The Gallagher Research Centre has been collaborating with Professor Ricardo Reis of the London School of Economics since 2023 to examine global macroeconomic risks and opportunities for re/insurers.
In a recent report, Reis provides an analysis of China’s real estate market and its implications for the (re)insurance sector.
Following a brief recovery after the COVID-19 pandemic, Chinese GDP growth has been underwhelming in recent years, primarily due to subdued construction activity. Although there was a significant rise in construction over the last decade, activity has noticeably decreased since the pandemic, falling back to or below historical averages.
There are widespread reports, though with unreliable data, of overcapacity and builders attempting to reduce inventories. Continued supply from new developments, combined with waning demand due to reduced domestic and foreign interest in Chinese real estate, has led to developers halting projects. This has resulted in "ghost cities" with partially built, vacant buildings showing little sign of completion.
Data from major Chinese cities and transaction numbers reflect a similar trend. Consequently, returns on real estate investment vehicles have been disappointing.
While a real estate crisis in China does not necessarily imply an inevitable recession, a decline in construction activity hampers growth. Housing wealth constitutes about 60% of household assets, so a fall in real estate prices reduces spending and consumption.
However, Chinese household debt is moderate compared to international levels. Mortgage debt is 31% of GDP, compared to household debt of around 75% of GDP in the US. The debt levels seen in the UK and the US, which could amplify an initial fall and cause a crash, are not present in China.
Construction activity impacts other sectors through financial obligations, known as accounts payables. Companies supplying goods or services to the construction sector may experience delays in receiving payments.
Despite this, there has not been a noticeable rise in amounts owed to companies by real estate-related entities. While Chinese real estate companies face cash flow problems, they seem able to obtain credit to meet their liabilities.
During the housing boom, Chinese commercial banks heavily extended credit to construction companies and buyers. The downturn in price adjustments and construction activity over the past four years has led to bank losses and non-performing loans. Available data shows a slight increase in reported non-performing loans by commercial banks.
Chinese state banks have stepped in to keep credit flowing. Some costs from past lending may transfer to the public purse through losses in state banks, but there seems to be sufficient fiscal capacity to manage this issue.
Government authorities have taken steps to address the real estate market slump, easing restrictions on non-residents buying property in urban centers and relaxing mortgage qualification criteria.
They also reduced the 5-year benchmark lending rate. The decline in the housing market strains local governments, which have relied on tax revenues from land sales to finance operations. The central government has used national savings and capital controls to address these gaps, a measure sustainable for some time.
China has a large stock of net foreign assets it can also draw down.
For the re/insurance market, the impact of the decline in China’s real estate will vary depending on the specific investment portfolio. Regional carriers are estimated to have about 8% of their portfolio invested directly or indirectly in the global commercial real estate (CRE) market, so direct impacts from Chinese real estate assets are likely to be limited. Exposure will depend on the specific investment class, size, and geographical composition.
Local life insurers in China are likely to feel these impacts more sharply. Exposure from a balance sheet perspective will be in the form of investments in direct commercial mortgages, Commercial Mortgage Backed Securities (CMBS), wholly owned direct real estate, and Real Estate Investment Trusts (REITs).
Commercial property mortgages are expected to be the largest investment class exposed. However, with a diversified portfolio, insurer impacts from China’s real estate market are unlikely to be significant compared to the performance of other investment instruments such as sovereign bonds and equities.
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