Evergrande and Real Estate Value Subjectivity

The world press has been rife with stories about Chinese housing developer Evergrande, and their probable inability to make do with their excessive debt payments. Evergrande, a top five Chinese housing developer, participates in a housing market that accounts for almost 30% of Chinese GDP. Currently, Evergrande has more than 800 projects spread among cities of all sizes in China. Unfortunately, construction has recently ceased on 500 of those projects as the firm has run into liquidity issues. One might question how this could happen, as housing demand in China has remained lightning hot. In fact, Evergrande had pre-sold 1.2 million homes in advance of completion. The unprecedented demand for housing has led to record home prices in China, a phenomenon also witnessed in Korea, Japan, India, and Australia. The increase in home prices should be familiar to Western audiences, as this same story has been told in numerous markets in Europe and North America recently. After almost two years of work from home owing to the pandemic, housing has never been more important. Unfortunately, at least in China, the concomitant rise in income has not kept pace with the increase in housing prices, causing the size of the Evergrande starter flat to continually shrink. As Chinese home buyers reach for that buoyant euphoric future, the resultant first home has increasingly resembled a smaller version of itself.

If housing demand was not the problem for Evergrande, what was? After the company went public in 2009, the ensuing decade saw loose credit and low interest rates, which allowed the firm to expand their empire via land acquisitions. For a housing developer, the first step in housing construction is often land purchases. Then, the firm can decide on what type and how many homes can be constructed based on local zoning ordinances and housing aesthetical and affordability considerations. As the credit enabled land acquisition binge was unfolding, Evergrande diversified into a dizzying array of unrelated businesses including electric vehicles, bottled water (as marketed by Jackie Chan), online car sales, an amusement park, and even a majority investment in the Guangzhou football club. These competing business interests, along with the accumulation of over 570 billion yuan of interest-bearing debt, have brought Evergrande to its current predicament. How these issues compounded into the impact on housing construction is evidenced by 60% of the firm’s assets now consisting of unbuilt/unsold properties. In order to move the projects forward, Evergrande turned to bartering, as the most common form of payment to suppliers and contractors has been unfinished homes since mid-2021.

Further complicating Evergrande’s business model was China’s Three Red Lines policy for the real estate industry whereby public real estate firms in China had to keep their liability-to-asset ratio below 70%, their debt-to-equity ratio less than 100%, and their cash-to-short-term debt ratio less than 100%. The purpose of this government intervention was to force Chinese real estate firms to deleverage. Evergrande breached all three red lines in fiscal year-end 2020, allowing the government to place limits on the company’s growth aspirations. Interestingly, the Shenzhen government is a large stakeholder in Evergrande, and the central government is also a primary shareholder through the Ministry of Finance’s CITIC Group. The government as shareholder concept may keep Evergrande from default, but it offers an interesting panoply of real estate valuation issues.

Take, for example, the Chinese Residential Mortgage Backed Securities (RMBS) market. This market practically got its start in 2016, and a challenge like Evergrande could prove to be the first serious test of repayment performance of those residential mortgage bonds. A review of recent market reports presents an unclear future, as some analysts focus on the fact that Chinese RMBS should be shielded from Evergrande as the mortgage loans in the mortgage bond pools are mainly completed homes. Of course, residential properties still under construction are often sold to the public. Once the top of a residential property is sealed, Chinese regulations allow for the property to be offered as collateral by a home buyer in taking a mortgage loan from a bank. While the home buyer and the lender are expecting the home to be completed soon after purchase, construction risk ensues if the developer is unable to complete construction, something that is happening in the case of Evergrande. Unfortunately, loans for pre-completion properties are also common assets for Chinese RMBS deals. Some reports have stated that Chinese RMBS pools can contain up to 30–40% of homes with construction risk. So far, the default rates on Chinese RMBS have stayed near historical lows. But the impact of Evergrande and how the Chinese real estate sector responds to the Three Red Lines policy remains uncertain.

In my new book, Real Estate Valuation: A Subjective Approach, readers can learn more about the subjectivity of real estate valuation, sustainable home valuation and housing bubbles, valuation problems facing residential property developers, and the various mortgage securitization models in the world including RMBS. To quote GLS Shackle, “Valuation is a judgment or aesthetic response influenced by perhaps a great number and variety of characters or measures which the chooser discerns in a particular imagined sequel.” Suffice it to say that Evergrande provides a real-time and real-world example of the pitfalls that await large real estate developers who become enamored with growth via debt, unrelated business expansion, and a movement away from the primary competency of the firm. When you include government market intervention, housing developer indebtedness to multinational lenders, a worldwide pandemic, and an inchoate secondary mortgage market, the resolution of this story might stoke even the calmest of hearts.

G. Jason Goddard

Wake Forest University

Issue 23(1) Introduction

While the world is constantly in flux, we at the Journal of Asia-Pacific Business strive to provide you with a stable foundation of scholastic inspiration for your research. We are aware that the contents of this editorial will be reaching you well after it was written, and the world will have changed phenomenally by then, but we are hopeful that the substance of the following four articles, our first of the new year, will encourage you to finalize your latest project or to begin an exploration of a business-related issue regarding the Asia-Pacific area from which we all can benefit.

Our first article for Issue 23, Volume 1 is “Cultural and Relational Capability on Business Performance: Role of Value Co-Creation,” by Mulyana Mulyana, Tatiek Nurhavati, and Lutfi Nurkholis of Universitas Islam of Sultan Agung. The article explores how value co-creation interacts with other business management strategies to improve businesses’ overall performance. The second article, “Philippine Television Network Companies’ Corporate Social Responsibility Engagements and Electronic Word-of-Mouth: The Intervening Role of Consumer-Company Identification,” is by Shaira Castro, Jean Paolo Lacap, Arisha Mae Garbosa, Estrelita Jimenes, and Seranne Finelle Mallari and investigates the positive relationships between electronic word-of-mouth advertising and consumer-company identification on the Philippine television industry.

The third article of the new volume/year is by Aparna Bhatia and Pooja Kumari of Guru Nanek Dev University. “Deleveraging Drive in the Indian Corporate Sector: Inter-industry Intervening Evidence,” examines influences on the capital structures of Indian industry over time and with the substitution of different debt structures. Our final article of the new volume is, “Factors Influencing Consumer Loyalty: A Study on Japanese Retail Stores,” by Takafumi Nakamori of Ryukoku University and Stephen Newell and Bernard Han of Western Michigan University. The study focuses on specific features of consumer experience that result in higher brand recognition and stronger consumer loyalty.

In one way, we remain constant, and that is in our gratitude to you, our readers, authors, and reviewers for your enthusiasm for scholastic investigation of Asian-Pacific business. We wish you well for the remainder of your university year and much success in your academic pursuits.

Thank you!

Disclosure statement

No potential conflict of interest was reported by the author(s).