Debt risk in the real estate sector deserves higher levels of attention and must be properly dealt with.

The "gray rhino" of debt risk in the real estate sector has started to emerge and deserves more attention. As a sector that is asset-heavy and highly leveraged, the real estate industry has accumulated a large amount of debt during its development process. Its debt level has been high. As the real estate sector has certain financial attributes, debt risk can be spread and is conductive, which is why such an issue deserves a high level of attention.

Since the beginning of this year, the "gray rhino" of debt risk in the real estate sector has begun to emerge. China's debt risk in the financial sector has been growing to a high level. By the first quarter of 2020, outstanding loans in the real estate sector reached as much as 47.8 trillion yuan ($7.41 trillion). It should also be noted that the period from now to the year 2022 may also be the peak debt repayment time for these real estate companies. It is necessary to pay close attention to the liquidity risk of real estate companies in the context of the tightening of real estate financing.

The COVID-19 pandemic situation and the "gray rhino" of debt risk in the real estate sector are bringing high levels of uncertainty to economic operations. While the Chinese economy is on a recovery track, the basis of recovery is not yet solid. In addition, variants of the pandemic have also added to current uncertainties, with more COVID-19 cases from other countries bringing disruptions to the Chinese economic recovery. At the same time, with continuing regulations targeting the real estate sector and financing conditions tightening, debt risk for real estate companies is becoming severely acute.

Authorities have increased attention to relative financial risks and are making efforts to keep them under control. The People's Bank of China, the central bank, issued a note on Sept 27 after the bank's third-quarter Monetary Policy Committee meeting that efforts shall be made to maintain the healthy growth of the real estate sector, and the legal rights for housing consumers need to be protected.

In the same week, a meeting statement regarding real estate financing, co-hosted by the PBOC and the China Banking and Insurance Regulatory Commission, also underlined that efforts are needed from both ministries and subnational governments to maintain the stable and healthy development of the real estate sector.

China Cheng Xin International Credit Rating (CCXI) said that between January and August, loan defaults by real estate companies reached up to 46.8 billion yuan. With the country's basis for economic recovery still not yet solid, large-scale outbreaks of debt risk will pose great challenges for economic recovery.

We believe that debt risk mitigation in the real estate industry requires proper pace and policy intensity. First, as the real estate industry has certain levels of financial attributes, the impact of their debt risk outbreak may cause systemic risk. During the process of their expansion, more often than not they have used financial leveraging and usually have very complicated interactions with the financial system. Their debt risk will impact the financial sector and cause deterioration of financial assets in the entire financial system. On the other hand, such outbreaks and tightening of regulations in the sector may cause changed expectations toward real estate investment. This will further cause a reduction in property sales, thus expanding risks for financial institutions.

At the same time, the real estate sector still plays a very important role in the Chinese economy and the outbreak of systemic risk may lead to a chain reaction. By the end of 2020, real estate investment still accounted for more than 20 percent of fixed asset investment, and construction and real estate accounted for more than 14 percent of GDP. It has driven growth of many upstream and downstream industries such as steel, cement, and home appliances. The quick slowdown of property growth will have a negative impact on the Chinese economy. It will also add to debt risk for regional governments.

Therefore, the pace and intensity of real estate sector regulation shall be noted. It should be a step-by-step process.

We also have a few suggestions for regulating the real estate sector. First, the loan quota for real estate development and mortgage loans shall be properly increased considering the current situation. As impacted by regulatory policies, the channel of equity financing for listed companies in the real estate sector has long been restricted and sales rebates and bond financing have long been the major financing channel for these enterprises. Yet due to relative regulatory changes, issuance of loans related to the above two financing channels has been notably slowed. These have resulted in liquidity pressure for many real estate enterprises. Against such a backdrop, the credit quota for mortgage loans and development loans should be increased to ease their liquidity crunch and help restore confidence in the sector.

Second, efforts should be made to set up a special fund for stabilizing the bond market to give proper guidance to the market to avoid the problem of real estate debt triggering severe fluctuations in bonds. Since the beginning of this year, with weaker investor confidence, bond prices or valuations of some real estate companies have fluctuated significantly, and the difficulty of refinancing has increased significantly. Under such circumstances, it is necessary to reasonably guide market investor expectations and reduce financial market volatility through certain institutional arrangements.

Third, regulatory approaches toward real estate enterprises should be put in place in a company-specific manner so as to avoid the occurrence of liquidity risks with a radical deleveraging process. Since regulatory departments have set up the "three red lines" for real estate company financing, liquidity, land and financing have all begun to favor those in compliance with the new requirements. Others that have not yet met requirements have started to face increasing hardships. Though the deleveraging efforts are quite necessary considering the fact that most real estate companies are operating with high borrowing ratios, attention should be paid to the speed and intensity in deleveraging real estate companies so as to do no harm to investor confidence or exacerbate liquidity problems.

The writer is an economist at the Renmin University of China and the chairman of China Chengxin International Credit Rating Co Ltd.

The views don't necessarily reflect those of China Daily.