The Bankruptcy of a Developer is a Red Flag for the Chinese Real Estate Market.

The failure of a Chinese developer has caused a selloff in mainland property businesses' bonds and equities, with the sector forecasting additional bankruptcies and defaults. Property

The threat of a financial crunch has caused Powerlong Real Estate's CEO to predict that one in every five of the country's tens of thousands of developers will fail in 2014.

"It'll be fairly normal if 20% of property enterprises die this year," said Hoi Wa-fong, CEO of Powerlong, a Hong Kong-listed company.

China's property sector is one of the most important contributors to the country's economy, accounting for 16% of GDP and 20% of all outstanding loans.

The failure of a privately owned developer and a bond default by a solar-power business have backed up Hoi's prediction.

China News Services reported on Monday that Zhejiang Xingrun Real Estate Co. is unable to repay its creditors. The company owes 15 banks a total of 2.4 billion yuan (US$390 million), including China Construction Bank. It's also possible that it owes money to private investors, which is a frequent but illegal way of borrowing.

Multiple Western media outlets have corroborated the bankruptcy report after speaking with government authorities in Fenghua city, where the company is situated. According to Reuters, both the company's owner and his son were jailed for unlawful money raising, according to Wang Ruilin, the officer in charge of the city's real-estate management office. The local government has been attempting to resolve the bad debt and liquidate the company's assets.

This decade has seen a torrent of junk-bond issues from Chinese property developers. As a result, they were able to replenish their land banks in 2013, with land purchases increasing 8.8% from the previous year.

Investors are now rethinking their positions. It used to be a simple "carry trade" to borrow money in the West at historically low interest rates and reinvest it in high-yielding bonds that profited not just from high dividends but also from a rise in the Chinese yuan's value.

However, the yuan has recently decreased in value, and interest rates in the West are rising. The risks have escalated as a result of the debt problems. The CSI300 Real Estate Index of mainland companies has fallen 27 percent in the last year, indicating that Chinese property companies have been on a lengthy and steady decline.

In China, there are around 60,000 property developers, a figure that is inflated by the fact that corporations frequently form new firms for each construction. According to analysts, a slimming down of the ranks would be beneficial, as larger developers would be able to consolidate a fragmented sector.

Developer bankruptcies are uncommon – corporations usually sell off projects or form partnerships by selling shares in the company rather than going out of business – but they can happen. The first wave began in 2012, with the failures of Hangzhou Glory Real Estate in Hangzhou, Zhejiang Province's metropolis on China's coast just south of Shanghai, and Guangdeye Property Development in Shunde, Guangdong Province's southernmost city.

According to Nomura economist Zhiwei Zhang, the property sector is China's No. 1 risk over the next two years due to oversupply, particularly in smaller towns. Despite the appearance of uninhabited "ghost towns" such as Wenzhou and Erdos, the property market inventory has tripled since 2009, a staggering increase given the shrinking labor force and slowing urbanization.

China recently had its first domestic corporate bond default, posing a risk to the real estate market.

Shanghai Chaori Solar Energy Science & Technology, a manufacturer of solar panels, became the first Chinese company to default on a bond on March 7. It was only able to pay out 4 million yuan of the 89.8 million yuan (US$15 million) in coupon dividends that were due. Its bonds may now be delisted, as the company expects to lose money for the third year in a row.

Other companies, such as LDK Solar, have defaulted on international debts in the ailing solar business, where Chinese low-cost suppliers abound and overstock is prevalent. Bond issues in the real estate business, on the other hand, would have a considerably greater impact.

On the one hand, some China watchers have praised defaults, claiming that they eliminate the "moral hazard" of an implicit Beijing or state-bank guarantee of corporate debt, even for badly run, uncompetitive businesses. Defaults, on the other hand, enhance the risk of a broader credit crisis and a loss of confidence.

"As China enters its first year of private-sector defaults, the time for a harsh landing has arrived," says Wei Yao, a China economist at Société Générale. She already expects China to miss its 7.5 percent GDP growth target this year, but she sees things going lot worse, predicting a 20% risk of a "hard landing" in which growth falls below 5%.

The majority of economists believe that a growth rate of at least 7% is required to ensure social stability and consumer confidence.