The China Housing Crisis

Evergrande Explained

This installment of The Matt Allen Letter is free for everyone. If you would like to read about my stock market picks, stock analysis, and much more. You can subscribe here.


Dear Friends,

In 2008, we suffered the worst housing crisis in the history of the world. We did this because of incredibly dumb and greedy actions by large institutions who are the self proclaimed “gurus.”

If you follow any sort of financial news, you have probably heard of the crisis that has caused international fear in the markets. This could have a HUGE impact on all of us, and it has caused PANIC.

However, it can be hard to understand, and I have had a bunch of people asking me to put it in simple terms for them!

At the end, I will explain how it affects people like us.

What is The Evergrande Group?

The Evergrande Group is a Fortune 500 real-estate developer with headquarters in Shenzhen, Guangdong, China. It was founded by Hui Ka Yan in 1996 in Guangzhou. It is a massive business that had sales of more than $100 Billion in 2020 with profits above $5 billion.

At its core, it's a homebuilder and commericial building business. Its website states that it has over 1,300 projects across 280+ cities currently on going. They are the largest developer in China, and they have done a good job in the past. They would be one of the largest developers in the United States.

However, for whatever reason, they decided to buy an EV company, a theme park, a soccer club, a media production company, and a mineral water company. Why? I have absolutely no idea other than greed. (This is why I preach, buy what you know)

The Money

As a developer, Evergrande has a major cash flow problem that is common in this industry (Cash Conversion Cycles.) Building a new project may take many months and requires a lot of cash that is given in advance throughout the project. They do not get paid until later, with the exception of smaller upfront deposits.

In simple terms, picture a big chunk of land that Evergrande buys for millions, spends more millions to build massive apartment buildings on this land which takes years, and then it takes more time to get the huge apartment building filled with renters. They would have to front tons of money that they didn’t have to pay for this.

So how did Evergrande fund their massive growth?

They aggressively burrowed debt at levels that are unprecedented for the standard of Real Estate developers. It became the world's most heavily-indebted developer, with a debt load of over $100 billion and over $300 billion in liabilities.

Essentially, Evergrande started burrowing more money to pay their debt off. At this time, the debt is so bad that they are getting charged $180 Million Dollars EACH DAY in interest alone.

Evergrande is facing two major issues: a technical one and a psychological one. The technical one (paying their debt): If your revenue and profits grow, you will have the ability to make these payments. The psychological one: If word gets out that you can’t make a payment, you will cause widespread fear among your shareholders and the banks that you owe money cause panic. In 2020, they were able to avoid this major issue, because an investor said “Pay me later.”

However, they are not able to do this as of September 21st, 2021. This has caused an international panic with every major stock market getting crushed.

The Fake Solution

To meet its ever growing obligations, Evergrande began tapping into "creative" financing strategies. It pushed employees to provide short-term loans to the company which it called "high interest investments” in order to ensure they received their year-end bonuses.

But the company quickly fell behind, missing payments earlier this month and leaving thousands of employees without a job. With over $7.4 billion of bond payments due in 2022, and large interest payments coming up as soon as this Thursday, the crisis appears to be accelerating.

Keep in mind that around 1 million Chinese Citizens have paid for their apartment and will likely not get an apartment or their money back.

Angry home buyers are waiting on as many as 1.6 million apartments to be completed. Suppliers of cement, paint and rebar are owed more than $100 billion in payments. Workers are panicking that loans they made to their employer cannot be repaid. Banks are worried about defaults across the industry.

Conclusion

Do not forget that the housing crisis of 2008 caused a widespread crisis in every international market. People owed money to the banks, they defaulted on their loans, and the banks were close to going under.

The Evergrande crisis poses a systemic crisis to the Chinese economy along with possibly the inernational markets. Evergrande has deep ties to financial institutions and working class consumers across China, a disorderly collapse would have far-reaching impacts that could affect me and you.

China has to decide, if they want to bailout Evergrande or let an economy crash after just recovering from Covid.

This will have a major impact on me and you, IF we have multiple banks across the United States that loaned money to Evergrande. At this time, I have not found any bank outside of Citigroup that has done this.

As always, do not panic. However, I think you should be informed of what is going on in the world.

Have a great rest of the week and see you Next Wednesday!

Stay Hungry, Stay Long,

Matt Allen