From Caijing Maganize

China’s real estate market enjoyed a figurative spring breeze in the depth of winter when the government, in late 2008, enacted a series of developer-friendly policies. But the cold winds returned, and soon the market froze.

“The real estate market curve took the shape of an ‘L’” and has hit bottom, said Pan Shiyi, chairman of property developer SOHO China. “It’s still unknown when it will begin to recover.”

Many observers are more pessimistic. Some lawyers, for example, are now busy preparing for the heavy caseloads expected from failed or soon-to-fail real estate enterprises.

Many lawyers previously working on real estate investment projects have switched to more stable, government-backed projects in areas such as railways and roads. One senior real estate lawyer told Caijing that a large number of small- and medium-sized real estate firms are likely to go bankrupt early this year.

“A lot of real estate companies have suffered from broken capital chains,” the lawyer said. “If they cannot pay off construction debt, bank loans and non-government loans due for settlement at the end of the year, lawsuits will ensue, and liquidations will follow.”

Some market players see opportunities in the downturn. Cash-rich Hong Kong developers are waiting in the wings, and international investment banks are raising funds for future investments in China.

China Minsheng Bank is trying to take advantage of a lending policy recently unveiled by the government aimed at promoting mergers and acquisitions within the real estate industry.

A top executive for the Minsheng real estate credit department told Caijing that “to avoid going bankrupt, developers who cannot repay loans have to take the initiative to lower prices.”

Even before the threats to the market became clear, it seems the central government had been aware of real estate firm bankruptcy risks – and the potential for developer failures to have a profound impact on the nation’s economy.  This awareness apparently led to the decision to encourage real estate M&As through policy moves.

But it’s uncertain whether companies will be able to follow through with M&A initiatives, get their financial houses in order, and prevent a plague of unfinished flats in failed developments.

Cai Hongping, chairman of China Investment Banking at the Swiss bank UBS, is worried.

“It’s quite likely that only one-third of the real estate enterprises may survive the severe winter,” Cai told Caijing in a recent interview. “There might be some rebound in market turnover, but housing prices will further tumble.”

Clashing Interests

The government’s rescue efforts are not likely to resolve the market conflicts that brought a winter chill to the real estate market and the nation’s nearly 65,000 developers. Indeed, these conflicts may intensify in coming weeks.

For starters, developers are caught in a liquidity crunch. Many cannot repay loans to banks and other non-government creditors.

A Chongqing Real Estate Chamber report to the Chongqing municipal government said many local real estate developers are unable to repay money they borrowed through non-bank sources at high rates just to maintain operations. These loans are already overdue. The chamber asked the government to investigate the issue and propose solutions.

Many large developers extended or transferred loans at the end of 2008. The total may amount to dozens of billions of yuan. One company alone – R&F Properties – had to juggle 8 billion yuan in loans, a risk management executive at China Construction Bank told Caijing.

Developers who fail to repay loans on time cannot get additional loans from banks, and a regulation says that a one-year loan can be extended for six months at most. When a developer defaults even after an extension, banks can order a mortgage auction.

Construction debts are squeezing developers as well, setting the stage for lawsuits from builders trying to collect. Meanwhile, building materials companies are knocking at the doors of builders who bought supplies on credit.

Developers are also at odds with their original “partners” – the local governments that provided land and issued permits for their construction projects. Local governments that rely on revenues from land sales are in a quandary as developers scale back. Land auctions no longer attract high bids, but developers who paid high prices during the market boom are unhappy with local governments that offer land at discounted prices to their competitors.

Meanwhile, the love affair between developers and home shoppers has lost its fizz.

“Today, no developer dares cut the prices of staged projects,” said one developer. “We are waiting for an opportunity.”

This “opportunity” would appear when forward-delivery houses sold on contract at high prices before completion are finally ready for occupancy. Only then would a developer risk upsetting pre-construction buyers by sharply cutting prices for the rest of the flats in a complex.

Some angry, pre-completion buyers have vented frustration by smashing real estate sales offices after realizing they bought a contract but not necessarily a house, the Minsheng banker explained. But a buyer’s wrath may cool after taking possession of an actual flat.

“Those who move into new homes will not break up sales offices or demand refunds because of the prices have fallen,” he said.

As a result, many developers are awaiting completions of forward-delivery homes before starting to sell future flats for other projects.

Most forward-delivery homes sold at high prices in early 2008 will be delivered in coming weeks. Afterward, developers are expected to launch a new round of price cuts.

Developers in Trouble

But future price cuts may come too late for major developers teetering toward bankruptcy such as Hengda Real Estate.

Hengda’s failure to launch a scheduled IPO in March 2008 signaled the nationwide downturn. Two months later, Hengda began a private placement drive, but this fund-raising plan is also in jeopardy.

After failing to go public, Hengda managed to secure private equity loans at rates similar to those for basic project loans. Caijing learned institutional investors such as Merrill Lynch signed these private equity agreements, agreeing that if Hengda fails to complete an IPO within a year, the size of the equity mortgage held by institutional investors will double. If that happens, the investors would acquire a more than two-thirds stake. And if Hengda defaults on the loans, the company will be liquidated by the investors.

Hengda is one of more than 50 developers who failed to get listed as planned on the Hong Kong Stock Exchange in 2008. Afterward, some introduced institutional investors. But now these developers face liquidation risks due to unpaid loans.

Things are no better for listed real estate companies. The already cowering capital market is expected to react negatively after companies release 2008 financial statements during the first quarter 2009. And a single bankruptcy or dissolution of a well-known real estate company will likely shake the market along with the industry. As incomplete buildings are abandoned, the crisis may spread to other sectors of the economy.

The real estate lawyer said large-scale developers can expect government and bank support to help them survive the winter. But unless the market recovers by the end of 2009, dodging bankruptcy may be impossible for large-scale developers.

Industry powerhouses that snapped up land on urban outskirts are among those that may be in serious trouble, said Cai. “An earthquake in the real estate industry will begin on the urban outskirts, since no one is willing to take over this land,” he said.

Some developers bet on government rescues. But those hopes are fading. In January, top officials in Beijing and Shanghai publicly stated that high real estate prices cannot be sustained, and that their local governments have no plans to launch bailouts. Indeed, bailout efforts in recent months proved the government lags behind the market and cannot be considered a lifesaver.

Seeking Opportunities

Nevertheless, hope springs eternal for some market players. For example, foreign investment banks that suffered heavy losses in the global financial crisis are now raising funds while preparing to jump back into the market.

Caijing learned that Morgan Stanley, for example, is continuing to raise money for its US$ 10 billion Real Estate Fund VII Global, and plans to put US$ 1.5 billion or more of that amount into China.

Fund-raising has not been easy, however, due to the property market’s downturn, prompting Morgan Stanley to extend the fund-raising period. But the fund is expected to begin investing worldwide before the end of the year, said a source with direct knowledge of the fund.

Morgan Stanley raised US$ 8 billion for its real estate Fund VI last year, investing most of the money and yet suffering losses in Japan, Australia and Europe. Its Fund V is now in its final investment cycle stage, although its efforts to sell properties in Shanghai and Hong Kong are in trouble.

Like investment banks, foreign property developers – especially those in Hong Kong -- are waiting for the Chinese market to hit bottom before launching new initiatives.

Many can afford to wait. Ronnie Chan, chairman of Hang Lung Properties, said many Hong Kong firms like his have experience with and the strength to endure economic crises.

Hang Lung, SHK Properties and others in Hong Kong have adequate cash reserves and few liabilities. Even active developers such as Wharf, which bought a lot of land at high prices in 2007, still have plenty of cash and are ready to expand.

Mainland developers are in the opposite position. Even the industry’s recognized leader Vanke has been frozen in its tracks, unable to expand.

Yu Liang, president of Vanke, told Caijing his firm has no plans to acquire other companies in the near future. At this stage, Yu said, survival is the developer’s top priority.

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