Edging local governments out of the land market

Editor’s note: In the four-part series In the Red, China Economic Review looks at how and why local governments amassed such huge debt, and the options Beijing has to deal with it. Click to read part one, part two and part four.

Residents in Heze, a third-tier city in Shandong province, were angered last week after they discovered they would have to turn over their homes to the local government. Officials in Juancheng county are offering a scandalously low compensation rate for land that they plan to clear, add basic utilities to, then turn around to a property developer at a steep profit. Residents there say they refuse to move.

Incidents such as these are commonplace. They occur as local governments, entrusted as the sole purveyor of rural land, look to finance regional development with the proceeds of land sales. However, reforms underfoot may soon edge local governments out of the rural land market.

A policy statement issued on November 15 after the close of a high-level leadership meeting in Beijing called for the establishment of a market for certain kinds of rural land. If it materializes, vast income from land transactions would be transferred to property holders instead of government officials.

But creating rural land markets after a pause of more than 60 years will be arduous and time consuming. Local governments will need to figure out who owns what land before a single lot can be sold. The move raises questions about how local governments raise money and may even change the nature of China’s skyrocketing residential real estate market.

Hands off our land

High on the minds of local officials is no doubt the question of revenues. Provincial and city balance sheets around China are deep in the red. Barred from formal borrowing, they have racked up an estimated US$4.6 trillion in off-the-books debt that experts increasingly fear may turn sour.

Cutting these cash-strapped cadres out of the rural land market, which some analysts estimate constitutes up to 40% of revenues in certain areas, will be a tremendous blow to their finances. Small governments around the country are likely to resist change.

“Nowadays, local governments need the money,” said Ma Qingbin, a senior researcher at the China Center for International Economic Exchanges (CCIEE) in Beijing. “They will certainly be unhappy to give up this chunk of fat.”

City governments have faced losing revenue from land before.

At the Third Plenary session in 2008, a similar proposal was submitted – with few results. Analysts at London-based Capital Economics though believe the new plan has a better chance of gaining traction.

Reform would start small, likely in the form of more experimentation. Land reform pilots have been popping up throughout the country during the past five years. At the heart of the plan is establishing a property-rights trading market, where farmers can transfer their titles for some forms of land directly to property developers. Initially, the category of land that this will apply to is known as rural “economic usage” land, a form of land in the countryside upon which factories can be built.

The central government will encourage rural dwellers to transform collectively held rights into shareholders rights that will give them returns on new property developments when companies buy up the land. This would begin to shut out the middleman – local governments – from the market.

“This is delinking the monopoly power that the local government has over selling land,” Wee Liat Lee, a property analyst at BNP Paribas Securities in Hong Kong, said on the prospects of the reform before policy goals from the Third Plenum were issued.

For years, after evicting local residents, officials have transferred rural land into urban land then sold it to developers at high profits. One practice they have used to boost profits on residential land is tightening supply and waiting for prices to rise before selling. On land earmarked for industrial purposes, they have taken a different approach. It has usually been sold at below market value to encourage profitable business to enter the community, generate jobs and pay taxes.

In 2010, at its peak, the value of government land sales was worth 4% of China’s total GDP, according to Capital Economics, or about US$250 billion.

Death and taxes

Local governments are sweating the idea of giving up rights to sell rural land. They will need to find more sustainable sources of revenue elsewhere. A rollout of a property tax trial to more areas floated at the plenum could help establish a new revenue source in the long term.

China has played with the concept of property tax for more than three years. Shanghai and Chongqing launched limited pilot projects for taxes on new residential units in 2011. The tests have brought in low revenues, and proposals to levy taxes elsewhere have not yet materialized. It’s unlikely that an expansion of the tax would solve short-term revenue deficits or relieve debt problems.

“I don’t think that property tax will help resolve the issues concerning local [debt],” said James Macdonald, head of research at real estate services firm Savills China. “I don’t think that’s the point of the property tax. I think the goal is to not exacerbate this problem in the future.”

An expansion of the property tax would be slow and target individual cities and provinces. Also, at first, a tax would be levied only on new homes. China is developing a comprehensive registry for home ownership but this work is still far from complete; until it is, a broader tax can’t be levied.

Developing a more substantial taxpayer base could take five to 10 years, Macdonald estimated. Lee at BNP Paribas put the timeframe at 10-20 years. The tax should incentivize officials to make urban areas more welcoming and convenient. Cities that are perceived as more suitable for living will attract more residents, creating a larger tax base, Macdonald pointed out. 

Flooding the market

The greater reform, establishing rural land markets, could fundamentally redefine the way local governments and property developers interact, Lee said. At the moment, the market between the two players is thriving – and the governments provide excellent service in order to keep their customers, the developers, coming back.

Land reform would break apart this relationship. Local governments would no longer have such strong incentives to guarantee developers flourish in their communities. This may lead to lower house prices, although that’s not for certain.

Local officials often help developers dodge centrally imposed controls that seek to slow housing sales. When officials ignore the rules, housing sales, and therefore prices, are kept high. “If this delinking happens, the local government will be more vigilant in terms of controlling the property prices,” Lee said. Nevertheless, prices wouldn’t drop but would rather moderate, he noted.

According to Ma at the CCIEE, creating a market for rural land could slowly lower housing prices over a long period of time, but “not in a few months or half a year.” At present, only “economic usage” land, or space for building rural factories, would be included in the experimental market.

If other categories of land, such as that designated for rural residences, were added to the market, the availability of land for new resi
dential projects would expand. This could lower land prices and eventually new home prices, Ma said.

The supply of rural land zoned for construction is seven times greater than the amount of urban land in China, according to Capital Economics, a figure that shows the scope of the potential market.

Solid support from Beijing, followed by visible progress in cities across the country, would be a sign that both the central authorities and local governments are serious about fundamentally changing the way the country operates. Setting up rural land markets will unlock a massive source of wealth that has been held back for decades – one that could actually fall into the hands of ordinary people.

The people’s gain is the government’s loss. Land reform could give farmers a promising new source of income, and one that will finance the costs of setting up new businesses or relocating to a city. It will also challenge cadres that have enjoyed easy yet opaque revenue streams for years.

For Beijing, the process of opening rural land to the market must be a delicate one: Tenacious enough to better the lives of farmers while not pushing local governments deeper into debt.