China's real estate industry, battered by three years of austerity measures, faces another major threat: the impact of a sudden credit crunch that threatens to lock up China's financial system.
China's central bank, the People's Bank of China, has in the last couple of weeks started squeezing money out of circulation, in a bid that many economists and China watchers say is aimed at causing a shakeout in the country's "shadow banking" system.
The crunch has the potential to pressure small, poorly capitalized property developers, with the companies likely to sell off projects or even sell out entirely to their bigger, financially stable competitors.
"We're expecting more demand for the small and medium-size developers," Craig Blomquist, the chief executive of Fan Ya Tai Asset Management Co., which specializes in the recovery of nonperforming real-estate debt, told the WPC.
"I think it's going to put a lot more pressure on the smaller guys and the intermediates. Everyone I know is scrambling to see who's got money."
Shadow banking in China refers to alternative, nonbank lenders such as trust companies, which have become immensely popular in China after the government slapped restrictions on many forms of traditional borrowing, including bank-issued mortgages. From the second half of 2011, many property developers turned to trust companies for finance to help complete projects.
The pressure had been easing over the last 12 months, as housing sales improved and home prices continued to rise. Now the PBOC's aggressive moves raise the specter that credit could once again dry up.
The most immediate effect of the credit crunch was a sudden spike in bank-borrowing rates. The Shanghai Interbank Offer Rate, or SHIBOR, reflecting the price banks charge each other for short-term loans, shot up to 13.4 percent on June 20 for an overnight loan. One other interbank rate hit 25 percent, reminding many of the credit freeze that happened in the United States in 2008.
The longer-term goal of the central bank may be to punish banks for "window dressing," disguising debt levels by shifting their exposure off bank balance sheets and into little-regulated trust companies.
"They have been looking to punish the banks for doing that," Simon Cox, a writer who has just penned an article on the topic for The Economist said on CNBC. "The big question now is how banks respond to reorganize their balance sheets."
Trusts are often organized by banks and backed by a small circle of wealthy individual investors. The investors put up cash that is then leant out at very high rates of interest - and investors are often given only a very general description of where their money is being deployed. While the returns are attractive for the investors, the trusts do not have the financial depth of a bank if loans start to go bad. With China's economic growth slowing markedly, the fear is that borrowers will struggle to repay their trust obligations, forcing a potential run on trusts or causing them to collapse.
"The big concern with the shadow banking system is that nobody knows how big the potential liability is," Blomquist, who is based in the southern Chinese city of Guangzhou, said. "That's what worries all the investors out there. And it should worry the government -- I don't think the government has got a handle on it."
Much of the trust money has been loaned into property developments or for the construction of infrastructure projects.
"Unfortunately so much of the shadow banking system has gone into infrastructure projects, some of which were aimed at creating employment rather than necessary projects," Blomquist added. "How many airports do you need in this country?"
China's economic ascendance tends to create polarized views, with bulls buying the "China story" and skeptics predicting economic collapse and doom. With this latest crisis and the prospect that growth could slow to as little as 6 percent next year - most economists say the country needs 7 percent growth to avoid social unrest - the skeptics currently have the upper hand.
Cox, the Economist author, does not anticipate widespread meltdown through the economy, just a lot of pain in the banking system.
"You could have a number of defaults without that clogging up the system, feeding into growth and causing the lost half a decade we had in the United States," Cox said.
For the real-estate industry, Blomquist also tends to be sanguine about the potential setback. Local governments will welcome financial help, he believes, since so much of their economy tends to be wrapped up in property or infrastructure.
"I think it will create some opportunities for people to pick up deals," he said, noting that he is looking at two deals that would see his company take over a debt-laden housing development and bring in a third-party contractor to finish it. "We're going to be problem solvers more than vultures. Some of these local governments have got problems."
He believes long-term prospects for housing in China are clearly positive given the massive urbanization under way. Since the best distressed deals in property often go to domestic dealmakers, he hopes this current crisis will shake out opportunities for expatriate distressed-debt lenders.
"The government is going to be slightly more accommodative in getting foreign investors to bring capital into the country," he predicted. "That's one of the things that will be very telling to me, is if the government makes it easier for foreign capital to come in. Then they realize it's a significant problem."