China’s Developers Face Shakeout as Easy Money Ends: Mortgages

The collapse of a Chinese developer in a city south of Shanghai foreshadows a shakeout among the nation’s almost 90,000 real estate companies as the government reins in credit and the housing market slows. 

Zhejiang Xingrun Real Estate Co., a closely held developer based in Fenghua, is insolvent, with 3.5 billion yuan ($562 million) of debt. Its residential projects have been halted and authorities have detained its largest shareholder and his son, according to the city’s government. 

Developers have proliferated since China began allowing private home ownership in 1998, causing a surge in demand and a rally in residential prices. For years, homebuilders binged on easy credit from banks and shadow financing from non-banks at higher interest rates. Now many developers are struggling with debt as thousands of apartment buildings across the country sit empty and the government abstains from providing further stimulus for the economy. 

“It’s a positive sign that companies are not being propped up,” said Richard van den Berg, Hong Kong-based country manager for China at CBRE Global Investors, a unit of Los Angeles-based CBRE Group Inc. CBRE estimates there are about 30,000 “true” developers, not including construction and project companies. “That is far too many, even for a country as large as China. Consolidation needs to take place.”

Policy Shift

Zhejiang Xingrun’s demise comes after a policy shift by Premier Li Keqiang to tighten credit. The effort to contain surging home prices comes after they climbed 60 percent since the government’s 4 trillion yuan of fiscal stimulus in 2008 to bolster the economy after the global financial crisis. Since becoming premier in March 2013, Li has refrained from using short-term stimulus measures, aiding government attempts to rein in shadow financing through companies with little transparency known as trusts. 

Officials have stepped on the brakes even as economic growth was already estimated to grow 7.4 percent this year, the slowest pace since 1990, according to a Bloomberg News survey of 55 economists. China’s seven-day repurchase rate, which measures interbank funding availability, hit a record high of 10.8 percent on June 20 during the nation’s worst cash squeeze on record. China’s credit growth trailed analysts’ forecasts in February: the 938.7 billion yuan in aggregate financing fell 28 percent short of the median estimate in a Bloomberg News survey.

More Failures

With lending tight, more developers like Zhejiang Xingrun will go under, Johnson Hu, a Hong Kong-based property analyst at CIMB Securities Research, said. In 2012, there were 89,859 real estate developers in China, according to the latest data on the National Bureau of Statistics website.
“Li has already signaled that as long as there are no systematic regional risks, the government won’t do much because some cases of default are inevitable,” Hu said.

Earlier this month, after the annual meeting of the National People’s Congress, Li said the government will control the residential market “differently in different cities,” taking into account local conditions. Li didn’t provide more details 

Li’s predecessor, Wen Jiabao, who stepped down in March 2013, had tried to curb the property market since 2010. His nationwide measures included higher down payment requirements and interest rates for second-home mortgages, increasing construction of low-cost social housing and restricting home purchases in about 40 cities. Authorities also imposed a property tax for the first time, in Shanghai and Chongqing.

Price Growth

Price gains for new homes slowed for a second month in February, rising 10.8 percent from a year earlier. That compares with 11.1 percent in January and 11.5 percent in December, according to SouFun Holdings Ltd., the biggest real estate website in China, which surveys 100 cities. 

The value of homes sold in January and February fell 5 percent to 598.5 billion yuan from the same two months a year earlier, the bureau of statistics said. Sales almost doubled in the first two months of 2013. 

Developers in regions where the housing market slowed and access to financing narrowed face rising default risks, Standard & Poor’s Ratings Services said in a Jan. 17 report. Renhe Commercial Holdings Co. and Glorious Property Holdings Ltd. (845) are two such companies, the report said, without providing information on the developers’ debt levels.

Glorious Property

Glorious Property will post a 77.3 percent increase in net gearing in 2013, according to an estimate by Samson Man, a Hong Kong-based property analyst at CMB International Capital Corp. in a Jan. 20 report. 

The Hong Kong-traded shares of the company, due to report full-year earnings March 28, have declined 13 percent in the past 12 months. Shares of China Vanke Co. (000002), the biggest developer traded on mainland exchanges, dropped 26 percent in the past year, even as the company sold the most apartments by value of any developer in China. That was compared with a 4.6 percent of drop of Shanghai Stock Exchange Property Index, which tracks 24 developers. The index fell 0.1 percent at the close of trading today. 

Net debt of Country Garden Holdings Co. (2007), the developer based in Foshan in southern China that has expanded to other parts of the country and overseas, increased to 67 percent at the end of last year compared with 54 percent in 2012, according to Bloomberg Industries analyst Robert Fong. The developer’s chief financial officer stepped down on March 19.

Rebounding Sales

As the industry added leverage to tap a rebound in home sales last year, the top 500 Chinese developers’ average debt ratio reached its highest level in five years, according to a March 20 e-mailed report by the China Real Estate Association and its partners. The ratio of cash flow to short-term liabilities -- a measure of the ability to service debt -- was negative 5.7 percent compared to positive 15 percent in 2012, according to the report. 

The 500 companies’ sales jumped 29 percent to 3.26 trillion yuan last year, accounting for 40 percent of total housing revenue, the report said. 

Leverage will rise in the next 12 months for some developers as a result of “aggressive land acquisitions,” S&P said in a report March 6. Land sales in 300 cities rose 50 percent to 3.1 trillion yuan in 2013, S&P analysts led by Matthew Kong wrote in the report, citing SouFun data. Land costs on average rose 24 percent last year, they said.

Record Price

Franshion Properties China Ltd. (817) paid 1O.1 billion yuan for a 96,429-square-meter (1 million-square-foot) plot of land in Shanghai in January. The total price was a record for a residential site in the city, according to China Real Estate Information Corp., or CRIC, a property data and consulting firm. 

Lisa Emsbo-Mattingly, director of asset allocation research at Boston-based Fidelity Investments, said Chinese developers are in the front end of the default cycle. She compared the challenge in China today to the U.S. in 2007 when the first cracks in the mortgage market appeared and blamed excessive leverage and the misallocation of capital to residential developers. 

“The government will be picking and choosing who gets help,” said Emsbo-Mattingly, whose firm manages $2 trillion. 

Fenghua, where about 500,000 people live surrounded by mountains south of Ningbo, typifies how the building boom has gone awry in China’s third- and fourth-tier cities. Fenghua is best known as the birthplace of former Chinese nationalist leader Chiang Kai-shek, who died in 1975.

Empty Buildings

Today, the city is filled with pawn shops, textile and garment factories and an abundance of empty residential buildings meant to meet the needs of Chinese with rising incomes. About 67 percent of housing under construction in China last year was in less affluent cities like Fenghua, according to Nomura Holdings Inc. 

Ningbo, which has jurisdiction over the city, had inventory of 32 months at the end of February, compared with an average of about 15 months in 13 major cities, according to Fitch Ratings, citing data from CRIC. 

To slow the building frenzy, Ningbo imposed home purchase restrictions in 2011, banning local residents from buying third homes and limiting non-locals to purchasing one home.
Ningbo’s home-price growth slowed for a second month in February, rising 6.1 percent compared with 7.1 percent in January, according to the National Bureau of Statistics. 

The oversupply of housing has caused some developers to cut prices in smaller cities. Agile Property Holdings Ltd. cut home prices at two projects in the eastern city of Changzhou and the western city of Chengdu by about 20 percent each in February and March, the company said.

Zhejiang Collapse

Zhejiang Xingrun, the biggest developer in Fenghua, doesn’t have enough cash to repay creditors. The developer owes 2.4 billion yuan to banks, 700 million yuan to private lenders and the rest to construction companies, Xu Mengting, director of the news office at the Fenghua city government, said in an interview March 21. 

Zhejiang Xingrun hasn’t yet declared bankruptcy, and the local government is holding discussions with the affected commercial banks over how to resolve the issue, he said. 

The main reason the developer is insolvent is it “wasn’t run well,” Xu said. “Also, there may have been some impact from the land prices.” 

The developer’s two controlling shareholders, Shen Caixing and son Shen Mingchong, were prosecuted for illegal fundraising by local authorities, according to Fenghua’s city government. The case is ongoing and the Shens haven’t declared their innocence publicly. It “takes time for the case against the them to go forward,” Xu, the city official said. 

The company, founded by the elder Shen in 2000, built Yangguang Mingdu, which translates as Sunshine Tea City, a high-end residential complex. It also began work on Land of Peach Blossom Palace, a villa project where construction has been halted, in Fenghua. Shen, a local celebrity, was known as “Cement Shen” because he started out with a renovation and cement business.

No Bubble

The developer’s collapse does not point to widespread weaknesses in the Chinese real estate market, according to Andy Rothman, an investment strategist with Matthews Asia in San Francisco, which manages $24.9 billion. 

He said he doesn’t see signs of a property bubble partly because urban income growth in China has outstripped the rise in home prices in the past eight years. He also said that Chinese buyers pay for homes either all in cash or with significant down payments, making the market very different from its counterpart in the U.S. 

“Is this the tip of the iceberg or a signal that there are serious problems in the Chinese real estate market? That seems highly unlikely,” Rothman said.
What has changed is that the Chinese government is more willing to let private companies fail, he said.

‘Creative Destruction’

“That is a good thing,” said Rothman. “If you are going to have creative destruction, some companies are doing to have to go out of business.” 

Private companies are likely to be more reliant on non-traditional sources like trust funding, which come with high costs, Fitch Ratings said in a report March 18. 

Since 2007, Chinese regulators have limited homebuilders’ ability to borrow to buy land, hurting in particular smaller developers, which have found it harder to get access to credit. The People’s Bank of China and China Banking Regulatory Commission in 2007 ordered banks not to make loans to developers that will be specifically used to finance land purchases.

Investor Opportunities

Foreign investors are taking advantage of the financing restrictions and credit tightening, said CBRE’s van den Berg, adding that the firm expects to increase the amount of deals it’s doing. CBRE is in talks to buy development land in cities including Chongqing, Chengdu, Wuhan and Shenyang, he said. 

“If credit growth continues to slow and small- and medium-sized developers have trouble accessing credit, that should lead to opportunities for private-equity investors as those companies potentially sell assets or partner,” Chris Heady, head of Asia region real estate for New York-based Blackstone Group LP, said. 

Blackstone, which opened an office in Beijing in 2008, offered to buy all the shares it doesn’t already own in Tysan Holdings Ltd. for about $322 million, the Hong Kong-traded company said in August. Tysan mainly develops and invests in residential properties in Shanghai, Tianjin and Shenyang.
“There will be a lot of merger-and-acquisition activities in the private sector,” said Alan Jin, Hong Kong-based China property analyst at Mizuho Securities Asia Ltd. and a native of Ningbo. “Bigger developers could take the opportunity to buy low.”