Developer's collapse highlights property sector risk

The China Index Academy, a property market research institute, said in a research note that the excess supply of new homes in smaller cities came as local authorities sold more land to cash in on the property boom; meanwhile fewer people are willing to migrate there.

In Wenzhou, another city in Zhejiang, the property bubble started to deflate last year and many local residents have rushed to sell their homes, with some even abandoning apartments to banks. The situation has sparked worries over a property market crash and huge potential risks for banks.

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Since the beginning of the year, some property developers in bigger cities, like Beijing, Hangzhou and Guangzhou, have also been offering apartments with discounts, in a promotional bid to attract buyers and retrieve funds.

"Compared to other sectors, the bankruptcy of property developers could have wider impacts and therefore should be more carefully handled," said Cheng. "The local authorities should help defuse risks to avoid similar cases from occurring."

Most Chinese real estate companies borrowed massively to capitalize on the property boom. But the developers, particularly smaller ones, could now be susceptible to defaults as the market slows and banks stop offering lifelines.

Moody's Investors Service said the collapse of Zhejiang Xingrun Real Estate Co is an isolated incident, but does highlight the vulnerability of small, highly leveraged developers with weak sales execution ability and high refinancing needs.

"In this environment, we believe financiers and investors will become more selective and favor borrowers with relatively strong credit, thereby further pressuring the liquidity of financially weak developers," said Moody's Assistant Vice President and Analyst Franco Leung.

Developers with weak sales and financial discipline will need to manage their balance sheets by selling assets, or risk being taken over or filing for bankruptcy, said the credit rating firm.

Moody's added that China's housing demand growth in the next 12 to 18 months will soften compared to 2013, and developers will need to balance their sales against their land purchases and development of new projects.