How does a China real estate blow up impact U.S real estate?

First I hope everyone is having a good fall. It is crazy how quickly the year has gone by. It has been quite the ride with last week no exception as the stock market plunged. The key culprit that started the stock market saga is the impending blow up of Evergrande, a Chinese property development firm. Who is Evergrande and how will this impact US real estate? Why should you be watching how this unfolds?

Who is Evergrande?

Evergrande is a 25-year-old developer based in the southern metropolis of Shenzhen. It has projects—about 800 in progress and spread across more than 200 cities—in every province of mainland China, according to its most recent annual report. Its deepening financial troubles have rattled investors, employees, suppliers and home buyers, and begun to spill over into other parts of the Chinese economy.

The company said work on some of its real-estate projects was suspended after it delayed payment to suppliers and contractors. Some unpaid contractors and would-be homeowners have protested at Evergrande’s offices.

Why is Evergrande likely to fail?

The Chinese government implemented several steps to reign in speculation in real estate. Unfortunately, a byproduct is the imminent failure of Evergrande. Evergrande reminds me of the old subprime days in the US prior to 2008 with loose credit and questionable values. When the credit shuts off it is next to impossible for companies like Evergrande to raise enough capital to cover the shortfall because at the same time property values are also falling. This leads to a cash crunch much like what happened in the US during the last recession. Evergrande and other property developers will need some sort of a government bailout to weather the cash demands.

What does a failure mean for the Chines economy and in turn the US economy?

Real estate and related industries account for almost 30% of China’s GDP — a far higher share than the U.S. at the height of its boom. As investors lose confidence in Evergrande, the contagion effect spreads and ultimately the bubble “pops”. This is what we saw during the last recession, although other parts of the US economy did not have issues, as soon as the real estate bubble popped, there was a stock market correction, consumer spending slowed, the government had to step in to bail out banks and other funds.

Evergrande’s failure is eerily like what happened in the US in 2008 and the contagion effect will be the next shoe to drop. With China’s GDP so heavily dependent on real estate, when there is a shock/correction the entire economy will feel the shudder. In the case of Evergrande, the dent in GDP will be felt by both companies and consumers as there is less disposal income and consumer confidence.

Many US and other international companies are banking on large growth in the Chinese markets. These growth projections are unlikely to materialize as consumer spending declines due to losses in the property sector. This is exactly what happened after the 2008 crisis in the US.

How will this impact US real estate?

Unfortunately we saw in the last real estate crisis in the US that the world economy is much more interconnected than it ever was. As the US economy corrected, most other major economies also faced a slow down.

The Evergrande blowup will influence the US economy albeit not as large as our own subprime crisis. The big impact will be indirectly US consumer confidence. The stock market is “trigger happy” with valuations at record levels so any little hiccup in the world economy will reverberate. If Evergrande is the beginning of a “reset” of US stock prices, then I would expect real estate to continue a slowdown as consumers become less confident.

Summary

The world economy is much more interconnected than it ever was. The biggest risk to the US economy and in turn real estate is the contagion effect of the collapse and in turn how consumers worldwide interpret the effects.

Furthermore Evergrande is a warning to the US about the effects of overexuberance in real estate. As interest rates remain at historic levels, the US could be creating their own “Evergrande” moment. It will be important to watch how the collapse of Evergrande unfolds in China and ultimately the impact it has on the US economy and real estate.

Additional Reading/Resources

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Written by Glen Weinberg, COO/ VP Fairview Commercial Lending. Glen has been published as an expert in hard money lending, real estate valuation, financing, and various other real estate topics in Bloomberg, Businessweek ,the Colorado Real Estate Journal, National Association of Realtors Magazine, The Real Deal real estate news, the CO Biz Magazine, The Denver Post, The Scotsman mortgage broker guide, Mortgage Professional America and various other national publications.

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