For the past decade, real estate investment in China has continued to expand, much like the name of the super-indebted real estate company that’s on everyone’s minds in October 2021: Evergrande.

In September 2021, Fitch Ratings downgraded Evergrande’s credit rating after the property developer missed key bond payments. A lower credit rating translates to a higher risk of default. For reference, Evergrande’s “CC” rating is one of the lowest speculative ratings Fitch assigns, just above D, which signifies an actual default. Not much better, the “CC” rating means Fitch asserts a default is likely.

What will happen if (when?) the Evergrande default occurs?

The troubled real estate company controls a limited share of the Chinese residential real estate market, thus the direct impact on local home prices will be limited. Further, it’s likely those homebuyers waiting for construction to finish on Evergrande homes will be bailed out by the Chinese government. In fact, the Chinese government — more heavy-handed than the U.S. when it comes to taming financial disasters — is expected to work with Evergrande directly to soften the blow of a potential default.

But no matter what, the indirect impact on consumer confidence in the Chinese real estate market and broader financial markets — in China and the U.S. — will be significant.

Further, Evergrande’s looming crisis isn’t a singular example so much as a canary in the coal mine. As China’s economy slows, the underlying problem is a supply-and-demand imbalance, with demand falling short of expectations, as examined in the New York Times.

Put another way, China’s population has consistently decreased since 2015, and will continue to do so for years. This shrinking population does not match up with the country’s hefty investments, much like Japan’s economy following their 1980s bubble, according to economist Paul Krugman. And with great investment comes great debt, a lesson China’s real estate sector is quickly beginning to learn.

As we have seen these past weeks, the impacts are already being felt in global financial markets.

During the month of September alone, the S&P 500 Index and the Dow Jones Industrial Average both declined over 4%. A major developer’s failure in China has implications here at home, thanks to the nature of our global markets.

Evergrande’s troubling uncertainty is just the first domino in line, as another Chinese real estate developer, Fantasia, defaulted early in October 2021. At the same time, Hong Kong’s stock exchange suspended trades of Evergrande stock while the company frantically tried to restructure its debts, according to MarketWatch.

All of these signs point to something everyone already knows: China’s real estate bubble market may look shiny on the outside, but its core is hollow.

When the shock waves reach California

While the threat of an Evergrande default and an implosion of other major Chinese investors has already shaken financial markets, the implications for real estate here in California are still emerging.

From a high level, some of California’s largest commercial buildings are held by Chinese investors. For example, China-based developer, Oceanwide, has major projects in Los Angeles and San Francisco. One of these was meant to be one of San Francisco’s highest skyscrapers, but is now literally a hole in the ground, with very little prospects of completion on the horizon. In Los Angeles, several multi-family buildings and a hotel are stuck in the construction phase.

Oceanwide is just one example of California’s many developers with money tied directly to China’s financial markets. City Century and Greenland are two more Chinese real estate companies with major projects in California.

Zooming in, many of California’s individual investors who real estate brokers work with on a regular basis hail from China. Foreign investment plays a significant role in California’s economy and real estate market. At the individual level, many Chinese investors own homes in California, taking advantage of our state’s pleasant climate, world-class university system and one of the highest gross domestic products (GDPs) in the world.

But the — somewhat — good news is that Chinese investment in California’s real estate market was already slowing going into 2021. After peaking in 2016, China’s investor presence rapidly declined in 2017 as the dollar became stronger, weakening the investing power of the Chinese Renminbi in 2018. At the same time, property prices in California have skyrocketed, making other areas more feasible for investments. Since then, trade wars and tightening borders have made U.S. investment less desirable for all types of foreign investors.

Related article:

Chinese property investment slows in California

One other piece of good news for California real estate — unlike China’s increasingly heavy supply-side imbalance, California remains overwhelmed by demand for housing, which is partly to blame for our outsized home prices. Therefore, any void left by exiting Chinese investors will be quickly filled.

For agents scrambling over scarce listings, another potentially disruptive problem remains at the macro level: large projects may be left unfinished when defaults begin to hit. At this point, shaken confidence threatens to poison developments not tied up in Chinese money.

Forward-looking licensees will be watching consumer confidence and demand in the coming months. If these high-water marks hold, Evergrande’s debt-fueled tidal wave is likely to diminish to a ripple by the time it reaches California’s coast.

But that may be an Evergrande-sized if.