Business News

Zero-interest loans highlight China property risks

Watch Berkshire
China's Evergrande Real Estate Group.
Brent Lewin | Bloomberg | Getty Images

China's third largest property developer, Evergrande Real Estate, has joined smaller peers in offering zero-interest downpayment loans, a practice reminiscent of the U.S. housing boom that precipitated the global financial crisis.

The easy credit shows the gamble Chinese developers are willing to take to keep sales on track, but also highlights the risk of a broader industry correction if buyers default. So far such defaults have been rare in China, where household debt is low by Western standards and banks have traditionally required hefty deposits from buyers seeking mortgages.

Many analysts believe the slowing property sector poses the biggest risk to China's economy in the second half of the year, despite a rebound in home sales in June as state-controlled banks offered more credit to support the market.

Read MoreAsia commercial property set for boom in second half

Guangzhou-based Evergrande, the country's No.3 developer by sales, is offering downpayment loans of nearly a quarter of the purchase price to home-buyers for some of its projects.

Such loans skirt government rules that require a minimum deposit of 30 percent of a home price, while buyers who have put down as little as 6 percent upfront would find it easier to bail if the market turns.

"Buyers who can't provide the 30 percent downpayment are generally low quality," said Midland Realty chief operating officer Samuel Wong.

Read MoreChina stimulus raises housing risk concerns

Data released alongside China's second quarter GDP numbers on Wednesday showed real estate investment slowed in the first half and new property construction plunged. Private sector surveys published ahead of official housing data due on Friday showed new home prices fell in June for the third straight month.

Home sales surged 32.5 percent in June compared with May, although they were down 5.4 percent compared with a year ago, as state-controlled banks offered more credit to buyers to avert a sharper slowdown.

While some analysts are still worried about financing difficulties, sluggish sales and rising inventories, others believe a recovery in credit growth will improve property sales in the near-term.

Read MoreChina economy grows 7.5% in the second quarter

"We think the improvement will continue until the end of the year, while starting into Q1 next year we'll start to see another deceleration due to a strong base, so that's the time when people will get worried again," said Chen Long, China economist of Gavekal Dragonomics, based in Beijing.

In June, mortgage lending rose 6 percent from May to 117 billion yuan ($18.86 billion), official data showed, compared with monthly growth of 2.5 percent in May.

Credit promotions

One of Evergrande's developments in eastern Jiangsu province's Yancheng city accepts downpayments of as little as 6 percent, according to a project salesperson, while the company provides an interest-free loan on the remaining 24 percent to be repaid over 24 months.

Read MoreThe bad news to China's good growth data is...

Another Evergrande project in the central city of Xian was offering interest-free loans to cover up to 40 percent of the required deposit, repayable over three years.

Evergrande declined to comment when contacted by Reuters, and it was not clear how widely the company was offering such incentives.

Liao Qun, chief economist at Citic Bank International, said interest-free downpayment loans increased the risk of default, but added that the scale of such promotions remained small.

Read MoreWe are friendswith China and Japan: Australia

Such incentives are more often offered by small, cash-strapped developers on selected projects, and are unusual among larger developers in China.

"The property market is undergoing a correction so developers need to launch these kinds of promotions to push sales," said Liao.

Showing the strain

While Evergrande recorded 69.3 billion yuan ($11.16 billion) of contracted sales in the first six months of this year, the third highest in China, the strain on its balance sheet is clear.

Optimistic on Chinese growth and stocks: Pro
VIDEO3:4403:44
Optimistic on Chinese growth and stocks: Pro

In particular, receivables - the accounting term for money owed by customers for goods or services already supplied - have been rising as the real estate sector has been squeezed by monetary tightening.

"Developers have seen their liquidity deteriorate as collections from presales have declined, because banks were not granting mortgage loans easily and developers had to provide instalment plans to attract buyers," said Agnes Wong, a Nomura credit analyst in Hong Kong.

"This means collections have slowed further. In the past, collections were made within 1-2 months of the sale, but now it can be as much as a year with a collection plan, or 3-4 months with a bank mortgage."

Read MoreIn the heart of Vietnam-China standoff at sea

In order to hedge against that risk, Evergrande last month introduced an asset management product, rare in the industry, to cover receivables due on July 1 for two projects in eastern Jiangsu province. The product aimed to raise up to 330 million yuan ($53.3 million), with annualised interest of up to 10.2 percent.

Evergrande Group and its listed entity in Hong Kong are the guarantors of the product, according to the sales document.

"Affected by the recent tight liquidity, inventory pressure and slow sales, some developers face cashflow problems and this kind of product helps," said Kell Yu, an analyst at trust research company Use Trust, based in Jiangxi province.

Too much debt?

Evergrande, which has raised a total of 3.3 billion yuan through seven trust loan high-yield investment products for its projects so far this year, reported 7.2 billion yuan ($1.16 billion) of trade receivables in 2013, double the previous year.

Read MoreChina studiesfloating gas plants for South China Sea

It said in its annual report that 2.8 billion yuan came from receivables within 90 days of their invoice date, the same level as in 2012, but receivables of 90 to 180 days surged to 2.5 billion yuan, 17 times the level of 2012. Those within 180 to 365 days jumped more than four-fold to 1.9 billion yuan.

Chief financial executives at several property companies all said 90-day trade receivables were the most common, as that is the period companies wait in order to collect the remaining home payment from banks, while those beyond 90 days were usually due to downpayment promotions.

While the use of credit promotions has raised concerns, some China property executives shrugged off comparisons with the "sub-prime" bust in the United States, citing China's low household debt ratio.

Read MoreThe main challengefor BRICS success: China

"It is not in the Chinese culture to take on too much debt," said James Macdonald, head of Savills Research China based in Shanghai.

"Also, I think U.S. home buyers took on more debt in the run-up to the global financial crisis as the general perception was that values were going up and would keep going up. In China this is not the case at the moment as the market is pretty soft."

Berkshire Hathaway Live Event