Developers are finding it difficult to obtain financing and so consolidation could be on the cards. Lynn Strongin Dodds reports

The Chinese government's attempt to rein in inflation and demand fuelled by speculation over the past two years has not made it easy for developers to obtain financing. Only stellar firms with strong banking ties and healthy balance sheets have been successful, while the rest are exploring other options such as raising property funds or tapping the global bond markets.

According to John Feeney, head of real estate debt at Henderson Global Investors, until recently China asset-level debt deals were generally financed either onshore or offshore, depending on the financing party and the leverage required. Onshore deals were typically full recourse and funded by domestic and RMB-denominated banks with direct asset security. Offshore deals were more convoluted with complex structures involving security over offshore vehicles, and they were typically US dollar denominated. The division between the two was mainly caused by limitations on onshore leverage, RMB foreign exchange restrictions and an absence of onshore lending licences for international banks.

The landscape has changed dramatically with the China Banking Regulatory Commission imposing more stringent controls on bank lending practices to cool an overheated residential sector, which is the most popular investment sector. Controls include restricting the purchase of second homes, increasing minimum down-payment requirements and introducing property taxes in certain cities. Banks were limited in extending loans and granting new credit to developers, and were required to enhance their monitoring of commercial property-collateralised and consumer loans.

"The government has clamped down on bank lending following a surge in 2008-09 as part of the Chinese stimulus package in response to the global financial crisis," says James MacDonald, head of Savills China research. "Concerns over inflation and rising house prices meant that bank loan quotas were reduced and lending to developers was discouraged. This was in order to encourage developers to lower prices to stimulate lacklustre sales in order to generate capital."

As a result, according to the National Bureau of Statistics, only RMB8.3trn (€1.04trn) was raised for real estate investment in 2011, of which 15% came from domestic loans. This is a significant reduction compared to the 2005-09 period where the average was over 30%. In addition, residential sales, which fuelled the boom, dropped 8% from January to March, while house prices are expected to plummet 10-20% from April to December this year, after slipping 5% in the first three months. There are also reports that many Chinese developers are more willing to sell their office buildings or retail space to free capital for their residential projects.

Mark Kumarasinhe, senior director at CBRE Capital Advisors, says: "At the moment, credit is extremely tight and access to funding is much more difficult and expensive than in the past. If you are not a top tier-one developer it is almost impossible - and if you do obtain financing, leverage is nothing like the past. The government is looking to reform loan practices and has imposed stricter criteria. Today, development firms have to be well capitalised, have strong balance sheets and have existing developments that are performing well."

Dimitry Vlasov, senior analyst at East Capital adds: "If you look at the real estate sector in China, there are not that many options available for property companies, with bank financing being the most extensively used. The cooling measures introduced by the government last year are making it difficult for small to medium-sized developers to obtain funding. It is blue-chip companies, which have long-term relationships with their banks, that are having the most success.

"Other developers have had to rely on more expensive trust loans. Some Hong Kong-listed Chinese property companies tapped into offshore bond market when it was open in the first half of 2011 and earlier this year but the window is closed now."

Over the past two years, the bond markets had become a popular funding avenue, raising $20bn (€15.9bn). Timing is everything: before the door shut, firms took advantage of improved market conditions and stuck their toes back into the water early this year. Agile Property Holdings, a mainland developer listed in Hong Kong, issued a $700m bond maturing in five years' time and priced at 9.875%. The proceeds were earmarked for buying land, refinancing, and for general working capital. Meanwhile, Shui On Land, controlled by tycoon Vincent Lo, raised a combined $650m from bond issues, while China Overseas Grand Oceans Finance sold a five-year HKD2.2bn ($226m) convertible bond at par to yield 2% through March 2015.

There has also been a surge of activity on the fundraising front although it is fledgling market. Last year, a total of 29 property funds garnered $4.1bn, up from $2.9bn by 28 vehicles in 2010, according to the consultancy Zero2IPO. Industry analysts expect that over $6bn will be raised in 2012 but this figure could skyrocket by 40-50% over the next few years. This year China Overseas Land & Investment Ltd and Gemdale Corp have launched their own funds, while China Vanke Co Ltd, the country's biggest listed property by sales, is looking to set up funds with other investors to help weather the slowdown.

Whichever route they choose, some of the weaker developers will struggle, given that most have low cash flows and are laden with debt.

Figures from Hong Kong-listed Chinese property developers show that revenues have plunged by about 20-50% over the year, while about $2.2bn in syndicated property loans and club deals will become due in 2012, according to Thomson Reuters data. In addition, a further 117bn yuan needs to be found to repay maturing real estate trusts.

Not surprisingly, analysts are predicting a wave of consolidation with some players - even the heavyweights - having to sell assets or exit the market. There is, however, plenty of scope for rationalisation, as the number of developers has ballooned over the past 10 years from just 20,000 to 85,000.