Beijing’s attempts to rein in bank lending have focused in part on stemming the flow of money into real estate developments. The problem here is not so much the large-scale, listed developers that have long-term strategies and increasingly diversified portfolios; it is the smaller and less reliable players.
Controlling the industry is no easy task because a) it is so fragmented (China Vanke, the biggest developer, has a market share of only about 3%); and b) developers are very savvy when it comes to getting their hands on cash.
A recent conversation with an industry professional threw up several (of what must be many) ways of finding funds:
1) Often relying on well placed contacts, developers position themselves in the right place at the right time to secure a parcel of land. Then they go to a construction firm and say, “You have the cash flow so you cover all the costs. Once we start selling off the units we’ll give you a cut of the profits.” This arrangement works on the assumption that both the construction firm and the developer have the funds to see the project through to completion. Sometimes they don’t and that is why half-finished buildings are not an uncommon sight.
2) Selling off the plan – i.e. selling units early in order to generate cash that can be used to finance other parts of a project. By putting down money for a property before it is completed an investor obviously runs the risk of the project not being completed or being completed to a low standard. The government has introduced measures to limit this – developers can only get sales proceeds from banks for mortgaged buyers once the building has been completed; the developers also have to put up at least 35% of the project financing themselves to qualify for a bank loan to cover the rest – but it’s unclear how effective they are.
3) A lot of the smaller players in the market didn’t start out as real estate developers. The stellar returns on property investments in recent years have drawn in many an individual investor. The same is true of companies. Having got rich on exports, it’s not uncommon for a trading company to diversify into real estate – in fact, it is often a sensible and natural move (expanding firm acquires new land but doesn’t need all of it so decides to build some apartments). Should it get in deeper, a company can always rely on income from its primary business to supplement the secondary one (i.e. property).
Encouraging developers to find alternative sources of funding is not necessarily a bad thing – it’s just that if you are not a large-scale player that can, for example, dip into the corporate bond market, the channels become increasingly opaque. Furthermore, the strategies upon which these fundraising activities depend are less likely to be vetted by an informed third party. This increases the risk that developments will turn bad.