胡润峰胡润峰 ・ Aug. 25, 2023
The Financial Implosion is What They Looked For
Relying on toxic solutions to quench thirst will inevitably lead to poisoning. Relying on capricious luck will only invoke Murphy's Law. The debt crisis of real estate companies is a result of their own problems.

Credit: Visual China

Credit: Visual China

By Hu Renfeng 

BEIJING, August 24 (TiPost) -- After Country Garden, a "model real estate company," was mired in a debt crisis , the state-owned enterprise Sino-Ocean Group repeat the same mistake. If the market continues its downturn, more real estate companies will default on bond interest payment.

Are there so many debt-ridden real estate companies in an industry that was once flourishing? Is it due to market, policy, or other factors? Looking back at the real estate regulation process since 2017, the answer may be found.

Going against the "no speculation in housing" policy, the real estate companies are like elephants in red shoes

In December 2016,  the principle of  "housing is for living, not for speculation" was established in the Central Economic Work Conference. Since then, "no speculation in housing" has become the guideline of the real estate industry.

In 2017, the first- and second-tier cities implemented comprehensive restrictions on purchasing houses, and various control measures were further intensified. However, the warning of stepping on the brakes was taken by real estate companies as the starting gun for a race for business expansions.

In retrospect, one might be curious about the mindset of the bosses of real estate companies. In such an industry where policies have such a big impact, where did their policy sensitivity go?

But at that time, the whole industry was in a state of fast expansions.

Thanks to the "higher price, the less inventory" strategy, the third- and fourth-tier markets boomed in 2017. Evergrande, Country Garden, and Sunac, leading a group of aggressive real estate companies, broke into a frenetic gallop.

In 2016, the sales threshold for the top 30 of CRIC, China’s largest comprehensive service provider of real estate information, was 45.5 billion yuan, with Evergrande at the top with 373.1 billion yuan. In 2017, the threshold for the top 30 soared 51% year over year to 68.9 billion yuan, and Country Garden became the leader with 550 billion yuan, a year-on-year increase of 47%.

These are no longer small companies. By comparison, China's total box office revenue in 2017 was 55.9 billion yuan, which was less than the annual revenue of the 30th real estate company.

Real estate companies have hundreds of billions of dollars in scale, with a growth rate of around 50%. Who says the elephant can't dance? And it's

How was this growth achieved? There are two tricks.

The first is to throw a sprat to catch a herring.

Friends from real estate companies say that it is a common practice in the industry to leverage 500 million yuan of self-owned capital to initiate several 5-billion-yuan projects in a year.

First, they pay a deposit for land auctions, usually 20% of the auction price. After acquiring the land, they immediately get a bank loan. Once they receive the loan, they withdraw the self-owned capital invested in the land initially and invest it in other projects. Construction starts in three months after the land auction, and the properties are put on sale after six months. They continue to invest in other projects when they receive pre-sales proceeds and repeat the steps.

It takes about two years from pre-sales to the completion of residential buildings. Most of the construction costs, material costs, and taxes can be postponed, which means that a large amount of capital can be used for free for two years.

By repeating such steps and developing more and more projects, the amount of their capital keeps growing. However, the bosses don't consider the fact that this high debt and high turnover approach also leads to higher risks.

Secondly, residential units in the third- and fourth-tier cities were sold in volume with a slim margin, while the accumulated capital was used to make big profits in first- and second-tier cities.

The housing prices in third- and fourth-tier cities are low and rise slowly, while those in first-and second-tier cities are high and rise quickly. Large companies like Evergrande and Country Garden simply pursue scale and speed in third- and fourth-tier cities without pursuing profits. They develop land in large quantities, sacrificing profits to build up their capital pool. Then, they go to first- and second-tier cities to make profits.

In order to maximize the efficiency of capital utilization, high turnover has become a common pursuit in the industry. Pre-sales within six months of acquiring land has become a routine, and some even started selling properties within three to four months, even when the procedures and documents for a building start are incomplete.

Residential properties, which are related to the quality of life for thousands of households, should be carefully designed and developed, but they have become “fast-moving consumer goods” in the assembly line. What's even more absurd is that the leading companies in this industry take pride in high turnover, and big-name real estate companies are following suit. Should such malpractice be in vogue?

However, the industry was still growing rapidly. In 2018, the sales threshold for the top 30 companies on the CRIC sales list reached 100.5 billion yuan, with Country Garden at the top with 728.6 billion yuan in sales. However, real estate companies that achieve scale growth through high leverage, high debt, and high turnover are like elephants wearing the red shoes – and they can't stop.

They witnessed Xu Jiayin being catapulted into the perch of the richest man in China, Country Garden becoming the "number one real estate company in the universe," and Sunac surging to 400 billion yuan in sales in ten years. They saw regional real estate companies that were once obscure rushing into the 100-billion club and moving their headquarters to the highly sought-after Hongqiao, Shanghai.

What they could not see was that the real estate boom, created and fueled by the combined forces of China's economic growth, urbanization process, supply-side reform, and a deluge of strong stimulus, was coming to an end.

Real estate companies defeated in battles against price and financing restrictions

With the policy of "housing is for living, not for speculation", the continuous housing price hikes in first and second-tier cities could no longer be tolerated by the central government. After the introduction of the restrictions on purchases in large cities, price controls on pre-sale properties were implemented. For some hot projects, the government's guided price was generally more than 20% lower than the surrounding second-hand housing prices.

There had been restrictions on prices before but they were just empty talk. And the changing policies had also fostered another tendency among real estate bosses: confronting with price control policies.

Here is a case told by my friend from a real estate company. A high-end developer acquired a "land king" project worth 5 billion yuan in a first-tier city for 10 billion yuan. Due to the desire to build high-quality buildings , the pre-development research and design took a long time, and financing costs were also high. By the second half of 2017 when it entered the market, it needed to sell for 15 billion yuan to break even.

The boss had high expectations and set the price at 150,000 yuan per square meter, with a total value of 20 billion yuan. However, in order to obtain the pre-sale permit, they had to accept the guided price of 125,000 yuan. After multiple negotiations that went in vain, the boss chose to wait for a loosening of the price control.

Ten years earlier, the boss‘s project in Tongzhou, Beijing had failed to sell due to its avant-garde design and had to be demolished and rebuilt. As a result, it coincided with multiple local positive factors , and the housing prices skyrocketed. The boss made billions of yuan from the misfortune.

But this time it was a different story. After a year, not only did the financial costs increased significantly, but the boss also faced an even stricter guided price: 115,000 yuan per square meter. Not long after, this real estate company collapsed.

Real estate companies that built funding pools in third and fourth-tier cities have been battling price control from 2017 to 2018. Some properties under construction were completed without obtaining pre-sale permits, but the developers were still unwilling to sell at a loss due to their wishful thinking.

After all, although Sun Hongbin experienced bankruptcy of Sunco Group, he was able to make a comeback with Sunac China. Xu Jiayin once considered taking his life in 2008, but in 2009, he bought his own jets. “Maybe victory is just around the corner?” they wondered.

But the huge financial costs started to create pressure, and developers had to increase their financing efforts. Unfortunately, the regulation continued to tighten, shifting from the transaction to the financing.

Trusts are now subject to comprehensive restrictions, and bank credit is also subject to total control and proportion control. Many banks have received guidance that real estate-related loans can only be reduced.

The anxious real estate companies are bending over backwards to get on the bank's whitelist and seize a slice in the shrinking market. How do banks make decisions with limited loan quotas? From the perspective of exemption from responsibility, they take the sales rankings of independent third parties as important reference indicators.

As a result, real estate ranking agencies had their most prosperous days. Companies like CRIC and China Index Academy were highly sought after, and smaller agencies like GDIRI and EH Consulting were also piggybacked..

Real estate bosses who dare to go against the regulation policies are even willing to falsify data in order to get to the top on the rankings. This is also an open secret in the industry.

As regulations tighten, real estate companies are resorting to desperate measures to raise funds regardless of the cost. Some are bribing bank executives, some are issuing high-interest bonds, and others are targeting their own employees.

A media friend of mine was quite tempted by the 24% interest rate offered by Evergrande's commercial bills at the time. She understood Evergrande's problems better than I did, but her reason was that it would take a considerable amount of time for the elephant to fall and die. Considering Evergrande's value on the media, even if a crisis were to occur, she should have a green channel to recover her principal.

There is also a real estate company that conducts internal fundraising with an annual interest rate of 18%, settled every six months. A “beautiful and brave” friend of mine who worked there applied for a loan and invested it in the company. Six months later, she retrieved the principal and interest, making a profit equivalent to an annual salary. Later, the company collapsed, and many more employees were unable to recover their investment funds.

I can only admire these bold operations. From a financial perspective, a return on investment of more than 18% cannot be guaranteed. It sounds a very dangerous warning if a

company borrows money at such an high interest rate.

From a liquidity issue to insolvency

In 2019, some real estate companies collapsed. More real estate companies were gambling on loosening policies while continuing to expand in scale. They were not unaware of the impending crisis but rather wanted to seize the panacea of  "too big to fail" before the crisis erupted.

In order to avoid a larger crisis, in 2020, the regulator issued "three red lines" to restrict real estate companies from further leveraging. Commercial banks began to withdraw loans, and real estate companies were forced to sell assets to repay debts, embarking on a passive deleveraging path.

As Evergrande and other real estate companies imploded one after another, the relevant authorities proposed to "implement the responsibility of local governments, ensure the delivery of housing, and stabilize people's livelihoods" when dealing with numerous stalled projects. Under the pressure of ensuring delivery, local governments have resorted to the strategy of depositing pre-sales proceeds into supervised accounts.

This means that the project company can only receive the money after delivering the houses. The company's headquarters has become an empty shell. The previously abundant resources are now lacking, and the headquarters are helpless.

As a result, the accelerated liquidity crunch of real estate companies led to debt defaults, trust crises, hindered sales, and the inability to sell assets even at a discount.

The collapse of real estate companies seems to be a liquidity crisis, where the cash inflow is unable to cover all expenses, especially interest payments, and once the remaining funds are exhausted, defaults occur.

Due to the pandemic, economic downturn, and other factors, the real estate market is also declining, further devaluing the inventory value of collapsed real estate companies. As a result, the company's assets are gradually depreciated, until they are lower than the debt. At this point, the collapsed real estate companies are facing an insolvency crisis.

According to the unaudited 2022 annual report of Evergrande, the total liabilities of the company amounted to 1.833819 trillion yuan, more than its total assets of 1.468557 trillion yuan.

Prior to this, the debt restructuring plan of China Fortune Land Development (CFLD) is to divide its existing assets into separate parts to offset debts, but there is still 55 billion yuan of debt that cannot be eliminated, which the company will gradually repay. The 55 billion yuan is essentially the gap between assets and liabilities.

At this point, there may not be any better solutions. It is merely a matter of who will bear the cost.

Is the market to blame? The company cannot simply rely on the expectation of a forever buoyant market when it comes to make strategic and operational plans.

Is it due to policies? Policies cannot be perfect, and business operators should fully estimate the impact of policies on operations, treating policies more as rigid constraints rather than as objects of speculation.

Whether it is fortune or misfortune, it all comes from the mind. All troubles are the result of self-inflicted actions. Frankly speaking, relying on toxic solutions to quench thirst will inevitably lead to poisoning; relying on capricious luck will only invoke Murphy's Law. The debt crisis of real estate companies is a result of their own problems. (This article was first published on the TiPost App, written by Hu Runfeng, edited by Ma Jin'nan)

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