"The Chinese economy is quickly falling apart."
"China already collapsed!"
-Youtube
In June 2022, a country that usually tolerates dissent in small doses faced a surprisingly strong revolt. People from all around the country were protesting; some walked to the streets, while the majority took to social media, both of which are often tightly monitored and censored by Chinese officials. Within just a month, the protests had extended to people in 100 cities.
So what really happened in China? The protests were not political, as one might guess. But it was essentially economic in nature. Apartment buyers, real estate investors, and angry homebuyers were all boycotting mortgage payments, as property developers across the Great Wall were on the brink of construction failures. S&P estimated that the boycotted loans could total $145bn, or it could be even higher as other analysts said.
To say that this is a problem would be an understatement. The property industry in China is one of the biggest contributors to the country's economy, accounting for around one-third of total economic output. This comprises housing, leasing, and brokerage services, as well as enterprises producing white goods for apartments and building materials.
Aside from the big industry, this crisis affects a large consumer base as well. Based on a crowd-sourced estimate on Github, people have purchased homes in roughly 320 projects across the nation. And according to banking giant ANZ, more than $220bn in loans could be linked to incomplete projects.
All of these issues can be disseminated into three aspects: the real estate developer, the lending system, and the homebuyer behavior. The essay's central question is not about the spillover impact from China to Indonesia, but the pattern in all three aspects would indicate a concerning trend towards similar issues.
The Real Estate Developer
The crisis first started in September 2021, when Evergrande, the biggest developer in Mainland China, became the world's most indebted property developer. It has been struggling to make payments on its more than $300 billion in liabilities, and even missing a major repayment date on its foreign debt in December 2021.
According to the banking giant Nomura, an increasing number of developers have failed to repay their debt and have been unable to complete their construction works since the Evergrande crisis. It appears to be true, as thirty other real estate firms have also failed to make foreign debt payments.
What actually triggered this problem in the first place? It all stems from a faulty development system and how property developers are exploiting it. Many of the developments rely on “presales”, with customers making mortgage payments on units that have yet to be built. According to Mr Evans-Pritchard, a senior economist at Capital Economics, these "pre-sales" account for 70%-80% of new house sales in China, and developers want the money to fund many projects at once. Some critics have even gone so far as to term this a massive Ponzi scheme (Hodges, 2021).
Ponzi schemes make it seem like it benefits people who join at the start, that they might obtain their promised value from the people who joined later. But at some point, the flow of buyers and investors stops. And eventually, the project couldn’t be continued. Developers and investors are overusing the leverage of lending systems and collaterals for home purchases, and this type of leverage has caused them to raise their risk-taking behavior in home purchase and investment. This was described by Professor Michael Pettis of Peking University while discussing the psychology of the bubble.
What about Indonesia? According to W&P, an Indonesian law firm specializing in Real Property, the development and sale of apartments and condos have risen dramatically in the recent decade. Back in 2018, Indonesian developers were expecting to create roughly 21,000 new apartment units.
With the number of new Apartments increasing significantly in 2018, developers are rushing to get a larger market share and increase sales to avoid a huge number of units going unsold. Hence, presale became a typical occurrence in the property industry. This pre-construction marketing strategy enables developers to take advantage of the asymmetric information over potential buyers, who cannot examine the property at the time of signing the sale and purchase agreement, and thus potential buyers' interests are frequently jeopardized due to uncertainty.
We may recall how the apartment developers Royal Afatar World (RAW) and Royal Mutiara Residence (RMR) in Sidoarjo, East Java, Sipoa Group never completed their projects despite consumers paying a down payment and making installments up to 23 times.
And as recently as 2021, disputes on bankruptcy litigation against property developers have become increasingly common, posing a significant risk to property customers. Property buyers have filed the most complaints with the Indonesian Consumers Foundation or Yayasan Lembaga Konsumen Indonesia.
The Mortgage Financing System
The issue in China's housing market is a structural one, and it also involves the financing system. First, this problem was exacerbated by easy access to loans, with banks eager to lend as much as possible. According to ANZ research, mortgages account for over 20% of all outstanding loans in China's banking sector. Second, property investing has always outpaced the market. Around 80% of the population owns property, with an astonishingly high number - over 20% in metropolitan areas, and estimates as high as 40% overall - owning several properties.
According to research done by Smith and Gjerstad in 2020, the Indonesian housing bubble could be heading towards a burst. Economic factors that are integral to its propagation have made this reality inevitable. For instance, a surge in house ownership predisposed the real estate industry to a recession, which can eventually lead to the bubble burst. The rise of ownership was caused mainly by the low interest loans offered by lending firms in Indonesia, usually known as Kredit Pemilikan Rumah or KPR.
This easy access to financing has resulted in a rise in the number of persons who owned homes despite having insufficient financial resources. It also resulted in the majority of homeowners being unable to repay their mortgages in the long term.
The Homebuyer Behavior in China and Indonesia
The property sector in China started booming after market reforms in 1998. Responding to the high demand from an expanding middle class that considered housing as a major family asset and status symbol, there was a significant construction boom. Purchasing real estate as an asset has been viewed as a reliable and secure investment by Chinese consumers, and it has been until now.
Many Chinese from the middle and high classes go on to acquire second and even third homes. In addition to the expectation of future financial gains, owning property symbolizes better status in Chinese culture and is regarded as an important milestone before marrying and raising a family (Witte, 2021).
This is also proven by the fact that real estate accounts for about 70% of personal wealth in China. Their willingness to pay for properties is also relatively high, with residents in Beijing and Shanghai paying property prices comparable to those in San Francisco and New York, while earning just one-fourth of what Americans do.
The homebuyer behavioral trend in China is strikingly similar to what has been going on in Indonesia, where parents used to tell their children how important property investments are as a family asset. This is supported by the people's belief that investing in real estate would provide long-term benefits, since there is an expectation of increased middle-class consumer spending on the residential business segment, as well as urban society demand for flats and condominiums (Daryanto, Samidi and Siregar, 2018).
According to Statista, Indonesia's real estate market has increased over the previous decade, with property demand increasing every year in accordance with population growth.
What to Look Out For
China’s property crisis didn’t only shock disgruntled Chinese homebuyers, but it also shocked the world. Many people are claiming that China’s economy is about to fall, and some are even claiming it as a replication of the 2008 Financial Crisis. But while the hype of a declining rival superpower might be “fun” for some, the narrative doesn’t really stand true.
China's economy is unlikely to undergo such a severe economic meltdown. According to Teneo's Wildau and several other experts, Chinese authorities have far better control over the financial sector and the actual economy than US policymakers had in 2008. So they have the means to avert a major disaster.
On another note, while there is a pattern of comparable variables and features in the real estate climates of China and Indonesia, it is difficult to determine whether Indonesia will experience a similar crisis as China has lately. There are a lot of additional factors in play, and even comparable variables may not be the same. Nonetheless, as a developing country and one of the emerging property players, Indonesia must exercise caution in its real estate management.
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Unix Bryan Sadikin | Economics 2021 | Staff of Kanopi FEB UI Studies Division 2021/2022
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References
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