Quandary of Foreign Capital in Property Market

China’s property market is like a huge encircled city. Some people outside want to enter, while some people inside want to get out.

Recently the exchange rate of the Renminbi against the US dollar keeps dropping. Some foreign investors has their money trapped in China’s property market and some of them have plans or thoughts to withdraw their capital from China

However, the 4-trillion-yuan stimulus package, large reduction of interestrate and some other financial policies give new hope to China’s property market. Some foreign investors are now eying covetously at it.

“The foreign capital is in a quandary in China’s property market,” saida senior manager of a Hong Kong-based investment bank.

The Money Being Trapped

“The foreigners putting their money in Evergrande Real Estate are now living a hard life,” said the above-mentioned manager. He compared that investment with a bet between the investors and the developer. The developer lost but had no money to pay the wager. “Such a case is beyond the jurisdiction scope of the government,” said the manager. “The investment risk is for everyone.”

According to the analysis of this manager, in 2007 a lot of private-raised funds, hedge funds, sovereign funds, individuals or companies with rich capital bought convertible bond from the property developers who have the plan of initial public offering (IPO) in Hong Kong. The total sum of financing was above 6 billion US dollars. However, due to the continuous depression of the stock market at the end of 2007, the IPO plans of the domestic-funded property developers, including Evergrande Real Estate, Glorious Property and Star Rive Property, were postponed. Those foreign investors having put their money in those companies couldn’t help screaming of desperation.

“In the next 6 months, some financing contracts will expire one by one, resulting in the advent of chilly winter for the property industry. Along with this will the businesses of the property developers be negatively influenced. In addition, presently the banks are reluctant to lend loans to those property developers, resulting in the failure of them to return the investment of overseas investors,” said Lin Hong’en, partner of Grant Thorntorn Certified Public Accountants which is based in Hong Kong.

“The investors have no way but re-sign the investment contracts. Otherwise their money will be deeply trapped and they even can not get their seed capital back,” said Lin.

“Most of the investors take the viewpoint of long-term holding towards China’s property market. They would prefer to re-sign the contracts and find the ways in which the property developers can continue their businesses,” said Xu Liming, Deputy Director of Shenzhen Branch of Asia Commercial Bank on December 5, 2008.

Some investors require the property developers to draw more investments from the sovereign funds and the companies with abundant capital.

“Some property developers have already begun to seek more investments from the hedge fund investors,” said an anonymous investor. “It seems to be desperate, but providing more capital conforms to the individual interests of the hedge fund investors. They have only two choices: the first one is to see the property developers break the contract and their investment play ducks and drakes without any further investments; the second one is to continue their investments and pray for the survivals of those property development companies.”

According to the investors, the fund companies taking part in the above-mentioned investment may include some hedge fund giants based in the USA, like Stark Capital, Och-Ziff Capital Management Group LLC and Citadel Investment Group.

“If the foreign investors withdrew from China in the first half of 2008, their return on investment ratio might be over 100%. If they stayed till the second half of 2008, their capital might be trapped,” said a researcher from the Financial Research Institute, China Academy of Social Science.

The Investors Waiting for Opportunities

Someone wants to get out; someone wants to get in.

From July 1, 2008, the right of examination and approval for the foreign investment in the property industry was decentralized from the Ministry of Commerce of the P.R.C to the commerce administrative departments of the people’s governments of all provinces, autonomous regions and municipalities. The experts think that China’s central government is intentionally leading the foreign investment to the property markets of China’s second-tier cities.

While some investors are longing for the opportunities to leave, the international capital market is happily absorbing the projects which were sold at low prices. They are waiting to enter China’s property market.

With the deepening of the macro-control, the financing activities in relation with “capital” and “projects” happens more and more frequently. The leading developers, which used to be quite abundant in capital, also begin to assign their projects and stock rights to others.

The data newly released by the listed companies shows that the applications of China Merchants Property Development Co., Ltd. (hereafter Merchants Property) and Shui On Property Co., Ltd. (hereafter Shui On Property) for introducing new investment partners have already been approved by the administrative departments. The coming new investments may release the property developers from the tension in capital.

A new group of institutional investors from Europe, Singapore and the USA are absorbing the property projects in China when the prices are low.

Merchants Property made an announcement on December 3, 2008, saying that it plans to sell 100% of the stock rights of its Fucheng (China) Co., Ltd. to ARA Managers (Asia Dragon) Pte Ltd based in Singapore. The total price is 1.75 billion yuan (USD 250 million).

At the same time, some foreign investment banks are accelerating their steps into China’s property market. They also change their former ways of entry and operation. Synergy Capital International Limited (hereafter Synergy Capital) is one of them.

“The bear market usually provides a good opportunity for the foreign capital. At this time, many property enterprises are confronted with the capital stress and no help is available. In order to overwinter safely, taking advantage of the foreign capital is a main financing channel for those enterprises,” said Dennis Huang, CEO of Synergy Capital.

It is known that Synergy Capital is an international investment bank which operates businesses of cross-bound investment and fund management. It owns Funuo Fund with the capital of 200 million yuan (USD 28.6 million), which is specialized in the investments in China’s property market.

Huang said: “We have just bought a piece of land in Xuzhou, Jiangsu at the cost of 50 million US dollars. Though this project is not large in scale, it has great difference from the former ways of entering and operation of the foreign capital. This time it mainly adopts the direct investment, instead of the equity participation or investment cooperation.”

“China’s government just issued a 4-trillion-yuan stimulus package to increase the domestic demand. Most of the money will be invested in the primary industry. As an industrial city, Xuzhou has untapped development potential in the future. And at present the land price in Xuzhou is also very favorable. So we take part in the auctions directly and buy the land by ourselves. Than we choose the developers through bidding and let them develop the land for us,” said Huang. “There are only a few companies making direct investments. So we have obvious advantages.”

However, according to the expert, majority of China’s domestic-funded property developers hope to cooperate with the international capital or assign their projects to the foreign companies.

According to the statistics from the leading global property advisory company DTZ, there were 64 deals of the completed whole building with the price per building of more than 10 million US dollars in China in the first half of 2008, with a year-on-year growth rate of 106.5%. Of them, there were 14 deals of the completed whole building made by the foreign investors.

Impulse to Rebound of House Prices

Obviously, the investment strategy of the international capital in China’s property market in 2008 has changed a lot compared with the one in 2007. In 2007, the international capital mainly focused on buying properties directly, real estate speculation and investment in the property enterprises through twisted means. In 2008, the foreign investors take part in the land auctions directly and control the stock of the project companies to conduct the primary development.

However, some problems arise. Will the preriously- issued restrictions on foreign investors’ entry into China’s property market be invalid? Will the international capital control China’s property market? Will the house price increase again?

In July 2006, six state ministries of the P.R.C jointly published the Suggestions on Specifying the Admittance and Management of the Foreign Capital in China’s Property Market (hereafter Suggestions). But the experts think that the Suggestions did not reach its initial goal which was to stop the speculations of the foreign capital in China’s property market. The Suggestions and the Notices on the Problems of Specifying the Management of Foreign Exchange in China’s Property Market issued later only exert restrictions on foreign investment in the ready-made properties and abolish the preferential conditions for the foreign investment in the property development. The impact on the foreign investment in the property market is very small.

To deal with those restrictions, the foreign investors with strength generally adopt the measures of “changing face”.

The China’s domestic-funded property companies have the land reserve and the foreign invertors have rich capital. Both of them just take what they need from each other. Guo Jianbo, President of Inland International Property Co., Ltd. said: “The Suggestions only restricted the speculations instead of the investment. This is a chance for those large-sized companies.”

The public data of the market shows that foreign investment institutions began to accelerate their steps into China’s property market from 2007. In February 2007, Morgan Stanley and Shanghai Yongye Group established a joint venture to develop a piece of land for commercial use in Luwan District, Shanghai. In March 2007, a union comprised of Chongqing Longfor Property Development Co., Ltd. and ING Real Estate Fund based in the Netherland obtained the development right of the piece of land belonging to Chengdu Aerospace Communication Device Company Limited at the price of 925.35 million yuan (USD 132.19 million).

It is also reported that the above-mentioned investment is just a tip of the iceberg. At least 30 billion yuan (USD 4.29 billion) of foreign idle money and speculation fund enter China through equity participation and buying enterprises’ bonds.

Will the international capital become the impulse to the rebound of house prices in China?

The analysts think that the house price, though decided by the supply and demand relationship, is also driven by the international capital. From 2006 to the beginning of 2007, China’s government took a series of measures, resulting in the “bear” of China’s property enterprises which lacked of capital. Though no apparent decrease occurred to the house prices, many property developers began to sell projects and properties.

The foreign investment companies with abundant money consider the “bear” of China’s domestic-funded companies as the “opportunities” for their entries. Many world-famous international investment companies, like Morgan Stanley and Goldman Sachs, swarm into China’s property market.