What's up guys and welcome back to wall street millennial, the recent ever grand disaster has stoked fears about the chinese real estate sector, which makes up close to 20 percent of the country's economy, while evergrand was perhaps the most leveraged and mismanaged developer in the chinese market. The general problems of excessive risk taking are by no means unique to them. Developers across the board have built up an insane amount of leverage to take advantage of china's inflating real estate market, the entire sector and some extent the entire chinese economy is built on a foundation of a house of cards over the past couple of decades. The government has walked a fine line between allowing real estate to inflate enough to fuel economic growth while at the same time making sure it doesn't get too big and collapse.

But the everground situation has exposed the fragility of the system in this video we'll look into how the chinese real estate bubble inflated to its current size and what will happen if it finally bursts. China's real estate inflation started in the early 2000s and at least for the first few years it seemed perfectly justified. They had only recently liberalized their economy and were rapidly transitioning from a primitive agricultural nation to an industrial powerhouse. Hundreds of millions of people were leaving their rural villages for a better life in the big cities.

With this, massive influx of new people demand far outstrips supply, causing prices to rise. This caused a boom of development which aimed to take advantage of the high prices, but by 2005, most commentators and market observers started to think that things were getting out of hand. This was the start of the real bubble people lucky enough to have already owned homes. In the big cities like beijing and shanghai were sitting on massive gains becoming millionaires after just a few years, and the developers who got in early were also making obscene amounts of money.

But success always brings in competition. People who didn't own a home got fomo and everyone was saving and borrowing as much as they could to buy real estate. New development companies were being formed every day to capitalize on the boom. Home prices were increasing far faster than people's incomes, so housing was getting increasingly unaffordable in china.

There is a huge social drive to own a home and it carries a huge social prestige for many families. It is almost a precondition that a man must own a home before he can get married. This causes people to take out huge mortgages to buy homes that they probably can't afford. It's not uncommon for half of someone's gross salary to go to mortgage payments and with prices seeming to only go up.

People who already owned a home started buying second properties purely to benefit from the appreciation. While prices were increasing across the country, the biggest gains were concentrated in a few big cities such as shanghai, which saw residential real estate prices, increased more than 150 percent between 2003 and 2010, and the frenzy wasn't just on the demand side, but also on the supply Side, industrial companies such as textile and chemical manufacturers started opening up real estate development subsidiaries to take advantage of the superior returns without having any core competencies in real estate. They usually made low quality developments with questionable safety in 2008. A collapse in the u.s housing market caused a financial crisis.

The failure of major financial institutions such as lehman brothers and bear stearns sent shockwaves across the global economy. This caused a massive deleveraging in the u.s real estate sector, with the average home price falling about 30. From peak to trough, china was not immune to the crisis and prices also dipped briefly, but surprisingly, they rebounded almost immediately and continued their upward trend. By this point, real estate was more important to the chinese economy, even than it was in the us.

The government knew that an uncontrolled collapse could lead to a major depression. They announced a 586 billion stimulus plan which was of an unprecedented scale at the time for comparison. Obama's stimulus package was about 800 billion dollars, despite the us economy being three times larger than the chinese economy. The chinese stimulus plan was wide-ranging, with most of the funds allocated to public infrastructure projects.

Much of the money was also loaned to state-owned property development companies to help them keep afloat and protect construction jobs. The stimulus plan was extremely effective and the slowdown in gdp was barely even visible in the long run chart with the economy continuing its strong growth. So too did real estate prices. Again, most of the gains were concentrated in the so-called tier 1 cities of beijing, shanghai guangzhou and shenzhen.

For example, in beijing, average home prices rose to 54 times the average income. This was about 5 times. The international average price to rent ratios were also very high, with the average home costing 500 times the monthly rent. That means that prices could not be justified by the rental income that they generate.

They were instead being purchased by people who thought they could sell it to someone else in the future at a higher price. By this point, the real estate inflation was starting to reach a point of absurdity. Much of the cost of the 2009 stimulus program was footed by local governments to fund their operations and pay down debt. Many local governments sold state-owned lands of private developers.

These land sales made up as much as 50 of their revenue with property prices already sky high. In the major cities, many speculators started buying properties in small cities, where prices were still low, developers would buy rural land from local governments and develop massive cities in the middle of nowhere. Very few people actually lived in these new developments, but people still bought them in the hopes that prices could rise in the future. This led to the creation of massive ghost cities that cost hundreds of millions or even billions of dollars to create but created no real economic value.

People would buy unfinished properties and let them sit empty for years while they wait for prices to rise. This is obviously an economic inefficiency, as nobody gets any utility from the empty building developers tried to build these properties as quickly as possible, with safety and quality taking a back seat. Many developments had to be demolished within a few years and rebuilt many observers, including famous short seller, jim chanos, thought that the bubble was finally reaching a breaking point in 2010. We consider we can.

What we define as a bubble is is any kind of debt, fueled, asset inflation, where people are borrowing money to buy the asset where the cash flow generation from the asset itself, a rental property office building, does not cover the debt service and the debt incurred to Buy the asset, so you depend on a greater fool. If you will, i think minsky called the great khans minsky called the ponzi finance, meaning you you. You need the greater fool to come in and buy it at a higher price because, as an income producing property, it's not going to do it and that's certainly the case in china right now, yeah. In fact, a lot of these apartments are empty.

That's the amazing thing: when you buy an apartment in china, typically in a high-end project, you get an empty shell, you don't even get internal walls floors and what's even more interesting as we did. Our research was the realization that investors who buy more than one property, as often we saw in miami and other markets in the us they keep them empty. They don't rent them because it's much easier to sell a unoccupied apartment for the next speculator to flip it. The game has to keep going they're on this treadmill to hell, as i call it, because so much of their gdp growth is construction 50 to 60 percent of this country's gdp is construction.

We've not seen that in terms of a major country i think in in for a long time, if not at all, and so for them to get off of stopping construction. You'll see gdp growth go negative very quickly. That's not going to happen because in china, as we say, it's all about making the number people are rewarded at almost every level of government of making their economic growth numbers. The easiest way to do that is put up another building.

But despite the apparent absurdity, property prices continued to rise. By this point, the chinese government was getting worried about the speculative excesses in the market. In the 1980s, japan had a real estate bubble, even bigger than china's when it finally burst in the 90s, it triggered a massive recession which they have not yet recovered from. Even today, they enacted new regulations requiring higher down payments for mortgages and limiting the number of residences that people can buy in certain cities.

This slowed down the inflation of property prices for a few years, but by 2013 they were increasing again, it's very difficult to call a top on china's real estate market, because the country is still urbanizing every year, tens of millions of people move from rural areas to Cities, so, even if there's a supply glut today, it's theoretically possible that demand could grow enough to justify the prices eventually and if people are willing to continue holding the majority of their net worth in real estate, the bubble can persist almost indefinitely. The government's currency controls make it difficult for chinese individuals to invest in overseas stock markets, and many investors are skeptical of the highly volatile chinese stock market. So real estate sometimes seems like the only option to preserve wealth and generate investment returns and with 20 years of accumulated price gains, the bubble seems to be as big as ever. In 2020, the chinese government again tried to rein in speculative excess by tightening leverage ratio, requirements on property developers and banks who lend to them.

These regulations forced evergrant to start fire selling their properties to comply. Evergrand will likely face a serious restructuring with common shareholders likely to be wiped out. This deleveraging is probably a good thing, as it will help stabilize the market, while evergrand was the most leverage of the major property developers they're by no means the only one. Almost all real estate developers in the country have built up massive debt burdens over the past decade, including country garden holdings, which is even larger than evergrand by sales country garden, invested billions of dollars in the forest city, artificial island development in malaysia, but a worsening of China-Malaysia relations and coveted travel restrictions turned this development into a complete disaster.

It currently has about 500 active residents compared to a capacity of 700 000. These types of projects show how much risk chinese property developers are willing to take on and they're primarily funded by debt, while the government is trying to cool things down. The excessive leverage already built up in the system makes the risks very high in an optimistic scenario. They could orchestrate a soft landing where property prices and economic growth slow down gradually.

In a worst-case scenario, there are a lot of other evergrads out there waiting to explode, alright guys that wraps it up for this video. What do you think about the chinese real estate market? Let us know in the comments section below, if you enjoyed this content, make sure to hit the like button and subscribe. So you don't miss future uploads as always. Thank you so much for watching and we'll see you in the next one wall, street millennial, signing out.

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