Li Xunlei: Highly leveraged management has always been the core of the market questioning Evergrande Real Estate. Leveraged management is also considered a double-edged sword for the operation of the real estate industry. So is the direct reason behind Evergrande's crisis time?

Chen Li: Let's put forward an opinion here. High leverage is not the core factor that determines the life and death of a housing enterprise; the ability to monetize the core assets of a housing enterprise is the lifeblood of an enterprise. In fact, Evergrande's overall net debt ratio has continued to decline since 2017, but the rapid overall deterioration in the ability to monetize the company's own real estate projects has directly led to the current liquidity difficulties.

Judging from the real estate development process, after housing enterprises acquire land, they obtain credit funds through land and projects under construction. After pre-sale conditions are met, commercial housing sales are completed, upfront loan funds are returned, and subsequent development is carried out through sales repayment.

Looking at Evergrande's current situation, the reason that triggered the risk event was not the weakening of the real estate market and the liquidity risk caused by financial institutions drawing loans brought about by falling housing prices. Until March 2022, Evergrande did not have domestic and foreign open market bonds due to maturity, putting pressure on the company to default. Therefore, I don't think high leverage has led to the current business difficulties of enterprises. Looking at the essence of the phenomenon, the rapid deterioration in real estate sales repayments is the core factor causing the current liquidity problem.

Li Xunlei: In terms of total volume, the growth rate of real estate sales has declined somewhat, but overall it has remained stable. Why has Evergrande's cash flow repayment situation deteriorated rapidly and significantly in the current environment?

Chen Li: We believe that since June, Evergrande's cash flow has deteriorated mainly due to the following four factors: 1. Mortgage loans have slowed; 2. Two-way price limits limit price reduction promotions; 3. There are obstacles to inter-industry mergers and acquisitions; 4. The operating debt structure has deteriorated.

First, judging from bank credit support, after centralized management of mortgages, the banking system's total credit support for real estate was limited, which in turn led to a situation where houses were sold but mortgage loans were delayed, sales were good but payments were poor.

Second, Evergrande's average land acquisition cost is about 1,900 yuan/㎡, and the average sales price is about 10,000 yuan/㎡. Land prices account for a low proportion of sales prices, and there is more room for price reduction promotions compared to other housing companies. However, since June, two-way price limits have been strictly enforced in the new housing market, and Evergrande's marketing strategy of acquiring land at low prices and selling at reduced prices has failed, leading to a sharp increase in pressure on the sales side.

Third, the path back to the sale of equity has not been as smooth as usual. Since the sale of the project company's shares also transferred the company's debt, all housing enterprises are controlling the increase in debt under the three red lines. Even if the M&A price is appropriate, the acquirer is unwilling to bear the consequences of the increase in debt ratio, leading to poor equity transfer.

Fourth, although Evergrande's net debt ratio continues to decline, operating debt continues to rise, essentially transferring Evergrande's debt to financial institutions to upstream suppliers. However, when there was a problem with corporate liquidity, the upstream spending also reached its limit. The pressure on liquidity could not be relieved. Commercial bill payments also had problems ahead of financial liabilities.

Li Xunlei: Judging from the current difficulties Evergrande is facing, in order to avoid the worst situation where projects are not completed in batches, how to resolve the crisis is the best policy?

Chen Li: We think there are several main ways to resolve the current Evergrande problem: First, in the short term, introduce suitable investors or funders, relieve short-term payment pressure through debt restructuring, equity sales, etc., guarantee the normal construction of projects under construction, and prevent the risk of unfinished business. Second, guide market expectations and increase the positive confidence of downstream buyers in the normal handover of sold projects. Finally, through normal sales repayment of the company's own projects, liquidity risks were gradually mitigated, and a soft landing in the Evergrande crisis was achieved.

Li Xunlei: In the current real estate market environment, since the financial system, especially banks, is closely related to the prosperity of the real estate industry, will the Evergrande crisis continue to spread and affect the stability of the financial system?

Chen Li: From the perspective of real estate prices and the extent of liquidity risk spreading within the industry, I don't think Evergrande's current problems will continue to spread to the financial system. On the one hand, it is true that since this year, the overall operating pressure of the real estate industry has increased, but not all housing enterprises have faced serious liquidity risks. The central government's three-line supervision policy has actually given the market a simple and effective risk assessment standard for housing enterprises. In particular, many green and yellow housing enterprises are currently under some pressure in terms of growth rate, but from the perspective of default risk, it is not significant. The financing costs of steadily operating housing enterprises are even continuing to decline.

On the other hand, judging from how domestic and foreign real estate crises spread to the financial system in the past, the reason for the impact on the financial system was usually the rapid decline in asset prices on a large scale. This round of developer liquidity crisis is a sporadic outbreak for individual companies. It is not due to the risk of falling housing prices in an environment where inventories are too high and demand is declining throughout the industry. In the current context of “housing without speculating”, the relationship between supply and demand in the industry is relatively balanced, and housing prices across the country are still relatively stable.

Li Xunlei: Judging from the introduction of the Evergrande incident to the real estate industry, in fact, since 2018, in this round of the real estate cycle, demand side policies for home purchases and supply-side policies of developers have continued to be tightened. Why did we only see a decline in industry fundamentals in the second half of this year?

Chen Li: Due to significant changes in the internal and external environment compared to the past three years, tightening industry financing in 2018 forced enterprises to push to increase market supply, which in turn supported investment in real estate development, and reversed at the current point in time.

In terms of the external environment, after three years of deleveraging, industry debt maturity pressure dropped rapidly. Since 2018, the maturity scale of debt in the real estate industry has continued to grow. Under pressure to repay debts, companies have been forced to supply land storage, increasing sales repayments to ensure the safety of cash flow, causing a reverse change in the rate of new construction and sales growth from 2018 to 2020, and the industry as a whole has been de-inventoried.

However, after the second half of 2021, the maturity scale of debt declined rapidly, and the reduction in debt repayment pressure directly prompted the direction of business operations to shift from the pursuit of scale to the pursuit of security. The change in business style directly curtailed the willingness of enterprises to acquire land and promote markets. From the internal perspective of enterprise operations, from the perspective of corporate land reserves, the scale of developers' interest-bearing debt has continued to decline since 2018, along with a continuous decline in the scale of land reserves that have already started construction and not sold in the table. In a situation where there is insufficient land stock, market supply elasticity needs to rely on incremental contributions.

Simply put, in 2018-2020, even if corporate inventories are high, stock supply can still maintain normal supply in the market; after 2021, when land storage is insufficient and growth is insufficient, the impact of the continued tightening of the policy environment on the supply side is gradually reflected.

Furthermore, since the second half of 2020, there have been frequent credit incidents in the industry, and the scale of credit bond defaults has increased dramatically. The balance of defaulted bonds was 62.8 billion yuan, while the total balance of defaulted bonds in the two years of peak credit bond repayment period from 2018 to 2019 was only 10.6 billion. With the clearance of small and medium-sized enterprises, the overall supply capacity of the market weakened marginally.

Li Xunlei: Since September, the second batch of centralized land supply has been sold one after another. Judging from a few cities that have already entered the centralized transaction stage, housing companies' enthusiasm for land acquisition has not resumed as scheduled. Why is there a big difference between the actual land acquisition situation of housing enterprises and market expectations after measures to optimize the land acquisition system, such as limiting premium rates?

Chen Li: We believe that developers' lack of motivation to acquire land is not only influenced by a single factor of higher land prices. As financing policies are tightened and corporate cash flow conditions continue to deteriorate, weakening land acquisition capacity is also a core factor in insufficient supply.

Due to insufficient land acquisition and development capital, the scale of land reserves continued to decline due to credit contraction, while insufficient supply combined with the current weakening demand in the real estate market further curtailed the growth of sales repayments and formed a relatively obvious negative feedback mechanism. Even though the centralized land supply system has been optimized to improve the willingness of enterprises to acquire land, there has been no significant improvement in the overall industry in terms of land acquisition capacity.

Li Xunlei: The recently released real estate data for August showed a decline to varying degrees, and there is no shortage of voices in the market that are relaxing real estate. How should we judge the interpretation of future policies?

Chen Li: Overall, we think that a complete relaxation of the real estate policy is unlikely. After 2017, the regulatory policy showed refined characteristics divided by city, supply and demand. Looking back at history, marginal changes in real estate demand and supply-side regulation policies are determined by marginal changes in housing prices and the difference in growth rates between real estate investment and fixed asset investment, respectively.

However, the current market environment is markedly different from the past. In a typical downturn in real estate in history, the core factor in the decline in housing prices was the deterioration in the relationship between supply and demand. For example, in 2008, 2011, and 2014, high inventory growth brought about by disorderly credit expansion of housing enterprises, compounded by marginal weakening of demand, which led to a rapid decline in prices. In the current environment, due to the acquisition and downturn in the second half of 2020, insufficient supply in the land market continues to spread to the commercial housing sales market. The shortage of supply in the core city market is even more significant. There is no rapid downward pressure on housing prices, and there is little possibility of easing on the demand side.

From a supply-side perspective, historically, when investment in real estate development continued to fall below fixed asset investment, putting a drag on the investment growth rate of the whole society, the financing policies of supply-side housing enterprises were clearly relaxed. This is why from 2018 to 2020, although real estate financing continued to be tightened and housing enterprises continued to reduce leverage, the overall investment growth rate of the industry was much higher than fixed asset investment, and there was no need to relax the overall regulation policy.

However, at this stage, judging from real estate data in recent months, the newly started area is rapidly weakening. At the same time, the growth rate of completed area continued to recover, and weak construction commencement and strong completion led to a marginal slowdown in the scale of construction, which in turn dragged down the growth rate of actual real estate development investment. With the increase in the flow rate of the land market in two or three rounds, mortgage repayments and liquidity investments for high-quality housing enterprises can be moderately increased, mitigating the downside risk of real estate development investment brought about by the spread of the flow phenomenon.

Li Xunlei: Finally, let's go back to the stock market. From an investment perspective, after real estate stocks have experienced this round of adjustments, how should we choose the direction of real estate stock investment in the future?

Chen Li: We believe that the regulatory policy has actually given a clear direction for the selection of real estate stocks in the stock market. The three red lines are good evaluation indicators recognized by the government.

In the past, housing enterprises, which were rapidly expanding nationalized, lost their market share during the leverage reduction cycle. Currently, they are unable to use leverage to recover their market position under the hard constraints of the three red lines. Meanwhile, housing enterprises that insist on steady operation have achieved high-quality scale growth in the process of reducing leverage in the industry. While the sales rate of the second round of centralized land supply sales is rising in many places, leading high-quality housing enterprises continue to supplement high-quality land storage at low cost, and the industry is going through a process of deception to preserve the truth.