Alarm bells rang in Beijing in April 2008 when the State Information Center claimed hot money inflows tripled in the first quarter to US$80 billion. Some analysts put the figure even higher at US$100-120 billion.
That growth came despite Beijing’s best efforts to stymie the tide of cash being deposited in equities, currency and property – all with a view to profiting from renminbi appreciation.
Tighter property investment controls were laid out in two notices, Circular 171 and Circular 50, released in July 2006 and May 2007, respectively, by the Ministry of Commerce (MOFCOM) and the State Administration of Foreign Exchange. Under the new rules, foreigners looking to invest in Chinese real estate must do so through foreign-invested enterprises (FIEs) registered in China. An FIE must be registered with MOFCOM and it must notify the ministry of all investments.
The amount of capital the FIE is permitted to spend must be registered – and none of the money can be backed by debt; it’s a cash only business. Originally, 50% of the capital could be debt financed, but the government upped the ante when it saw that hot money inflows still weren’t falling, said Maurice Hoo, a partner in the Asia private equity group at law firm Paul Hastings.
"It’s a cash trap," said Hoo. "It might take two years to finish the building and begin selling and then after two-and-a-half years you start to bring in money. The remaining capital is stuck with the company until all the units are sold and all the tax has been paid, which may take another year or so."
Problems also arise in the general structure of the business. A foreign investor usually sets up a company in the Cayman Islands that holds a controlling stake in the onshore enterprise and receives the profits via dividends. However, due to foreign exchange controls, the holding company is unable to use onshore assets as a guarantee for money raised offshore and injected into the onshore enterprise.
"It has affected investor interest," Hoo said. "When you need to keep more money in the country for longer it affects your internal rate of return. One or two years ago when the real estate market was really hot, more people were willing to overcome that. Maybe now they feel the return is insufficient."
While the rules are still in place, Jack Rodman, the Beijing-based senior advisor to property-focused private equity firm Westport Capital Partners, said the approvals process has been eased considerably in recent months.
"Now people can get things done in 30-45 days that in the past we would tell them might not get done at all," he said. "Six months ago they were writing about hot money inflows. Now that hot money is going the other way."