Foreign. On August 18, 2023, the massive Chinese real estate developer Evergrant filed for Chapter 15 bankruptcy protection. This didn't really come as a surprise to anyone. Their financial troubles were widely reported in the media last year, including on this channel.

Evergrant had so much debt that when the property Market turned South they were unable to complete their existing projects. A bankruptcy filing was ultimately inevitable. What's much more concerning is the recent financial troubles of another Chinese property developer called Country Garden Country Garden is the single largest developer in China with 240 billion dollars of assets and 200 billion dollars of liabilities. In early August, they missed an interest payment on one of their bonds.

There's a 30-day grace period, so they technically haven't defaulted yet, but this suggests that money is tight and Country Garden is seriously tight on cash. Their share prices declined 93 over the past five years, and their bonds are currently trading around 10 cents on the dollar. After years of strong growth, home prices started declining in 2022. This has been a disaster for Real Estate developers who borrowed inordinate amounts of money on the assumption that prices could only rise.

In this video, we'll take a look at the rise and fall of Country Garden China's largest property developer and see what this means for the country's economy in general. Foreign was founded in 1992. They build large development projects of high-rise buildings with each apartment being sold individually. Most of the large property developers focus on large cities like Beijing and Shanghai.

These cities are the richest, so people can afford to pay top dollar for luxury apartments. The problem is, with so many developers wanting to build in these cities, the land prices have also become very high, which eats away a lot of the profits. So Country Garden Followed a different strategy. they focused on smaller cities and relatively poorer regions.

of. China They would buy land cheap and build massive high-rise apartment buildings. Over the past 30 years. This strategy worked brilliantly.

China's economy was growing rapidly, so people, even in the smaller cities could afford to buy the apartments. Investors from out of town were also lining up to buy them as speculative. Investments For example, Let's suppose an apartment in downtown Beijing cost 1 million dollars. An apartment of similar quality in a smaller City only cost two hundred thousand dollars.

The rent in the smaller city is much lower, so on rental income them alone, you couldn't justify the price. But if you think the city will grow and rents will rise over time, this could be a good long-term investment. Country Garden Strategy worked brilliantly throughout the 2010s as real estate prices in China generally increased. In 2021, their revenue reached a peak of 523 billion.

Chinese Yuan and they generated a 27 billion Yuan net profit. This is equivalent to 72 billion in 4 billion dollars, respectively. Property development is one of the most Capital intensive Industries in the world. You have to put up tens or even hundreds of millions of dollars to buy the land and fund the construction.

It'll be a few years before construction is complete and you can deliver the finished departments to customers. They funded their growth primarily through debt. At the peak in 2020, they had two trillion Yuan of assets, the majority of which was properties held for sale and under construction. They had 1.75 trillion Yuan of liabilities, giving them a liability to asset ratio in excess of 85 percent.

To be clear, Country Garden wasn't alone. Almost all the Chinese property developers had similar leverage ratios. So long as real estate prices are rising by the time your high rises are finished, the value will have increased. The money you make from the sales will more than offset the debt you incurred to build the project.

The more money you borrowed and the faster you grew, the more profits you made. Developers like Country Guardian and Evergrant were rewarded by investors with strong share price gains in the late 2010s. Country Garden had a few ways of securing funding for new developments. Firstly, buyers would often pre-purchase The Apartments before construction begins, making down payments as high as 30 percent.

Most of the remaining funds came from issuing corporate bonds and borrowing money from banks. With their confidence bolstered by prior success, they engaged in increasingly ambitious projects. For example, since 2014, they've been spending billions of dollars to develop an artificial Island full of luxury condos off the coast of Malaysia. While some of the construction has been completed, legislation passed by the Malaysian government made it more difficult for Chinese citizens to buy the properties which was supposed to be the main customer base.

Most of the condos remain empty and only a tiny fraction have been sold. The project is widely considered to be a debacle and Country Garden is on the hook to lose many billions of dollars. Despite the project running into many unexpected problems, this has not shown up on. Country Gardens financial statements with the company reporting positive net profit every year until 2022.

Properties under development are recognized is value of the land plus construction costs incurred today. In theory, the progress of each development should be periodically reviewed if it's going worse than expected. The company is supposed to recognize an impairment charge. historically.

Chinese property developers have been slow to recognize impairment charges, so it's difficult to get a sense of how much their real estate assets are actually worth. As of the end of 2022, Country Garden had 1.74 trillion Yuan of assets and 1.43 trillion Yuan of liabilities. So In theory, they had positive shareholders Equity of 310 billion, but if their properties are worth just 20 percent less than they think they could be insolvent for most of the past decade, this wasn't a problem. Even if some of their projects were boondoggles, most of them did well with China's real estate market red hot.

They were able to quickly sell their Apartments upon completion, and the cash flow was more than enough to service their debt On paper. Their shareholders Equity kept increasing, allowing them to borrow even more money and keep growing. Everything changed in 2021 when the Chinese government rolled out the Three Red Lines policy. This created maximum allowable leverage ratios for property developers.

Any developer that exceeded these levels would be required to deliver their balance sheet over a period of time. While the Three Red Lines policy itself did not cause the real estate collapse, it did cause investors to pay greater attention to the precarious financial position that many of the developers were already in. Evergrant was in the worst position, and they soon became the subject of credit ratings downgrades, making it even harder for them to refinance their massive debt load. Also, customers were reluctant to make down payments on new Evergreen developments, as they feared that the company would not be able to finish construction.

Tens of thousands of home buyers were stuck with half-finished properties that Evergrant didn't have enough funds to complete. The Evergrand collapse created a domino effect, with everyone on edge speculating about which developer would be the next to fall. In 2022, new home sales decreased by 40 across the industry. Country Garden was not immune.

In the first seven months of 2021, they sold 357 billion Yuan worth of apartments. In the same period, in 2022, this had declined by 40 to 215 billion. in the first seven months of 2023, this declined yet another 35 percent to 141 billion. Country Garden was especially hard hit because their developments were disproportionately in the so-called tier 3 and Tier 4 cities.

These are smaller, up and coming cities and Real Estate Investors consider them to be more speculative. With the rapid change in sentiment, investors no longer wanted to buy these apartments. If they decreased their prices substantially, they'll be able to sell them at fire sale prices. and to some extent it looks like that's exactly what they're doing.

On August 10, 2023, Country Garden published a profit warning where they said they will report a 50 billion Yuan loss for the first half of 2023. This losses the result of lower margins on property sales as well as impairments on some of their development projects. This loss came despite enacting massive Cost Cuts At the corporate level. they said the financing environment is an extreme distress, making it difficult to refinance their bonds and they're burning significant amounts of cash.

They admitted that they invested excessively in third and fourth tier cities and did not understand at the time that this would cause an oversupply. They're attempting to fire sell their properties, but the market is declining so fast that the proceeds they generate may not be enough to cover their debt. Basically, the same thing that happened to Evergrant is now happening to Country Garden They haven't gone bankrupt yet, but by this point it looks almost inevitable. Country Garden currently has over 3 000 developments under construction, representing an estimated 1 million.

Apartments. Given their financial difficulties, it's unlikely these projects will be finished anytime soon. Thank you! It's not just Ever. Grand and Country Garden Over the past two years, dozens of property developers with trillions of dollars in Collective liabilities have either defaulted or entered into some kind of financial distress.

This could have a number of knock-on effects for the rest of the economy. Firstly, there are hundreds of thousands of people who have already paid significant down payments for homes that may never be completed. Also, millions of investors across China have indirect exposure to the real estate developers without even knowing it. In addition to borrowing from the traditional Banks, many property developers have turned to so-called Shadow bangs.

These shadow Banks raise money from wealthy individuals, offering them higher yields than what they can make from traditional savings accounts or government bonds. The shadow bank then lends the money to various companies, including property developers. They have far lower credit standards than traditional Banks and the loans often have non-standard terms. The investors who buy into these shadow banks are often led to believe that it is a safe investment without fully understanding the credit risk.

One of the biggest Shadow banks in China is called Zhongjir. With over 1 100 billion dollars of assets under management, they are believed to have significant exposure to distressed property developers. And in August they announced they would be restructuring their debts. This likely means their retail investors will take significant haircuts.

The bottom line is that a lot of people are going to lose a lot of money in China and this has raised fears about the country's economic growth going forward. Many analysts are comparing China's current real estate disaster to the Japanese real estate bubble, which popped in the early 1990s. Following that bust, Japan's economy is stagnated with minimal economic growth. China is indeed facing similar problems with a real estate market That Grew too fast and now needs to come back down to Earth, But there are a few major differences.

In the 1990s, Japan was already an advanced country with high-tech Industries and output per capita similar to the US and Western Europe, The rate of economic growth was set to slow down anyway, as they had pretty much exhausted all the easy gains from the post-world War II Re-industrialization China is still a relatively poor country and they still have a a lot of room to grow in the manufacturing and Technology sectors. While the bursting of the property bubble will certainly be painful for the next few years in the long run, it's probably a good thing for the economy to become less reliant on construction, and the government seems to understand this. The Draconian crackdowns on the technology industry from 2021 have gradually been wound down. The government is now supporting these companies And I hope that they can replace some of the lost jobs from the real estate sector.

While the problems in the real estate market are real, it's too early to count China out as a major economic power. Alright guys, that wraps it up for this video. What do you think about Country Gardens Financial troubles? Let us know in the comments section below. As always, thank you so much for watching and we'll see you in the next one! Wall Street Millennial Signing out.