Breaking China’s Backbone: The Real Estate Crisis and Vanke’s Descent

 

Vanke's decision to sell prime Shenzhen land at a 29% discount highlights the desperation and financial distress gripping China's property giants.

Land in Shenzhen, China's southern technology hub, is a land of sky-high aspirations and equally lofty real estate prices. Historically, land in Shenzhen has been a golden ticket for property firms, with plots fetching exorbitant amounts. However, the recent announcement by Vanke, one of China’s largest property firms, to sell 19,000 square meters of land at a staggering 29% discount from its purchase price seven years ago signals a desperation unseen in the sector before. This article explores the potential collapse of Vanke, arguing that such an event could undermine confidence in the Chinese state’s management of its economy.

On May 18th, Vanke's decision to offload prime Shenzhen land at a discount of 900 million yuan ($125 million) epitomizes the firm's financial distress. With debts piling up, Vanke's struggles underscore the broader crisis in China’s property industry. Four years into this crisis, the potential collapse of another giant might seem unremarkable. However, Vanke's situation is different. Unlike Evergrande, which fell in 2021, and Country Garden, which succumbed in 2023, Vanke enjoys significant state backing.

Shenzhen Metro, a state-owned firm, holds approximately a quarter of Vanke's shares. This affiliation has provided Vanke with greater access to state funds compared to its purely private counterparts. Moreover, Vanke was recently included on a list of “high-quality” developers to which the government encouraged bank lending. Despite these advantages, Vanke is still grappling with a severe cash crunch.

Vanke's financial woes are alarming. In the first quarter of 2024, the company reported a loss of 1.7 billion yuan, with sales plummeting by 43% year-over-year. Vanke’s debt obligations are substantial, amounting to 320 billion yuan, including 31 billion yuan in public bonds due to mature over the next year. The fear of default is palpable among investors. A default at Vanke could shake confidence in all state-backed developers, which until now have fared better than their private counterparts amidst the crisis.

Analysts at Jefferies, an investment bank, have noted that a default at Vanke could “break China’s back.” The implications extend beyond Vanke's balance sheet, threatening the perceived stability of the state’s economic management. The loss of trust in state-backed developers could lead to a broader loss of confidence in the state itself.

Another critical issue exacerbating the crisis is the swift decline in land-reserve prices. Vanke's land in Shenzhen, initially bought for 3.1 billion yuan in 2017, is now set for auction at 2.2 billion yuan. This significant drop in a top-tier location’s land price is shocking. Ever-increasing land reserve prices have been the backbone of Chinese real estate, but this trend is reversing.

Big property developers hold around 2 billion square meters in land reserves, according to ANZ, a bank. This figure excludes land held by unlisted companies, which often hold substantial amounts in smaller cities. Historically, developers relied on the increasing value of these reserves to bolster their asset values and secure loans. As land prices rose, developers would use their increasingly valuable land as collateral to obtain more loans and buy additional land, creating a cycle of ever-increasing leverage.

In 2020, recognizing the risks of infinite leverage, the Chinese government intervened, limiting the debt companies could take on relative to their assets. However, this measure came too late to gain full control over the property crisis. When land prices stopped rising in 2021, banks began to question the true value of reserves used as collateral. This skepticism led to reduced leverage, further deflating land prices and perpetuating a downward spiral.

The severity of the situation is difficult to gauge fully because most land reserves are tightly held by developers hoping for a market rebound. Vanke's current predicament offers a rare and alarming glimpse into the reality of the crisis.

The potential collapse of Vanke could signify more than just the downfall of a major property developer. It could symbolize the fragility of the Chinese state's economic management and the perilous state of its property market. Vanke’s struggle to stay afloat amidst mounting debts and falling land prices exemplifies the broader issues plaguing China’s real estate sector.

If Vanke defaults, the ripple effects could erode trust in all state-backed developers, undermining confidence in the state’s ability to manage its economy effectively. Such a loss of confidence could have far-reaching consequences, potentially destabilizing the entire economic framework. The unfolding crisis in China’s property market, highlighted by Vanke’s desperate measures, is a critical issue that demands urgent and decisive action from policymakers.

The story of Vanke is a cautionary tale of how even state-backed giants are not immune to market forces and economic mismanagement. As China navigates this complex crisis, the outcome will be closely watched by investors and economists worldwide, each looking for signs of stability or further turmoil in the world’s second-largest economy.