By staff reporters Zhang Yinguang and Gong Jing, and intern reporters Wang Su and Deng Hai

An office tower overlooking downtown Guangzhou offers a bird’s eye view of Yuancun, the last old-style residential village left in the city’s business core, the Tianhe District. It’s a scene of contrasts, where gleaming company headquarters loom above a migrant workers’ slum.

Yuancun’s landscape was supposed to change this year. In January, the real estate company Hengda won a nearly 100-round bidding war for a valuable plot in the village called Juanmachang, agreeing to pay 4.1 billion yuan. The developer planned to build 310,000 square meters of apartments, and charge an average 13,000 yuan per square meter, making it the priciest real estate in Tianhe.

But suddenly, the local property market froze in its tracks. Hengda’s plan hit a brick wall. And now, the slums will stay.

Any piece of land in Yuancun “is hard to sell now, as housing prices around it are even lower than site costs,” said Li Zhengwei, a realtor and president of Luckyhope Property. “Almost every company was looking for projects at this time last year; no one was willing to co-develop a project with others.”

This autumn Guangshou real estate companies “are trying to sell their projects,” Li said. “No one is willing to buy.”

It’s a similar scene across China, where local real estate market bubbles have burst, and key market players including developers and land-owning governments are scrambling to limit their losses.

In 2007, the market skyrocketed in cities such as Guangzhou, where prices for downtown property climbed 10 percent and even the most cautious developers feverishly grabbed land. But the market suddenly turned sluggish in January and started to fall. By June, average house prices in Guangzhou had plunged from the previous year’s high of 15,600 per square meter to just 12,400 yuan.

Hengda’s bid in Yuancun marked a heady peak. Soon afterward, though, real estate company bidders failed to show up for the land auctions sponsored by Guangzhou’s local governments.

Heading Down

Hengda tried to cut its losses by selling or returning the Yuancun plot to the local government. Similar games between real estate developers and local governments, which own and control land in China, are now under way nationwide.

The land scramble began in 2005 in major metropolitan areas including Beijing, Shanghai, Guangzhou, Shenzhen and Hangzhou. The craze later spread to smaller cities, moving from east to west.

Now, returning land has become one of the major strategies for developers who are trying to adjust to the market slump during the traditional “golden sales” period of September and October. Most developers agree that the market is experiencing “a near-term adjustment that may last two or three years,” said Huang Xiong, vice president of Centaline (China) Property.

Huang predicted prices would fall back to 2005 levels. A bit more optimistic is Gao Haiyan, director of the Shenzhen Academy of Social Science’s City Operation Research Center, who thinks prices will bottom at 2006 levels.

Li Wenjiang, a former local Land and Real Estate Bureau official in Guangzhou, said the price decline over the past year was the steepest he’d ever seen. Now a real estate analyst for Hope Fluent, Li told Caijing the city government expected land transfers to yield 9 billion yuan in revenue last year. But by year’s end, transfer collections hit a record 20.7 billion yuan, including 9.5 billion yuan for 13 plots auctioned September 11. Guangzhou governments sold only six plots and collected 5 billion yuan during the first half of 2008, expecting to raise just 10.9 billion yuan by the end of the year.

Fan Xiaochong, vice president of the real estate agency SUN 100, said expensive land bought in 2007 would weigh down developers for the next two to three years. Another senior real estate manager said that, at least for now, at least 30 percent of the plots auctioned last year will yield no profits for developers.

That means developers will be forced to sell newly acquired plots, or return it to governments, said Jin Yong, chairman of BA Consulting.

Playing Games

Returning land is a tricky game for developers and local governments. It’s based on relationships and the willingness of public officials to share vested interests.

How the game plays out varies from place to place. In Shanghai, for example, the Suning Group worked out a deal to return a plot to the Huangpu District Land and Real Estate Bureau for which it paid 4.4 billion yuan last year.

Suning’s project was supposed to cost 66,930 yuan per square meter – the highest in China – but construction never began, and later Suning invalidated its contract with the bureau, blaming the government for taking the plot for subway construction. An insider said it was a phony excuse; Suning just wanted to avoid losses in a slumping market. Eventually, the government agreed to return all the money.

Capital Land (HKSE: 02868) used a similar excuse for returning land to a local governments. A company report said it got its money back from a government in Taiyuan, Shanxi Province, and slithered out of a project Suzhou, Jiangshu Province, for which it had invested 570 million yuan.

“Many developers who scrambled for land last year tried to find loopholes in contracts to return land to governments,” the insider said. “But it’s hard for those who paid some of the funds to get the money back, as it will be almost impossible for local governments to auction the land again at such high prices.”

Meanwhile, Hengda is trying to escape its quandary by dealing with Guangzhou officials. It’s also searching for a partner. So far, though, the developer has only had to pay its 130 million yuan deposit for the Yuancun plot – it was supposed to pay the full 4.1 billion yuan by the end of August.

Company Strategies

Looking back on the life of the bubble, it’s clear some developers acted rashly. For a time “flour was more expensive than bread” on the Chinese property market. But the sharp downturn can also be blamed on the land auction mechanism and the government’s monopoly of land. The system contributes to inconsistent planning and inefficient development.

Consider the case of China’s leading developer, Vanke (SZSE: 000002), which used to buy land on the secondary market at relatively low prices. The company threw caution to the wind in 2007 and paid unusually steep prices, until prices fell suddenly and without warning.

Vanke bailed out by finding a buyer for land in Dongguan, Guangdong Province, where the peak price fell more than 15 percent between late last year and June, to 5,761 yuan per square meter. In May, reports said Vanke would sell 50 percent of its equity in one plot for 5 million yuan to local developer Winnerway.

Vanke is a large developer that can weather the crisis. It reported sales of 24.1 billion yuan for the first half year and has 15.4 billion yuan in cash. Vanke also plans to market 5.9 billion yuan in corporate bonds soon.

Big firms have plenty of revenue, although financing for future projects may be a headache because bank lending has tightened in the past year. But many smaller firms have no way out except to return land they bought at bubble prices and lose their down payments. Sales are simply not keeping pace with goals. Indeed, most developers this year can expect to reach only one-third of their sales targets.

One such loser was Fujiang Rongxin, which lost 70 million yuan after returning land bought last year for 904 million yuan. Shanghai Zhicheng lost 30 million yuan after returning a plot it bought for 1.1 billion yuan last September.

Developers have also had to cut back on projects. Country Garden (HKSE: 2007) bought more than 30 million square meters of property immediately after an IPO last year, and saw market capitalization peak in last year’s bull market at 220 billion yuan. The company vowed to become a “Real Estate Wal-Mart” with projects in more than 300 big cities and 2,000 smaller communities nationwide.

Now, Country Garden President Cui Jianbo said the company should act more cautiously. He said the company has plenty of cash, although Morgan Stanley analyst Derek Kwong expects Country Garden to complete only 3 million square meters of projects, far short of its planned 5.5 million square meters.

The current environment has shadowed a scheduled stock offering by China Merchants Property Development Co. Ltd. (SZSE: 000024). The firm has permission to issue another 8 billion yuan in stock, but has yet to make the move. Merchants reported only 2 billion yuan in sales for the first half 2008; its target is 10 billion yuan for the entire year.

“The expiration date for an additional issuing of stock is January 2009,” said Liu Ning, board secretary. “We still have time to wait.”

Promotional Wave

Many developers launched promotion campaigns in hopes of harvesting during the golden September and October. The strategy runs against the grain in an industry where home-price cutting was shunned by developers. 

Now developers “are not afraid of discounting promotions. What they fear is consumers’ loss of confidence when housing prices are going down,” Li Zhong, general manager of Regal Lloyds International, told Caijing. “It’s the last measure developers will turn to.”

Hengda began a promotion after Vanke lowered prices, starting in October 2007 in Shenzhen. Apartments in Vanke’s Jinyu Dongjun project were offered at 7,500 yuan per square meter, down from 10,000 yuan, and sold out in one day. Prices all across Shenzhen then started to fall. Vanke then took its campaign across the country, cutting prices in Beijing and Shanghai in February.

Hengda decided to cut prices nationwide in September, offering 15 percent discounts at 13 projects in 11 cities. He Miaoling, company vice president, told Caijing that Hengda expects revenues of 3 billion to 5 billion yuan. Financial pressure is being relieved thanks to US$ 600 million from a private equity firm.

In some cases, the discounting has backfired. After Vanke started offering 226 apartments in a Hangzhou project with a 25 percent discount, protests were heard from angry customers who had bought flats at the full price in Shanghai and Hangzhou. Many rushed to Vanke’s offices demanding reimbursements.

The Vanke and Hengda promotions also tested other developers who have yet to launch sales. They are now deciding whether to slash prices.

“Real estate developers have reached a consensus about the market trend,” said SUN 100’s Fan. “Everyone realizes that the downward trend is anything but a short-term adjustment.”

Ready for Gold

But developers still hope for a golden season this fall. Companies such as Country Garden and R&F Properties have not adjusted annual sales targets, despite a slow first half.

“The golden season of September and October will see a blowout for real estate projects, which will be a turning point for real estate market to be a buyer’s market,” Huang predicted.

Country Garden will push 16 projects. Cui said the company will work hard to promote sales. Gemdale, another flagship developer that’s lowered prices, plans to put 15 projects on the market in September and October. Merchants’ Liu said his company plans to offer apartments in 12 of 19 projects in the second half.

And it appears prices could go lower. The average land cost for Merchants is 2,500 yuan per square meter, while Vanke pays 2,000 yuan and Gemdale just 1,900 yuan. Nevertheless, one analyst noted that these are the developers’ average land costs, and that prices paid in 2007 were a lot higher.

Real estate prices now vary from one city to another. So far, Beijing’s housing prices have been stable, while prices in medium-sized cities such as Nanjing, Shenzhen and Suzhou have plummeted.

“Large developers don’t fear decreasing prices,” Fan said. “What they worry about is that the lower the price is, the fewer apartments will be sold as the market’s confidence sinks with the price.”

Government Interests

Aware that developers were struggling, the State Council, China’s cabinet, in September dispatched a panel to Guangzhou to investigate the city real estate market. Caijing learned that the panel’s aim was to get a clear picture of the industry and advise policy makers.

But developers with slumping sales who may have been looking for some kind of government relief must have been disappointed.

The government took note of reports linking an August 2007 decision by the State Council to falling property demand. The council tightened real estate market controls by increasing down payments and loan rates for buyers of second apartments. Later, the market was affected by the U.S. subprime mortgage crisis and inflation in China, causing speculative capital to flee Guangzhou and Shenzhen, leading to a real estate slump.

Data for 10 cities including Shanghai, Beijing, Guangzhou, Shenzheng, Tianjing, Chengdu, Xiamen, Shenyang, Wuhan and Changsha said sales volume fell an average 41 percent in the past year. Sales in Shanghai, Shenzhen, Wuhan and Xiamen alone fell more than 50 percent. Central bank data also showed that loans to real estate enterprises fell 30 percent to 399 billion yuan in the first half of this year.

The State Council panel’s involvement started two months after the Ministry of Construction, with other central government agencies, formed an investigative group to look into borrowers who stopped paying mortgages. But group member Gao Haiyan told Caijing they concluded only a few borrowers had stopped repaying loans, and that the media had exaggerated the issue.

Nevertheless, a report from Liu Chaohui of the central bank’s Shengzhen branch said the non-performing loan rate increased as housing prices fell in Shenzhen. Statistics show the balance of nonperforming mortgage loans for individual housing was 1.3 billion yuan in the first quarter 2008, up 81 million yuan from the end of last year, while the non-performing loan rate was 0.58 percent, up 0.04 percent since the end of last year.

Governments that auction land have been affected by the sluggish market. Many auctions this year had to be called off due to a lack of bids, and land transfer volumes have declined. Guangzhou’s land transfer revenue for the first half 2008 was only one-fourth the amount reported in the same time 2007. Shanghai’s revenue in the first half fell to 5.7 billion yuan, compared with 60.8 billion for all of 2007.

A State Council agency said land transfers account for 60 percent of local government fiscal revenues nationwide, and many small cities are heavily dependent on the cash source.

BA Consulting data said Beijing’s land transfer fund for 2007 was 43.8 billion yuan, accounting for 29.3 percent of the city’s annual revenue of 149 billion yuan. The Chongqing Land and Real Estate Bureau showed that city’s land transfer revenue was around 37 billion yuan last year, or 47 percent of its fiscal revenue.

At least one government has stepped in to prop the market. In early September, the Xi’an government said it would subsidize real estate buyers by up to 1.5 percent of a property’s price. It was said the program was aimed at combating aftereffects of the Wenchuan earthquake, which occurred in nearby Sichuan Province in May. Only quake-hit areas such as Chengdu have adopted a similar practice. Xi’an was not in the quake zone.

But developers do not expect other governments to follow Xi’an’s example. In fact, government policies have tightened for developers.

The central bank and bank regulators recently announced that banks may no longer lend to developers to pay for land transfers. And the State Council in January declared that land left undeveloped for two years will be confiscated.

But these policies are not sitting well in light of the failed land auctions and developer attempts to return land to local governments.

Wang Deyong, an analyst at Citic Securities, said there has been “no detailed practice for the policy. It will not be executed smoothly as the central government and local governments have different interests.”

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