China real estate development

The silver lining in high-priced urban land — China Daily commentary

Leave a Comment / August 12, 2020

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For those of us living in prosperous first- and second-tier cities in China, the land beneath our feet is exploding in value. Every week seems to set a new price record, as real estate developers buy up land to build on in Beijing, Shanghai, Shenzhen, Guangzhou, Hangzhou, Nanjing and elsewhere.

This has two ill effects. First, it adds more upward pressure on already high housing prices. Second, since the land buyers have mainly been large State-owned enterprises, they will need to sell the apartments they plan to build at one of highest prices per square meter in the world to make profits. It’s another matter that the SOEs are meant to help solve, rather than exacerbate, the serious lack of affordable housing for China’s ordinary urban population.

But there is one hidden and perhaps surprising benefit. The high and rising land prices are confirmation that land sales are becoming more transparent, less prone to potential favoritism and insider dealing. That is ultimately good for just about everyone in China. In the recent record-high land sales, the seller is the local government. In some cases, the price paid was more than double of what the government itself estimated the land would fetch. So it is up to the government now to spend the windfall wisely, in ways that will improve living standards for everyone in the city.

Too often in the past, urban land for residential development was sold for less than its true market price. The unfortunate result was that a comparatively few lucky real estate developers were able to buy land at artificially low prices and then make unconscionably high profits. Not for nothing was it said over the past 20 years that the easiest way in the world to make big money was to become a realty developer in one of China’s major cities.

When a local government sells land at artificially low prices to developers, it can amount to a transfer of wealth from China’s ordinary folks, the laobaixing, to those favored real estate companies. That’s because the developers take the cheap land and then build and sell expensive apartments on it. And the government itself gets less revenue than it should have. This means less money to spend on services that benefit everyone: urban transport, affordable housing, schools, parks, hospitals and the like.

Few Chinese developers have mastered the art and business of building and marketing high-quality apartments on time and within a set budget. Apartment prices have almost always risen during the three years it takes to go from an undeveloped plot to a finished building. If a developer got a good deal on land, he/she was able to sell the new apartments during construction, use the cash to pay off the bank loans and lock in a very high profit.

Going forward all this will become far more challenging. When a developer goes bankrupt, the real victims are usually the ordinary folks who have bought apartments during the construction phase. Time and again, it has proven difficult, nerve-wracking and time-consuming for these buyers to get their money back or make sure the apartments they bought are completed.

As the risk of bankruptcies rise with land prices, I’d like to see rules requiring residential developers to buy insurance to automatically reimburse buyers in case they go bust. The insurance will also put additional and useful pressure on developers to complete work on time and maintain an acceptable quality. If the developer isn’t making progress, or there are other signs of trouble, the insurance company would either withdraw coverage and reimburse buyers or require a new and more reliable developer to take over. Either way, the goal must be to protect, in a transparent and predictable way, the investment of ordinary homebuyers.

Up to now, too much pressure and risk has landed on the shoulders of buyers rather than builders, with cities also short-changing themselves. A fairer and better balance may now be emerging.

The author is chairman and CEO, China First Capital.

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http://www.chinadaily.com.cn/opinion/2016-06/22/content_25798648.htm

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China’s Most Profitable Industry Becomes One of the Toughest

4 Comments / July 7, 2011

Chinese real estate is no longer the easiest legal risk-adjusted money-making business in the world. It’s been a swift reversal. For the better part of twenty years, there’s been no simpler way to amass a great fortune than developing property in China.

The business model was as simple as it was profitable: acquire a piece of property from friends in government at a fraction of its market value, mortgage the property heavily with obliging state-owned banks, sell out most of the units (either offices or apartments) within weeks of construction beginning, and then pocket returns of 500% or more before the building was even occupied.

Continuously rising property prices, often increasing by 10% or more per month,  provided incentive to hold onto some units for later sale. A final wrinkle was to demand a cash advance from the construction company when awarding the building contract, so limiting even more the amount of capital needed, and improving return-on-equity even more.

There was just about zero risk in deals like this. Then, the Chinese government began clamping down, starting gingerly about a year ago and then with added ferocity in recent months,  in an effort to restrain property prices and overall inflation. At this point, what was once the easiest business in China has become one of the hardest. Sweetheart land deals are far more rare, as the central government in Beijing is no longer turning a blind eye.

More importantly, banks have all but stopped lending to property developers. This has dried up liquidity in an industry that was for many years awash in it. The projects getting built now, for the most part, are those where little or no bank debt is required. That means heavy upfront equity investment, or taking money from loan sharks who charge interest rates of 25%-30% a year. This fundamentally alters the arithmetic of a real estate deal in China. The more equity and high-interest debt that goes in, the lower the returns and, it seems,  the more likely a project is to hit problems.

And problems have become the norm. Another government change, little reported but absolutely crucial to the change in fortunes of the real estate business in China, is that it’s no longer easy and cheap to get current residents off the land, so it can be sold at a high price to a developer. New rules make it very expensive and risky for any developer to undertake this process of relocation and demolition.

Any delay, and delays are rampant, can quickly drain away a developer’s cash. For example, if one old tenant refuses to take the relocation money and move out, it is no longer a simple thing in most instances to get the local government, or hired goons, to force them out. Until all old tenants are resettled, no construction can begin. This can push back by months or even years the date that developers can begin pre-sales. Meantime, you keep paying usurious interest rates to lenders who have taken the whole project, as well as many of other unrelated assets, as collateral.

A final nail: residential real estate prices are now rising far more slowly. This is the result of tighter mortgage rules, property taxes in some cities, as well as new regulations that limit the number of apartments people can buy. In Beijing, for example, you need to prove you have paid local Beijing taxes before being allowed to buy.

Of course, taking the easy money out of real estate is a prime policy objective of the Chinese government. That the government would be successful in this was never much in doubt. The speed and geographical scope of the impact, however, has caught a lot of people (including me) by surprise. Projects that six months ago looked like sure things are today struggling. The sudden evaporation of bank finance, in particular, is playing havoc. Banks in China are state-controlled. When they responded slowly, earlier this year, to government suggestions they slow the flow of funds to the real estate sector, the government took more active measures, including raising six times banks’ reserve requirements.

Rocketing property prices are a major contributor, directly and indirectly, to inflation, which is now, by official figures, at its highest level in China in over three years. So, the government’s actions had a broader purpose than altering the return formula for real estate investment in China. At the moment, though, that’s been the main impact, to make it far harder to do both residential and commercial real estate projects in China. When and by how much inflation will be curbed is unclear.

The bigger question is: has the game changed permanently in Chinese real estate, or will things revert as soon as inflation is down to where the government wants it to be. The rising real estate prices of the last 20 years have not only helped the country’s real estate barons. They have also been a main source of rising middle class wealth in China. That’s where the government policy becomes more an art than science: how to strip away real estate developers’ easy profits, while keeping the middle class feeling flush and contented. I’ll write about that in a following blog post.

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