China Evergrande soared with the real estate boom.  Here’s why it failed.

In January, more than 100 financial detectives were sent to the Guangzhou headquarters of China Evergrande Group, a real estate giant that had defaulted on a $300 billion debt a year earlier. Their longtime auditor had just resigned and a nation of homebuyers had directed their ire at Evergrande.

Police monitoring the protesters stood guard outside the building and the new team of auditors was given permission to enter. After six months of work, auditors reported that Evergrande had lost $81 billion in the previous two years, much more than expected.

But they still had questions. Some records they had requested from Evergrande were incomplete. Numbers were missing. Significant accounting errors or inaccuracies may not have been detected. How had things gone so wrong at Evergrande, once one of China’s most successful companies?

China’s real estate boom was the biggest the world has ever seen, and Evergrande’s rise was fueled by rapacious expansion, the system that fueled it, and the foreign investors who threw money at it. When China’s real estate bubble burst, no other company imploded so spectacularly.

In 2021, the blame for Evergrande’s failure fell squarely on a political directive from Beijing to cool the market by restricting access to loans by real estate developers, depriving the debt-ridden company of cash to finance its operations.

But interviews with people close to Evergrande and a reconstruction of publicly available documents offer an alternative explanation: Questionable accounting and poor corporate oversight, which led to problems such as the disappearance of $2 billion, had already sent the company downward. the catastrophe.

The scale of Evergrande’s rise was staggering. For three decades, he wielded power in Beijing and in cities and towns thousands of miles away. The success made its founder and president, Hui Ka Yan, one of the richest people in the world and enriched an entire ecosystem, from local governments that sold him land to Wall Street banks that charged him fees to raise money.

The magnitude of Evergrande’s setbacks was overwhelming. The company promised hundreds of thousands of buyers apartments it never built. It raised billions of dollars from families and employees, some of whom have disappeared. It took labor from construction workers, painters and real estate agents without compensation, unpaid bills that have ballooned to $140 billion.

Today Evergrande remains in default, unable to pay its debts but not officially extinct. Its shares trade for a few cents a share. A legal attempt to force its liquidation was dragged out on Monday, with a judge postponing a hearing in a lawsuit seeking to formally dismantle the sprawling company to repay some of the investors who lost money.

Evergrande officials and their representatives did not respond to multiple requests for interviews or comment.

China’s real estate boom began around the time Hui founded Evergrande in 1996 in the city of Shenzhen, a special economic zone where the Chinese Communist Party was experimenting with capitalism.

Evergrande expanded beyond Shenzhen as China underwent massive urbanization and was instrumental in the largest movement of people from the countryside to the world’s cities. Mr. Hui ingratiated himself with the families of some of China’s highest officials. He put Wen Jiahong, brother of then-China Vice Premier Wen Jiabao, on Evergrande’s board of directors in 2002.

When Evergrande began selling shares to the public in Hong Kong in 2009, it had already faced questions about its voracious expansion. Foreign investors, many of them American private equity funds, hedge funds and Wall Street banks, had poured money into real estate companies a few years earlier, and debt was piling up. Hui hoped to raise $1.5 billion, but the company ended up with $722 million thanks to its stock listing.

A global financial crisis was reverberating around the world, beginning with a drop in housing prices in the United States. But in China, after a brief and pronounced crisis, the government invested $500 billion in building roads and railways, boosting growth and allowing China to emerge from the crisis before other countries. By listing its shares in Hong Kong, Evergrande had access to money outside of China to buy land in China. Dozens of other developers were doing the same thing. Three of them (Kaisa Group, Yuzhou Properties and Fantasia Holdings) raised money during the same weeks as Evergrande. Since then, everyone has defaulted.

In 2010, the market was showing signs of overheating. House prices were rising faster than median household income. Soon economists warned that China’s real estate market was overvalued, supply was overbuilt and its developers were overleveraged.

Still, Chinese homebuyers continued to flock to construction projects. As cities filled with new apartment blocks, developers sought satellite cities and more rural areas.

Prospective buyers were led through showrooms and model apartments and then given a sheet of paper to sign. For a third of the price of an apartment, and sometimes even more, they bought a promised apartment, an apartment not yet built. For households with few places to store their wealth, it was difficult to imagine how a bet on real estate could go wrong.

But things went wrong. Over the past decade, authorities have tried to rein in lending, but real estate companies found ways around each restriction, sometimes cutting spending on apartments and sometimes taking debt off their balance sheets. Finally, a 2020 policy that made borrowing more difficult began to push developers over the cliff.

Estimates vary on how many apartments remain empty. He Keng, former deputy director of China’s statistics bureau, recently joked on an estimate that the number of unoccupied homes was not enough for three billion people. “That estimate might be too much,” she said in a video posted by China News Media. “But 1.4 billion people probably won’t be able to cover them.”

For months in 2021, Evergrande kept global markets on edge as it moved closer to default, testing the belief that some Chinese companies were too big for authorities to let fall. Foreign investors continued to buy bonds from real estate developers even after one of the biggest beneficiaries of the real estate boom, real estate tycoon Wang Jianlin, warned that China’s real estate market was “the biggest bubble in history.”

On December 9, three days after Evergrande missed the deadline to pay interest on some bonds, a credit rating agency declared the company to be in default. That set in motion a fight between investors, homebuyers, suppliers and banks over how to get what they were owed.

Evergrande’s collapse was just one domino in a downward line. Since then, another 46 developers have defaulted on payments, leaving a landscape of boarded-up construction sites, angry homebuyers and unpaid builders. Concerned about social unrest, authorities have quietly pressured companies to continue building apartments. Evergrande built 300,000 apartments in 2022 as the company spoke to its creditors about how to repay them.

But years of corporate mismanagement and bad behavior at Evergrande were spreading to the public as financing became harder to come by.

Three months after its default, Evergrande said banks had confiscated $2 billion. An internal investigation later. revealed that top executives had devised a plan in late 2020 to circumvent borrowing restrictions by arranging for third parties to obtain loans using Evergrande subsidiaries as collateral.
The investigation concluded that the scheme breached the company’s disclosure and compliance obligations.

However, some employees said “it was not their place to question an issue that was known and driven by senior executives,” according to the investigation.

Senior executives, including the chief financial officer and chief executive officer, resigned. “The behavior of some of the then directors fell below the standards expected by the company,” according to the internal report, signed by Mr. Hui, the founder.

In January this year, Evergrande’s former auditor, PricewaterhouseCoopers, resigned and said he could not complete his work. The Hong Kong Accounting and Financial Reporting Board had already announced two reviews of Evergrande’s books. A little-known accounting firm, Prism Hong Kong and Shanghai, was hired to do the work.

Prism said in July that Evergrande had lost a combined $81 billion in 2021 and 2022. That, compared to what the company said in 2020, was a profit of $1 billion. There were clues in the new audit that Evergrande had been treating the money it had received for the apartments as income, even though it had sometimes not yet built them.

After the new audit, Evergrande agreed change the way it would recognize income in its accounts by requiring documentation that an apartment had been built for the first time.

Evergrande’s wealth management arm, which had offered short-term, high-interest products to homebuyers and employees when money was tight, said investors in August who would not be able to make payments.

Within weeks, the police arrested the staff of the wealth management unit. Chinese media reported that the company’s former CEO, its chief financial officer and the former president of Evergrande’s life insurance unit had also been detained.

Behind the scenes, the company’s management team in Hong Kong was moving toward a restructuring deal with foreign creditors and private lenders. Then, on September 24, Evergrande said it had to re-evaluate and scrapped the deal. A few days later, it was revealed that Mr. Hui had been arrested.

Chinese social media was filled with comments about how Hui had become “an enemy of the Chinese people.” People directed their anger at foreign investors and the company’s decision to file for bankruptcy. Famous businessmen insisted that foreigners would get a share of the remaining company that belonged to homebuyers.

According to company documents, Mr. Hui had paid himself and his wife more than $7 billion in dividends since the company went public in 2009. For at least two years he has told people that He and his wife were divorced, according to two people with direct interactions with the company who were not allowed to speak to the media. Documents filed in August indicate he and his wife were no longer married. The assets that have been transferred to his ex-wife will be in dispute.

Two years after the default, it is still unclear how the company will be liquidated, how much money will remain and who will keep it.