by mainland Chinese courts.
Evergrande did not respond to requests for comments. When Evergrande defaulted, it had issued over $20 billion in offshore bonds.
Negotiations for Evergrande’s restructuring led by Kei Yi Law Firm and Hong Kong investment bank Moelis have primarily focused on its offshore listed subsidiaries, but no agreement has been reached with creditors over the past two years.
An anonymous investor from a large international company told the Financial Times that now they have “discovered what lawyers have already known, that… enforcement is not easy and will consume a lot of time and money, with limited possibilities of recovery.”
Another investor remarked, “We have always believed that engaging in the recovery process is not worthwhile. Bankers and lawyers need to sit down and devise a better structure for (future issuances).”
He predicted that such discussions might have to wait until conditions in the real estate industry improve. “That kind of market in the past two decades… no longer exists.”
A private equity investor involved in mainland companies’ listing in Hong Kong since the 1990s believes that overseas funding into these Chinese enterprises is based on a “delusion.”
“They are always the ones not getting returns.” The anonymous private equity investor said.