They are building settlements, airstrips, and bases on disputed islands. It is absolutely not lawful.
It's true that the Chinese presence in the islands is disputed. US military presence on Japan is disputed. Disputed != Illegality; they should not conflated or confused.
All of the policymakers I follow complain about how difficult the situation is because technically it IS legal. It's unfortunate. But it is legal.
(In addition, they are building new islands from nothing, and then inhabiting them. This is mostly without precident, but the precedents that are there have it legal.)