Will Evergrande remain ever grand?


THERE is a common joke in China’s real estate fraternity. When the real estate market is bad, buyers will complain about everything during the property handover. But during a bull market, if you handover a unit without a front door, they would still gladly take possession.

That is the nature of the real estate industry. It is one of the most important sectors in the economy in most parts of the world, not only from an economic standpoint but also from a societal angle.

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Housing for the masses has always been a thorny issue that governments of the day are required to address.

A good government is one that is deemed to have a policy which balances the people’s housing needs versus the vibrancy of the real estate market. This is because real estate functions not only as an asset class but it also serves a greater humanitarian need, a roof over one’s head.

Traditionally, developing economies around the world have higher gross domestic product (GDP) growth percentage in comparison to developed nations as real estate and construction forms a huge weightage in its contribution towards the GDP of a country.

The real estate sector creates far reaching spillover effects where a boom in this single industry results in growth for other sectors along the value chain such as building materials, steel, furniture, logistics and countless others.

However, as a country’s economy transits from developing to developed, one would notice a gradual slowdown in the pace of its real estate projects.

Indeed, real estate, infrastructure and construction is the most direct way in which fiscal stimulus can inject life into the economy but it is never the most sustainable.

This is primarily because it is a debt driven sector where developers, contractors and end consumers rely on loans to fuel its demand. Hence, debts will pile up substantially over time, especially if unregulated.

This brings me to the most pressing issue in the real estate world today; China’s Evergrande Group’s (Evergrande) potential collapse. Evergrande is the second largest real estate developer in China by sales revenue. Another interesting “title” it helms would be the world’s most indebted company.

Evergrande has liabilities amounting to an estimated US$300bil (RM1.26 trillion) from years of aggressive expansion.

To put it into perspective, Malaysia’s total debt as of December 2020 stood at RM1.26 trillion. Imagine a company’s liabilities is equivalent to our nation. Now what if it defaults on its debt obligations and goes under? Until today, China has yet to go through any major recession unlike other economies around the world. Many market commentators are increasingly worried that the potential default by Evergrande would pose a systemic risk to the economy of China.

Some are even saying that Evergrande may potentially be China’s version of Lehman Brothers. Although I do not think so, there are flashing red signals.

At present, Evergrande has 10 active offshore bonds issued on the market. To get a gauge on its precarious state, the company’s bond with the soonest maturity on March 23, 2022 has fallen a whopping 70% to 30 US cents as of Sept 14, 2021.

For the bond furthest from maturity on June 28 2025, it has fallen 67% to 27.46 US cents. This essentially means the bond market is pricing a default. The table shows five of the largest Evergrande bond issuance in size and its performance.

When the 2019-2020 Hong Kong protest (also known as Anti-Extradition Law Amendment Bill Movement) erupted, many with the government of the day blamed the Hong Kong youths as unpatriotic, unappreciative and hateful.

While not highlighted sufficiently, there were actually underlying economic factors which spurred the protest.

The key one being exorbitant housing prices which made it out of reach for many youths. Unlike Singapore, the affordable housing schemes in Hong Kong is far from comprehensive due to the expensive land cost which is part of a key revenue stream for the Hong Kong government.

During the protest around September, 2019, I was in Hong Kong for a business meeting. I remembered my friend’s 630 sq ft private condominium unit in Sai Kung (which is near the port and surrounded by fishing villages), cost HK$11mil (RM5.9mil).

That is equivalent to an unfathomable RM9,400 per sq ft. In my view, most youths would never be able to own a home at such pricing.

Real estate is often described as old economy and many of the older generation built their wealth from real estate during the booming economic years.

In fact, many of the “old money” of the world today have some ties to real estate one way or another. After all, it is an asset class that hedges well against inflation and preserves the value of wealth or money rather effectively.

Yet, whether real estate should be economic driver of a country is debatable.

Whenever I assess the real estate market, a respectable figure that comes to my mind would be Tan Sri Chew Chee Kin, the long time president of Sunway Group and trusted general of Tan Sri Jeffrey Cheah.

Back in 2015, I was a group strategy manager with the organisation and had the opportunity to sit in some of the leadership meetings.

I remembered his wise words to the senior management at the time. He said “the golden age of real estate may likely come to an end with the supply flooding the market, the company needs to take note of this. Unless one can find a way to build houses like how Toyota build their cars, otherwise it is hard to maintain a dominant position in a fragmented market.

Although we are witnessing real estate companies venturing globally to foreign markets, at the end of the day, real estate is still a localised industry. It is important to remember why HSBC did well and it has to do with its motto; “The World’s Local Bank.”

Years later, I met Chew again during a friendly corporate delegation visit. At the time, several of the largest real estate developers in China were venturing into Malaysia in a big way.

I will never forget what Chew said in eloquent Mandarin as an ice-breaker during the visit, “Sharks may rule the ocean, but not freshwater river. That said, I look forward to learning from you.”

The pandemic exposed the structural flaws in many emerging markets economy and in a way, brought about a great reset for industries, companies and people.

I personally learn to appreciate the conventional wisdom of the business leaders before my time and the older generations like my father.

Sunway Group has proven to be a resilient organisation which has a core group of industry titans sitting right at the top.

They are guided by the success and mistakes of the past, especially the two economic crisis in 1986 and 1997/98 that nearly brought the group down. As they pivot along the industries (property to healthcare) within the conglomerate prudently, it showed bigger is not necessarily better.

There is no more fitting illustration of the importance of prudence and fiscal responsibility than the Evergrande episode. Whether Evergrande remains ever grand is a side story. Nonetheless, it should be a lesson to all companies especially those within the property sector. Ng Zhu Hann is the author of Once Upon A Time In Bursa. He is a lawyer and former chief strategist of a Fortune 500 Corp. The views expressed here are the writer’s own.

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