The Gallagher Research Centre has partnered with Professor Ricardo Reis, of the London School of Economics, since 2023 to explore global macroeconomic risks and opportunities for (re)insurers. In the latest blog, Professor Reis provides insights into China’s real estate market and what the current situation means for the (re)insurance sector.
Key takeaways
- China's real estate market has experienced a significant decline since the onset of the COVID-19 pandemic, with activity in construction and real estate sectors sharply decreasing, leading to a slowdown in economic growth.
- While manageable household debt and proactive government interventions mitigate immediate recession risks, increasing non-performing loans pose challenges for Chinese banks, potentially transferring fiscal burdens to the public despite government measures ensuring a continuous flow of credit.
- Despite challenges, China’s robust fiscal capacity and substantial national savings provide crucial buffers against potential economic crises, offering reassurance amidst ongoing market fluctuations.
- The impact of the decline in China's real estate market varies for insurers, yet with diversified portfolios, the overall impact is anticipated to be manageable compared to other investment instruments.
China’s real estate crisis
Despite a spike in recovery immediately following the COVID-19 pandemic, Chinese GDP has been disappointing over recent years (Figure.1), in large part because construction activity is subdued.
Figure 1: China’s GDP growth rate since 2014 (data source: National Bureau of Statistics China)
Figure 2 and Figure 3 demonstrate the real estate crisis in China since the pandemic.
Figure 2 takes the perspective of macroeconomic real estate activity showing the share of the construction and real estate sector in GDP. Following a significant rise over the last decade, activity has reduced noticeably since the pandemic, dropping back to the historical average (or below it).
Additionally, there are widespread reports (but unreliable data) pointing to overcapacity, and of builders trying to draw down their inventories1 . Continued supply through new developments alongside a waning demand due to reduced domestic and foreign interest in Chinese real estate has led to developers halting projects. This has led to so-called "Ghost Cities" of partially built buildings that are entirely vacant and show little sign of being completed anytime soon2 .
Figure 2. Construction activity and the real estate sector in China (Data Source: National Bureau of Statistics China)
Figure 3 looks instead at property prices in two major cities, Beijing and Shanghai. The red dashed line reveals the boom pre-pandemic, up to 2020, while the solid red line shows the subsequent plateau since 2020. Data from most major Chinese cities shows a similar pattern, as does data on the number of transactions3.
Subsequently, returns on investment vehicles tied to real estate have had disappointing returns.
Figure 3. Property prices in the two major Chinese cities (Data Source: CEIC)
Impacts on China’s economy
It is important to emphasize that a real estate crisis in China does not mean an inevitable recession in the country. That said, a decline in construction activity puts a drag on growth. Housing wealth is about 60% of household assets, so a fall in real estate prices brings down spending and consumption.
However, Chinese household debt is moderate by international comparisons. Mortgage debt is only 31% of GDP3, compared to household debt of around 75% of GDP in the US4. The data do not demonstrate the debt levels that we typically see in the UK and in the US to amplify the initial fall and cause an inevitable crash.
In terms of production, construction activity impacts other sectors through their financial obligations, known as accounts payables. This means that companies supplying goods or services to the construction sector may experience delays in receiving payments. However, despite this impact, there hasn't been a noticeable rise in the amounts owed to companies by real estate-related entities. While Chinese real estate companies are facing some cash flow problems, they seem to be able to obtain credit to keep up with their liabilities5.
The role of credit and banks
As almost always happens during a housing boom, Chinese commercial banks were previously heavily involved in extending credit to construction companies as well as to buyers.
The downturn in terms of price adjustments and construction activity over the past four years has resulted in losses for banks and non-performing loans. While there is limited data to confirm this, the available data does show a slight increase in reported non-performing loans by commercial banks5.
Chinese state banks have stepped in heavily to keep the credit flowing6. In part, this implies that some of the costs from copious lending in the past will be transferred to the public purse through losses in those state banks. But, at least as of now, there seems to be more than enough fiscal capacity to deal with this problem.
Other actions by government authorities
Over the last year, government authorities have employed a far-reaching approach to deal with the slump in the real estate market. They have eased some of the restrictions on non-residents being able to buy property in urban centers and eased the regulatory criterion to qualify for a mortgage, with a reduction in the 5-year benchmark lending rate.
The decline in the housing market puts a big strain on local governments, which have relied on tax revenues to finance their operations over the last few years, especially from selling land7.
To plug these gaps so far, the central government has stepped in with a pool of national savings from domestic savings and capital controls, which can be used for this effect for some time before running into a crisis8.
From the perspective of the country as whole, China has accumulated a large stock of net foreign assets that it can also draw down.
Considerations for the (re)insurance market
The impact of the decline in China’s real estate on insurers will vary from company to company, depending on their specific investment portfolio. With regional carriers estimated to have around 8% of their portfolio invested directly or indirectly in the global CRE market9, impacts stemming directly from Chinese real estate assets in a portfolio are likely to be limited. Exposure will be a factor of specific investment class, size, and geographical composition.
It is likely that these impacts will be felt more sharply by local life insurers in China. Specific exposure from a balance sheet perspective will be in the form of investments in direct commercial mortgages, Commercial Mortgage Backed Securities (CMBS), wholly owned direct real estate, and Real Estate Investment Trusts (REITs). Commercial property mortgages are likely to form the largest investment class exposed, though with a suitably diversified portfolio, insurer impacts from China’s real estate market are unlikely to be material compared to the performance of other investment instruments (e.g. sovereign bonds and equities).
Learn more about commercial real estate and recessionary headwinds
Professor Reis has recently published a report for Gallagher Re, exploring a macroeconomic outlook on commercial real estate investments and recessionary headwinds for insurers.
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