China is drawing up new laws to tackle rising levels of distressed debt. Florence Chong assesses what this means for the real estate sector
The Chinese government is taking a multi-prong approach to deal with the rising level of distressed debt. As real estate companies contribute to a significant level of China’s corporate indebtedness, the government is focusing on a series of new laws, including sanctioning leasing and converting debt to equity, to tackle the problem.
Lou Jianbo, associate professor of law and co-director of the Centre for Real Estate Law at Peking University, says these new initiatives could create fresh opportunities for foreign institutional investors.
Lou is helping the government draft new real estate laws. He says the government is planning new regulations to foster property leasing, with the twin purpose of absorbing large unsold housing inventory and providing housing for newcomers to key cities.
These regulations will set out rules for both companies and individuals to own rental properties. “We are still deciding on legislation to cover tax treatment on companies which are interested in owning residential rental assets,” Lou says.
For more than two decades, says Lou, the Chinese government’s policy was to encourage families to buy their own homes in new developments. While residents in most major cities now own their homes, new migrants from rural or small cities cannot afford the cost of housing in big cities.
To solve their housing problem, the government wants to create a leasing market in China. “That means real estate companies must learn to hold, manage and lease property to make money rather than build to sell,” he said. This, he believes, offers “a huge opportunity for foreign investors” to own property in China.
Edmund Ho, chief economist with Standard Chartered Bank, predicts that the current wave of volatility in China will create more opportunities for mergers and acquisitions.
“We are seeking sovereign funds and insurance companies looking for core assets in China,” he told a seminar on distressed debt in Hong Kong, hosted by law firm Latham & Watkins.
These institutional investors have replaced private equity groups like Blackstone and Carlyle in the market, he added. “Two years ago, foreign investors were picking up small assets in tier-two or tier-three cities,” he said. “Today, you are seeing more good assets being sold in tier-one cities.”
Ho expects, as an example, assets in the high-profile Xintiandi precinct of Shanghai to become available.
Recently, China’s Shiu On Land sold hotel assets in the Xintiandi entertainment complex to Hong Kong-based Great Eagle Holdings. And Shimao Property, one of China’s largest property groups, sold its equity in a Beijing commercial property to Leshi Holdings.
Observers and credit-rating agencies believe Shimao’s sale may herald the beginning of a trend that sees over-geared Chinese property groups dispose of assets to lower their debt burdens. Shimao said it would use the RMB3bn (€411m) proceeds of its sale for general working capital and development of other projects.
Ho said foreign investors are now able to look for core, rather than core-plus, assets. But he warned that there would be competition from domestic buyers.
In the past 18 months, Chinese investors have gone from simply expecting a 6% return from investments to adopting a more sophisticated means of assessing return expectations – the internal rate of return (IRR) metric. “They have become more sophisticated and are prepared to look at IRR types of return,” he said.
In the late 1990s and early 2000s, China dealt with distressed debt problems by setting up special asset management companies to take on problem loans. This time around, however, Chinese banks are being encouraged to convert debt to equity.
Lou expects developers to try moving their debt to banks in debt-to-equity swaps. “I was in Jiangsu recently and was told that three property companies were in the bankruptcy procedures. And this is in just one province,” Lou says.
When asked about the extent of bad debt in the real estate sector, Lou says it is difficult to get an accurate handle on the situation because of the many layers of debt. “We have statistics on loans made to developers by banks. So we know banks’ debt exposure to the industry. The government is trying to control the level of debt exposure and each bank has a quota of how many development loans it can make.”
But developers have been taking loans from the shadow banking system, which does not have the same level of government oversight. “We believe exposure to real estate in the shadow banking sector is much bigger than that of the banks,” Lou says, adding that there is yet another layer of exposure – that of individual buyers.
In order to buy more than one property, buyers are entering into convoluted arrangements, including divorce-on-paper, to access more loans. “It is hard for the government or researchers to get the true figures on how big the total debt is,” he says. “That is our big problem.”
The slowdown in the Chinese economy and the overbuilding in the housing market have exposed indebtedness in corporate China, especially among property companies.
Hong Kong-based brokerage firm CLSA says bad debt accounted for 15-19% of Chinese banks’ loan books last year, and that Beijing may have to add RMB10.6trn in new capital to the banking system. That is 15.6% of gross domestic product.
Until recently, the high-yielding, domestic and international bond markets provided a fertile source of alternative funding for Chinese companies. Such debt issuance has slowed, and defaults have started to take place.
Yunfeng, a 20.5%-owned affiliate of China’s major developer, Greenland Group, was reported to be in default in January on CNY2bn (€273m) of privately placed notes.
According to a report in the South China Morning Post, about 40% of Chinese corporate bonds issuances in 2015 were by property developers.
In late-2014, property developers were allowed to issue new debt as Beijing reversed an earlier ban on fundraising, imposed as part of measures to help cool China’s property sector. About CNY1trn in corporate bonds were issued on the mainland in 2015.
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