Folly of China’s real-estate boom was easy to see, but no one wanted to stop it

Polo fields at the Tianjin Goldin Metropolitan development in northern China in 2016. KEVIN FRAYER/GETTY IMAGES
Polo fields at the Tianjin Goldin Metropolitan development in northern China in 2016. KEVIN FRAYER/GETTY IMAGES

Summary

Developers, home buyers and Western bankers all ignored warning signs, but not two accountants who went looking for “financial anomalies” and “shenanigans.”

When New York hedge-fund manager Parker Quillen visited a glitzy new development in northern China called Tianjin Goldin Metropolitan, he wondered how on earth the developer would fill all that space.

It had apartments starting at $1 million and plans for an office tower bigger than the Empire State Building, an opera hall, shopping malls and hotels. Its total square footage was to exceed the land area of Monaco.

Was there a plan for attracting buyers? Quillen asked. Polo, said the marketing agent showing him around.

“Polo? You mean the horse thing?" he asked.

“Exactly," he recalled her saying.

The agent, dressed in riding gear, led him through a stable with more than 100 polo ponies. Quillen asked if Goldin’s founder, a billionaire polo enthusiast who got rich selling computer monitors, had done a viability study for the project. She said she had no idea.

“Then I realized that the vision was that international executives would come to Tianjin and set up their corporate headquarters here because they like polo," Quillen said. “I was like, oh my God."

When Quillen returned to New York, he poured more money into his wagers against Chinese property stocks.

That was 2016, during the heady days when the Chinese property boom was just getting going. Even then, the truth was obvious to anyone who knew what to look for: The boom had turned into a bubble—and was likely to end very badly.

The bubble proceeded to get even worse, though, because no one wanted the music to stop. Chinese developers, home buyers, real-estate agents and even the Wall Street banks that helped underwrite the boom all ignored warning signs.

Developers found ways to obscure the amount of debt they were holding, with the help of bankers and lawyers. Buyers who suspected the property markets were overbuilt bought more anyway. Chinese and foreign investors seeking juicy returns flooded developers with funding.

The cheerleaders were operating on a seemingly bulletproof assumption that China’s government would never allow the market to crash. Chinese people had invested the majority of their wealth in housing. Letting the market tumble could wipe out much of the population’s savings—and erode confidence in the Communist Party.

Now China is paying the price for failing to act earlier to rein it all in.

More than 50 Chinese developers have defaulted on their international debt. Around 500,000 people have lost their jobs, according to Keyan, a private think tank focused on Chinese property. Some 20 million housing units across China have been left unfinished, and an estimated $440 billion is needed to complete them.

Prices for secondhand homes in major cities fell 5.9% in March. Local governments, deprived of income from selling land to developers, are struggling to service their debts. The overall economy is fragile, as real estate and related industries, which once accounted for around 25% of gross domestic product, become a bigger drag on growth.

China Evergrande founder and chairman Hui Ka Yan was once one of the nation’s richest men. PHOTO: BOBBY YIP/REUTERS
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China Evergrande founder and chairman Hui Ka Yan was once one of the nation’s richest men. PHOTO: BOBBY YIP/REUTERS

‘Worth nothing’

In 2016, the same year Parker Quillen toured the polo grounds in Tianjin, a pair of Hong Kong-based accountants traveled to mainland China and hit the road in a rented Buick.

Gillem Tulloch and Nigel Stevenson and their firm, GMT Research, specialize in digging out what they call “financial anomalies" and “shenanigans," and they suspected a lot of that in China’s housing market.

Decades earlier, in the Mao Zedong era, the market was controlled by the state, and most people lived in homes provided by their Communist Party work units. In the 1990s, authorities started liberalizing the market, and private developers sprang up everywhere, erecting row after row of housing towers in one of the biggest investment booms in history.

By the time Tulloch and Stevenson began their trip, many government officials and economists were warning of a bubble. But whenever the market showed signs of faltering, the government would step in. Beijing rolled out new policies to stimulate buying, lowered interest rates and lifted home purchase limits. Confidence was restored, and sales took off again.

Tulloch and Stevenson were suspicious. As they drove across the country, they were amazed by the number of empty buildings and busted projects.

They zeroed in on the projects of China Evergrande Group, the country’s largest developer by sales. Its founder and chairman, Hui Ka Yan, was on his way to becoming China’s richest man, with personal wealth of more than $40 billion in 2017, according to Forbes.

Tulloch and Stevenson visited 40 Evergrande projects in 16 cities, concluding that many of them were “dead assets," earning little or no income. Those included sparsely occupied hotels, shops that hadn’t ever been occupied and entire developments far from major population centers.

At one project, in a port city a few hours from the North Korean border, six residential towers were abandoned, with no workmen, residents or marketing staff. Yet according to Tulloch and Stevenson, Evergrande still treated the project on its books as a performing asset, without writing down its value.

Tulloch and Stevenson paid special attention to Evergrande’s parking garages. Many were nearly empty. By their reckoning, Evergrande had built some 400,000 parking spaces it was struggling to rent or sell, yet in audited statements it continued to value the spaces at $7.5 billion, or nearly $20,000 per space.

The developer booked the parking spaces as investment properties rather than inventory assets—an accounting treatment, unusual among its peers, that allowed Evergrande to overstate their value and book gains early, the two accountants said.

“The company is insolvent by our reckoning, and its equity worth nothing," they wrote to clients later that year, in a report titled “Auditors Asleep." The report concluded Evergrande could stay afloat only by borrowing more.

Evergrande has defended its accounting and business practices, saying its financial results were audited.

Tulloch and Stevenson said that many of their clients agreed with their analysis, but they don’t think many of them acted on it.

They were right not to. China’s property market was on the eve of a rebound, thanks to the government’s property-market rescue plan rolled out a year earlier. The next year, 2017, home sales rose 11%, and Evergrande’s Hong Kong-listed shares surged 458%.

To many Chinese people, real estate seems like a smarter and safer investment than stocks. Many bought multiple units and left them empty, satisfied just to see their values increase.

Chen Yanzhi, now 35, says she began buying homes while still in college, after making a bit of money trading stocks. She started visiting new projects around the country, snapping up units whenever she saw one she liked.

Over a decade, she bought and sold more than 20 homes in places such as Nanjing, Shanghai and Hainan province. The first cost around $70,000. Years later, she paid $3.8 million for a property in Shanghai. “I love houses, and I love everything about houses," Chen said in an interview.

Young people made fortunes working for developers.

Remen Xia, 40, was a sales manager at Evergrande in China’s northern Jilin province before he jumped to other property companies. By 2018 and 2019, he said, he was earning $280,000 a year, when the average salary for Jilin was less than $4,500, according to data provider Wind.

Developers needed a lot of capital, which meant fees for financiers willing to raise it. From 2017 to 2021, Chinese real-estate developers raised $258 billion by selling dollar-denominated bonds, according to data provider Dealogic. Banks, including Wall Street heavyweights such as Goldman Sachs and Morgan Stanley, collected $1.72 billion for underwriting these deals.

Bankers met to discuss deals in the lobby of the Hong Kong Four Seasons hotel. One hedge-fund manager recalled attending parties at least once a month on yachts owned by Chinese developers, with Champagne and female escorts.

An unfinished China Evergrande residential compound on the outskirts of Shijiazhuang, in Hebei province. PHOTO: TINGSHU WANG/REUTERS
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An unfinished China Evergrande residential compound on the outskirts of Shijiazhuang, in Hebei province. PHOTO: TINGSHU WANG/REUTERS

‘Hole-digging’

Chinese banks and international institutions such as Fidelity, Invesco, BlackRock and Pimco invested in Chinese property bonds. Demand for the bonds, which yielded double-digit returns, far exceeded supply, so investors appeared willing to tolerate dubious deal structures.

One popular tactic, which bankers and investors nicknamed “hole-digging," involved using shell subsidiaries to borrow money, guaranteed by the parent development companies. The guarantee was valid all year long—except, according to documents reviewed by The Wall Street Journal, for June 30 and Dec. 31, the cutoff days most Chinese property companies use to base their financial results on.

The structure enabled the parent companies to avoid disclosing on their own balance sheets the liabilities incurred by guaranteeing the subsidiary’ debt. It wasn’t illegal, lawyers and accountants said, because a balance sheet is supposed to provide only a snapshot of a company’s financial health at a specific point in time.

Developers sometimes pledged the same collateral multiple times when borrowing money, according to developers and bankers familiar with the activity.

An executive at one hedge fund recalled seeing the same list of collateral—shares of developers’ subsidiaries, receivables or company officials’ private jets and mansions—on term sheets for a half-dozen private debt offerings. He bought the debt anyway, given the need for high returns.

“If a portfolio manager chooses not to overlook the collateral issue and refuses to buy those bonds, his performance will rank last, and he will get fired," he said.

Chinese banks were so eager to underwrite such offerings that they sometimes agreed to invest tens of millions of dollars of their own money in the bonds, no matter the pricing, according to bankers and an executive at one development company. Such bank participation would suggest to other investors that the deal was hot, thereby holding down the interest rate and making it less expensive for developers to raise money.

“At that time, we chose investors, not the other way around," the executive said.

Evergrande, having become China’s biggest developer, set its sights on becoming one of the world’s top 100 companies by 2020.

One executive at a Chinese rating agency said Evergrande asked him to award the company a sovereign credit rating, which would signal Evergrande was as safe as the Chinese government.

Three large Chinese domestic companies awarded it triple-A ratings, the highest possible. S&P Global gave Evergrande only a B-plus rating, junk-bond territory.

Chinese state media highlighted the discrepancy, with People’s Daily writing that it was partly due to “a lack of understanding of [Chinese] companies." People’s Daily blamed Western firms for “exaggerating the potential risks of the Chinese economy and companies," and said international firms could be helping short sellers.

After a brief pause during coronavirus lockdowns in early 2020, the market resumed its relentless climb.

The total value of Chinese homes and developers’ inventory hit $52 trillion, according to Goldman Sachs, twice the size of the U.S. residential market and bigger than the entire U.S. bond market. Chinese people had nearly 78% of their wealth tied up in residential property, compared with 35% in the U.S., according to a report by China Guangfa Bank and Southwestern University of Finance and Economics.

Skeptics like Quillen, the New York hedge-fund manager, and Tulloch and Stevenson, the Hong Kong accountants, were flummoxed.

Quillen had lost millions of dollars on the short positions he accumulated after his visit to the Tianjin development. Shorting China property stocks, he said, was like having a conversation with the devil in which the devil promised that a $10 stock would go to zero within two years. “But what the devil didn’t tell you," he said, “is that within those two years, the stock goes to 100 first, then goes to zero."

By late 2020, it was becoming harder to ignore the warning signs.

Prices in Tianjin were comparable with the most expensive parts of London. Millions of units across China sat empty.

Quillen figured the writing was truly on the wall now. President Xi Jinping kept declaring that “homes are for living in, not for speculation," and reports surfaced that regulators were planning to tighten credit. Quillen made new short bets.

Some 20 million housing units across China have been left unfinished, including many in this stalled China Evergrande project outside Shijiazhuang. PHOTO: TINGSHU WANG/REUTERS
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Some 20 million housing units across China have been left unfinished, including many in this stalled China Evergrande project outside Shijiazhuang. PHOTO: TINGSHU WANG/REUTERS

‘Red lines’

On the first day of 2021, regulators imposed a policy known as the “three red lines," which restricted new borrowing by overleveraged developers. Banks started demanding early loan repayments. Investors stopped buying developers’ bonds.

Within months, Evergrande was unable to pay suppliers of building materials and construction services. In August 2021, it stopped construction at hundreds of projects. It sought government help later that year, but didn’t get a bailout.

Chinese home buyers, spooked by the possibility that developers might run out of money and leave their homes unfinished, stopped buying. At China’s biggest 100 developers, sales nosedived. High-yield-bond issuance by Chinese developers fell from $23 billion in 2021 to $431 million in 2022, according to Dealogic.

Developers fell into liquidity crises like dominoes.

At the end of 2021, a high-yield-bond fund managed by BlackRock still had $941 million of exposure to China property bonds, and a Pimco fund, $741 million, according to Morningstar. Fidelity International had $1.28 billion of exposure in one bond fund.

Chen, the individual investor who had been buying and selling homes for years, said half of her homes are now without tenants, and several are worth less than what she paid. She said she isn’t in a hurry to sell, though, and remains optimistic.

Xia, the former Evergrande sales manager, quit the industry in early 2023 after his then-employer, another developer, stopped paying his salary for six months. He now runs accounts on Chinese short-video apps.

Stevenson, one of the Hong Kong accountants, had written in August 2021 that it was still possible to profit by shorting Evergrande’s stock, even though the Hong Kong-listed shares were down 95% from their peak. He predicted they would go to zero.

In December 2021, Evergrande defaulted on its international bonds. In January 2024, a Hong Kong court ordered Evergrande to liquidate, and trading in its shares were suspended at 2 cents apiece.

In March, the Chinese securities regulator said that Evergrande overstated its sales in 2019 and 2020 by a total of $78.4 billion, making it one of the largest ever alleged financial frauds.

PricewaterhouseCoopers resigned as Evergrande’s auditor in early 2023, saying it was unable to obtain information relating to revenue recognition for some property sales, among other issues. Tulloch, the other Hong Kong accountant, said he recently sent his firm’s 2016 Evergrande report to a complaint line at PwC, but that he doesn’t expect a reply.

Goldin Financial, the company that developed the Tianjin project Quillen visited, is bankrupt. An office tower there, designed to look like a walking stick, has become a favorite of international urban explorers who stage stunts there and post videos to YouTube. The Guinness Book of World Records has certified it as the world’s tallest unoccupied building.

The polo center’s horses, wines and furniture were listed on an auction website in 2021.

Quillen, now chief investment officer at Contrarian Alpha Management, won’t say how much he eventually made on his bets against Chinese developers. He said anyone shorting the stock after the 2017 spike who didn’t get squeezed out when the stock rose would have notched a 100% return.

He said he felt vindicated, but regretted his bet wasn’t bigger.

Cao Li contributed to this article.

Write to Rebecca Feng at rebecca.feng@wsj.com

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