Tempting but treacherous, China’s real estate market has attracted foreign investors of all stripes. Some institutional players from North America and Europe have prospered; others have not. Individual investors, meanwhile, rushed in during the first half of the last decade but have spent much of the second half on the sidelines, frozen out by a government concerned over asset bubbles.
To a large extent, the foreign love affair with Chinese property has been a slave to regulatory maneuverings. And as this affair continues – confidence may have taken a hit when the property bubble burst last year, but China is still the strongest economy in the developing world – investors look for ways to smooth their path.
One strategy that has recently received attention – certainly among small developers targeting small projects – is the use of a long-term lease.
A long-term lease is a contract, not a transfer of an ownership interest in property, and so approval can be completed at the local level. This is easier and quicker than going to the provincial or national authorities as required for ownership transfer projects. A lease also provides access to properties that simply would not be available for development in a sale context.
For example, an enterprising foreigner who wants to turn one of Qingdao’s early 20th-century German buildings into a boutique hotel would never be allowed to buy the property. But he may be able to get it on a long-term lease.
Areas of uncertainty
However, the very flexibility of the lease contract approach raises important legal issues that must be addressed by foreign investors.
For a start, it is often difficult to determine the identity of the property owner for purposes of the lease. Many leased projects are for state-owned buildings that have never been converted to ownership by a specific corporation or other legal entity. It is therefore unclear who is authorized to act on behalf of the state. Often the lease is negotiated by a low-level organization on behalf of higher authorities that only visit the property once every several years. The nightmare scenario is that the higher authorities make a spot visit, object to what is going on and insist that the lease be terminated and the project demolished.
The other major concern arises from the fact that a lease is just a lease. It affords no more protection for either party than any other contract under Chinese law. While Chinese courts are quite good at enforcing written contracts, there is always a degree of uncertainty.
This uncertainty is compounded by two factors. First, since the landlord is often a government agency, it is important that the investor be comfortable that the courts will faithfully enforce the terms of the lease. Second, lease law is relatively new in China and it is difficult to predict how the courts will decide on key issues. With no code provisions or customary practice to fall back on, lease contracts are inevitably long and complex, which means landlords are often unhappy about entering into them.
Get it registered
Much of the uncertainty concerning the lease’s validity can be resolved by registering it with the local real estate authority. Most importantly, this puts the lease in the public domain, thereby preventing the landlord from leasing the property to a third party, an unfortunate practice that occurs in China. Local authorities will also refuse to register a lease if the landlord has no authority or if the terms are not valid.
Registration provides vital protection for the tenant, but the questions thrown up during the procedure are a turn-off for many landlords. Even if a landlord ticks all the boxes and has the authority to enter into the lease, registering it means he can’t avoid paying real estate tax on the rental income.
It is therefore up to the tenant to play hardball and insist registration happens and happens early. Much time and money can be wasted in extended negotiations, only for the local authorities to refuse to register the lease.
As is the case with many legal structures in China, the long-term lease solves some problems with real estate development, but not without opening a can of worms or two in the process. It remains to be seen whether the lease approach will fully catch on and indeed grow to encompass larger projects. Anyone looking to dabble in this area would do well to keep an eye on the small print.