Chinese real estate private equity industry as giant loan sharks19 April, 2012, 13:41. Posted by Zarathustra
More than a year ago, while there have been sign that real estate developers are highly leveraged and their costs of borrowing were getting higher, we actually had relatively little idea on what the smaller guys were up to, particularly for those who are not listed on the market, except that we suspect it could be worse. Now pieces are falling into place.
For more than a year, I have been suggesting that a cooling real estate market would be triggered by highly-leveraged real estate developers who find themselves in trouble as they were over-aggressive in expansion. These developers, just as expected, were those who cut prices in the past few months to get the cash flow to service their debts. To them, this is no longer a matter of profitability, but a matter of survival. Two known cases of real estate developers filing for bankruptcy has been noted (one in Guangdong, one is Hangzhou), and I am still expecting more to come.
In the China Economy: 2012 and beyond series, and indeed in many previous occasions, I have been covering the shadow banking problems in China. Partly because of the credit tightening last year, and as always because the big banks give preferential treatment to state-owned companies, other companies have been finding it harder and harder to obtain credit. On the other side, depositors seemed to be looking for return higher than bank deposit rates. As a result, banks have been packaging so-called wealth management products to wealthy clients offering higher return, while the money is then lent to real estate developers and the likes at very high rate of interest.
21cbn.com has a fascinating story on these so-called “private equity” for real estate developers. Banks and financial advisors in the wealth management businesses of banks set up limited partnerships (LPs) for clients to invest in their bonds, offering high expected return, which could be as high as 40% per year. The money raised from these “private equities” were then lent to real estate developers, at very high expected rate of interest of course. Alternatively, it is much more common for the real estate developers to post equity interest in a project as collateral for the loans from these “private equity”, and the covenant would state that if the project return is below a certain level (say 25%), the investors will get the equity interest instead of a high interest payment. In this type of structure, according to the report, most investors were deceived as the returns could be below target rather easily, and there was no transparency whatsoever on what is really happening. And going forward, it is not hard to imagine that more of these investors will be disappointed as the real estate market cools.
The size of this real estate private equity (or loan sharks in disguise) industry is enormous. As of December 2011, the asset size amounted to almost RMB100 billion according to the Ministry of Housing and Urban-Rural Development (via eeo.com.com), which was about 100% higher than the 2010 year-end number, demonstrating the explosive growth of this sector. Just like many other things in China, this is not sustainable.
China group eyes $2.8bn real estate fund – Financial Times