Scorched earth

Just as investors in China’s stock markets remember last year’s boom months fondly, so too do property developers. A record US$8.75 billion was raised through share offerings by real estate firms as the market peaked, helping finance massive additions to developers’ land banks.

Hopson Development Holdings was in the thick of things. The Guangzhou developer increased its land bank by more than 50% to 21 million square meters last year. Revenues rose 61%. But, as any retail investor will say, things are different now.

Firms like Hopson are facing a major funding squeeze as policies designed to cool property markets kick in. Developers now have plenty of land, but not the cash to build on it.

These land surpluses became potential liabilities in January when the State Council announced an anti-land hoarding measure which forces developers to start building on newly acquired land within a year or face fines of up to 20% of the land transaction price. Worse, if developers don’t start work within two years then the government reclaims the land.

Hopson announced that contracted sales for the first five months of 2008 were worth US$437 million – the same as last year. But with a bigger land bank, a two-year ticking clock and US$1.3 billion in capital commitments, merely repeating last year’s performance means the company’s cash inflow won’t cover costs, according to a report by Fitch Ratings.

“Previously, [developers] had almost unlimited access to credit,” said Greg Hyland, director of corporate capital markets for China at Jones Lang LaSalle. “Now credit is drying up quite rapidly and the ability to execute projects is diminished.”

Lending lockdown
Commercial banks are the main targets of Beijing’s cooling measures. Over the last 18 months, the government has imposed a series of increases in the required reserve ratio – which means banks must hold a greater proportion of their assets in reserves, thus restricting new bank loans – and interest rates charged on new loans.

Banks have also been handed annual loan quotas and told to keep the level of credit issued below last year’s US$529 billion. By May, some commercial banks had already reached 59% of their annual loan quota, according to a report in the respected Chinese newspaper Economic Observer.

Thanks to the slowdown in the capital markets, developers’ potential sources of project funding have been narrowed still further.

In March, Guangzhou-based Evergrande Real Estate Group shelved a Hong Kong listing that it had hoped would raise US$2.12 billion, citing market volatility. Half of the IPO proceeds was reportedly set aside to pay for land it had accumulated last year. Two other developers, Guangzhou R&F and Beijing-based Soho China, have delayed mainland listings this year.

On June 25, Henan-based Central China Real Estate became the first mainland real estate company to list in Hong Kong this year, raising US$175 million. But its shares closed the day 2.9% below the initial offering price.

“That was pretty respectable in comparison with other companies,” said Jamie Barr, a partner at law firm Lovells, who worked with Central China on the listing. “For most developers, the market is pretty much closed.”

Last year, the government raised minimum down-payments on second homes to 40% from 30%, and also raised mortgage rates for second homes. This has dissuaded many middle-class home-buyers from investing in property and prices have been hit.

Guangdong has fared particularly badly. In Guangzhou, only 9,000 new apartments were sold in the first quarter of 2008, down 45.8% over the same period last year, according to official statistics. Shenzhen-based China Vanke, the country’s biggest developer, slashed prices 5-30% on some of its properties in Guangzhou, Shanghai, Beijing and elsewhere to drum up sales. China Merchants Property Development and Gemdale Group have launched similar promotions.

A property-price downturn puts small developers in a tight spot, as their portfolios are less diverse. They also face an uphill battle against larger rivals for a shrinking pool of funds.

“As the market tightens, funders are going to look much more closely at developers’ ability to deliver,” said Steven Mooney, executive director of investment properties in Shanghai for CB Richard Ellis. “Without a track record, it’s far harder.”

PE opportunities
Many believe these weakened developers – and their unfinished projects – will become attractive acquisition targets. Mooney said he expects private equity funds to move into second-tier cities where there are higher risks and higher potential returns.

“[They] are getting their war chests organized,” he said.

Investment banks and other institutions are also joining in. JPMorgan, UBS and ING have all launched China real estate funds this year.

“There is a mess to come,” said Fred Chang, an associate with Lovells. “The developers are looking for any way they can get cash.”