A headline-making debt woe afflicting a small Chinese property developer has highlighted an ongoing cash-flow headache in the sector. Industry analysts said they expected some smaller companies to default and home prices to decline in third- and fourth-tier cities.
Zhejiang Xingrun Real Estate Co., a privately-owned small developer in east China's Ningbo City, is struggling to pay a 3.5-billion-yuan (573.8 million U.S. dollars) debt after its capital chain snapped.
Of the debt, some 2.4 billion yuan was borrowed from banks, who are working with local governments to find solutions. Two owners of the real estate firm have been detained by police on suspicion of illegal fundraising.
A preliminary investigation showed that plummeting land prices was one of the major contributors to the money crunch. It is estimated that the company has lost about 1.4 billion yuan from its purchased land because of shrinking value.
Most of Zhejiang Xingrun's business was in Fenghua, a small city under Ningbo. Fenghua has a population of about 500,000. Its land price at the end of 2013 was approximately halved compared with that in early 2010.
"There are high stockpiles in medium and small cities, and the performance of developers based in third- and fourth-tier cities was sluggish in the first two months of 2014," said Zhang Dawei, chief analyst with property agent Centaline.
A possible default by Zhejiang Xingrun is "symptomatic of major themes in the industry -- polarization in favor of larger, better funded homebuilders; oversupply in smaller cities; and significantly slower growth rates and profit margins," Fitch Ratings said in a note.
Zhejiang Xingrun had run into trouble since, firstly, it is a privately owned company, meaning it has limited access to equity funding. Chinese regulations limit the ability of homebuilders to use bank borrowings to purchase land, Fitch said.
Private companies are likely to be more reliant on non-traditional sources like trust funding, which come with high costs.
Second, its core market, Fenghua, is showing signs of overbuilding. Finally, key shareholders of Zhejiang Xingrun were arrested relating to illegal fundraising, which suggests a significant corporate governance lapse.
"We believe there will be further defaults in this industry as these themes will persist, but they will be limited to smaller companies like Zhejiang Xingrun," Fitch said.
Zhang Zhiwei, chief China economist with Japan's Nomura Securities, shared similar views.
Zhejiang Xingrun is the largest property developer in recent years that is at risk of bankruptcy, Zhang said.
"More property developers will face similar pressures as transaction volumes slow and cash flow conditions tighten, and expect this problem to be more severe for unlisted developers in third- and fourth-tier cities with limited access to financing," he said in a research note.
Zhang maintained that China's property sector suffers from overinvestment and has a significant oversupply problem.
The risk is particularly high in third- and fourth-tier cities, which accounted for 67 percent of housing under construction in China in 2013, he said.
The falling price of land in Fenghua is consistent with the deceleration of home price growth in China over the past few months.
Last month, new home prices in 70 major cities tracked by the National Bureau of Statistics rose by an average of 11.1 percent year on year, slowing by 1.3 percentage points from January.
Prices for existing homes rose 6.4 percent year on year, compared with an average growth of 7.4 percent in January. On a month-to-month basis, 57 out of the 70 cities saw rises in new home prices, fewer than 62 cities in January.
Deceleration of home price growth has changed the psychology between home buyers and property developers and boosted a wait-and-see sentiment, even in first-tier cities with a sizzling housing market like China's capital Beijing.
As of March 16, sales of new homes and existing homes in Beijing plunged 57.5 percent and 66 percent year on year, respectively, official data revealed.
Meanwhile, a lackluster property sector has made banks more cautious of offering credit to property developers.
With eyes on cash flow, some developers have chosen to cut prices to cash in. Two local developers in Hangzhou, capital of Zhejiang Province, announced sales promotions in late February.
Combined sales revenue of 30 monitored home developers stood at 66.5 billion yuan, nosediving by 39 percent from January, according to Zhang Dawei.
Major home developers, especially listed ones, are eager to publish impressive financial results. A business slump could cause their stocks to drop.
Li Tiegang, director of the real estate research center of Shandong University, said sales promotions in big cities could lead to similar actions in smaller cities.
"We may see some price cuts in two or three months," said Li.