China's house price crisis is creating a perverse bailout bubble for property companies

Chinese flag mask boyREUTERS/Jason LeeA boy wearing a Peking Opera mask waves a Chinese national flag on Beijing’s Tiananmen Square, March 1, 2011.

China’s house prices are sinking at the fastest pace on record, but you wouldn’t know it to take a look at the country’s massive property companies.

Prices tumbled 5.7% in the year to February, falling across 66 of China’s biggest 70 cities.

China’s booming economy has driven a colossal supply of houses, including the ghost cities that the country is now infamous for.

But the country’s growth is now slowing considerably, falling to the lowest level in 24 years in 2014, and falling house prices raise the risk of a debt overhang — when households and businesses have more property debt than the buildings they own are worth. Rabobank’s analysts suggest the crash “likely still has years to play out given the level of over-supply.”

And you would think that would be bad for China’s big property and real estate companies. After all, residential and commercial buildings are the thing they make their living from selling, so falling prices certainly seem like a bad thing.

But shares China Vanke, the country’s largest property developer, rose by 4.04% on Wednesday.

It’s a similar story for Poly Real Estate Group, another massive developer. Shares rose 5.05% overnight, and are up by more than half in the last year. In fact, both companies easily outstripped the 2.13% rise in Shanghai stocks overall on Wednesday. But why?

The answer lies in the perverse incentives on offer — and the fact that China’s Evergrande Real Estate Group just got a $US16 billion (£10.85 billion) lifeline from China’s state-run banks.

Here’s how the New York Times reported the effective bailout for the developer:

The Chinese leadership is concerned about the health of the country’s property market because it is so deeply interconnected with other parts of the economy. Real estate is an important driver of steel consumption, loan growth and jobs for sales agents and migrant construction workers. A drop in home prices hurts ordinary Chinese because they tend to invest a disproportionate amount of their savings in real estate.

It’s a more extreme version of the “good news is bad news” phenomenon that a lot of investors closer to home have complained about in recent years — that positive economic news is bad news for stocks because it’s a sign that government or central bank support could be pulled away more quickly. Property prices falling in China means more bailout money.

In fact, Kaisa Group, another property developer that defaulted on offshore bonds in January saw share prices surge Wednesday, up 9.52%. China’s house price crash may well be bad news for China, but perversely, it’s good news if you’re a struggling property developer.

NOW WATCH: Watch 2 armed gangs fight on a busy road in China

NOW WATCH: Money & Markets videos

Want to read a more in-depth view on the trends influencing Australian business and the global economy? BI / Research is designed to help executives and industry leaders understand the major challenges and opportunities for industry, technology, strategy and the economy in the future. Sign up for free at