The collapse of a Chinese developer has sparked a selloff in the bonds and stocks of mainland property companies as a whole, with the industry predicting more bankruptcies and defaults to come.
The prospect of a credit crunch has led the head of Powerlong Real Estate to forecast that one in five of the country's thousands of developers could go under in 2014.
"It'll be quite normal if 20 percent of property firms die this year," Hoi Wa-fong, the CEO of Hong Kong-listed Powerlong, told a press conference.
The property market in China is one of the biggest contributors to the country's economy, accounting for 16 percent of GDP and 20 percent of all outstanding loans in china.
Hoi's forecast has been given credence by the collapse of a privately owned developer, and a bond default by a solar-power company.
Zhejiang Xingrun Real Estate Co. can't repay its creditors, state-owned China News Services said on Monday. The company owes 2.4 billion yuan (US$390 million) to 15 banks, including China Construction Bank. It may also owe money to private investors, a common but illegal method of borrowing.
Government officials in Fenghua city, where the company is based, have since confirmed the bankruptcy report to multiple Western media sources. Reuters quoted Wang Ruilin, the official in charge of the city's real-estate management office, as saying both the company's owner and his son had been detained for illegal fund raising. The local government has been trying to work out how to handle the bad debt and sell off the company's assets.
Chinese property developers have flooded the market with junk-bond offerings this decade. That helped them replenish their land banks, with land purchases up 8.8 percent in 2013, compared to the year before.
Investors are now reconsidering those holdings. It was previously an easy "carry trade" to borrow money at historically low interest rates in the West, and reinvest it in such high-yielding bonds, which benefited not only from high dividends but also an increase in the value of the Chinese yuan.
But the yuan has recently dropped unexpectedly in value, and interest rates are rising in the West. The debt issues have increased the risks. Chinese property stocks have been on a long and steady slide, the CSI300 Real Estate Index of mainland stocks down 27 percent in the last year.
There are around 60,000 property developers in China, a number boosted by the fact that companies often create a new company for each development. Analysts say some whittling down of the ranks would be healthy, with larger developers able to consolidate a highly fragmented industry.
Developer bankruptcies are unusual - companies typically sell off projects or forge partnerships by selling equity in the company rather than going out of business - but not unheard of. The first wave began in 2012, with the collapse of Hangzhou Glory Real Estate, in Hangzhou, the capital of Zhejiang Province on China's coast just south of Shanghai, and Guangdeye Property Development in Shunde, in southern Guangdong Province.
Thanks to oversupply, particularly in smaller cities, the property sector is China's No. 1 risk over the next two years, according to Nomura's economist Zhiwei Zhang. Despite the emergence of unoccupied "ghost towns" such as Wenzhou and Erdos, the property market inventory has tripled since 2009, a ballooning that is hard to swallow as the labor force shrinks and urbanization slows.
China recently had its first domestic corporate bond default, a threat that could spill over into the real-estate sector.
On March 7 the solar-panel maker Shanghai Chaori Solar Energy Science & Technology became the first Chinese company to default on a bond in China. It was able to pay only 4 million yuan out of coupon dividends of 89.8 million yuan (US$15 million) that came due. Its bonds may now be delisted as it predicts a third year in the red.
Other companies such as LDK Solar in the troubled solar industry, where Chinese low-cost suppliers are numerous and oversupply rampant, had defaulted on overseas bonds. But bond problems in the property industry would have a much broader impact.
On the one hand, some China watchers have welcomed the idea of defaults, noting that they remove the "moral hazard" of an implicit Beijing or state-bank guarantee of corporate debt, even for poorly run, uncompetitive companies. On the other hand, the defaults raise the prospect of a broader credit crisis and loss of confidence.
"As China enters its first year of private-sector defaults, the moment when a hard landing could occur has arrived," Société Générale's China economist Wei Yao says. She already expects China to miss its 7.5 percent target for GDP growth this year - but sees the prospect of it getting much worse, adding there's a 20 percent chance of a "hard landing" where growth falls below 5 percent.
Most economists say a growth rate of at least 7 percent is necessary to maintain social stability and sustain consumer confidence.