Country Garden and the end of China's property model

Country Garden missed $22.5 million in coupon payments on its international bonds, and the last pillar of China's private property model cracked. The company was once the country's biggest and most respected private developer. It was no speculative gambler in the mould of Evergrande. It was a conservative, sprawling builder concentrated in smaller cities. Its cash crunch means the presales model is finished.

Three years of attrition

The trouble began with policy. In August 2020 regulators imposed the so-called three red lines, limits on leverage and liquidity that cut off new borrowing for developers who breached them. The aim was to deflate a bubble gradually. Instead, Evergrande ran out of cash and defaulted on its dollar bonds at the end of 2021, and a string of other private developers followed. By the middle of last year homebuyers in dozens of cities were refusing to pay mortgages on flats that builders had stopped working on.

Country Garden held out longer than most because it had kept its balance sheet in better order and because its projects sat in lower-tier cities with less speculative froth. It was among the few private developers regulators seemed willing to support. The missed coupons, due on 6 August, show that even the survivors were running on the same fuel as the casualties.

When presales stop selling

For two decades Chinese developers acted as shadow banks, funding themselves with cash collected from homebuyers before any bricks were laid. That works only while buyers trust that their flats will be finished. Once the trust goes, sales collapse, and with them the cash needed to complete projects and pay debts. Regulatory forbearance cannot revive a business whose source of funding has disappeared.

The mechanics explain why the collapse is self-reinforcing. A buyer paid a deposit and often the full price, financed by a mortgage, years before completion. The developer used that money to buy land and start the next project, so each year's sales financed the previous year's construction. When local governments responded to the crisis by requiring presale cash to sit in escrow accounts tied to specific projects, developers lost the ability to move money between sites. Cash became trapped where it was not needed and absent where it was.

Where the losses fall

Offshore bondholders stand at the back of the queue. They hold claims on a Cayman Islands or Hong Kong holding company, while the assets sit in onshore subsidiaries whose first obligations run to homebuyers, suppliers and domestic lenders. Evergrande's creditors have waited nearly two years for a restructuring deal, and on 17 August the company filed for protection under Chapter 15 of the US bankruptcy code as part of that process. Recoveries in these cases have tended to be low.

Inside China the losses spread wider. Construction firms and materials suppliers are owed large sums, often in commercial bills that developers cannot redeem. Local governments, which relied on land sales for a large share of their revenue, have seen that income shrink as developers stop bidding. The strain has reached the shadow-banking system as well: trust companies that lent to property projects are under pressure, and Zhongrong International Trust, part of the Zhongzhi group, missed payments on investment products this month.

The winners are relative. State-owned developers such as China Overseas Land and Poly Developments have gained market share, since buyers trust that a state-backed builder will finish their flat. That trust is exactly what the private model has lost, and it cannot be bought back with a coupon payment.

The Japanese precedent

Japan after 1990 offers the closest parallel, though not an exact one. Land and property prices there fell for more than a decade after the bubble burst, and banks kept lending to insolvent borrowers rather than recognise losses. The result was a long period of weak growth and falling prices in which the problem was managed but never resolved. China's banks are less directly exposed to developer debt than Japan's were, but households have far more of their wealth in housing, which makes the drag on consumption larger.

The lesson from Japan is that forbearance buys time at the cost of productivity. Keeping developers alive to finish projects protects homebuyers, but it leaves capital tied up in firms with no viable future. The same prices and credit conditions that let a zombie developer survive discourage new investment in the sector.

The case for rescue

The strongest counterargument is that Beijing has both the means and the motive to stabilise the sector. The Politburo said in July that property policy would be adjusted, which markets took as a signal of easing. Special lending programmes launched last year were meant to guarantee the completion of stalled projects, and local restrictions on buying homes can be relaxed quickly. If buyers believe the state will make sure flats are finished, presales could recover without the private developers needing to be trusted.

That argument supports the idea of a managed wind-down more than a revival. A guarantee that projects will be finished removes the buyer's risk, but it does not restore developers' margins or their ability to fund new land purchases. With prices still falling, buyers who can wait have every reason to do so. Demographics add to the gloom: the population shrank last year for the first time in six decades, and urbanisation is slowing.

What happens next

Country Garden has a 30-day grace period before the missed coupons become a formal default, which puts the next deadline in early September. It has also asked onshore creditors to delay repayment on a domestic bond and suspended trading in several of its onshore bonds. Monthly sales data from the largest developers, and any decisions to cut interest rates on existing mortgages or ease purchase limits in the biggest cities, will show whether demand has a floor.

Country Garden's default closes the era of the private developer that drove Chinese growth for twenty years. Beijing can delay the reckoning for creditors, but it cannot bring the old model back. The likeliest path is a slow restructuring over the next year or two, with offshore bondholders taking deep losses, state-owned builders absorbing what is left of the market, and local governments looking for revenue to replace land sales that will not return.