Summary of Key Points
The new real estate policies introduced at the end of August have adjusted the rules regarding pre-sales and credit. The most significant change is the significant delay in the timing when real estate companies can collect payments from the sale of properties, which directly disrupts the business model that has been in place for over a decade, where companies relied on high turnover to fund land acquisitions. Recently, there have been a series of counterintuitive outcomes in land auctions across the country: a core plot of land near Shanghai's inner ring, valued at tens of billions, went unsold, while smaller plots in the suburbs were auctioned 29 times over at higher prices; a high-quality plot within Beijing's fifth ring, adjacent to Wangjing, was temporarily suspended from sale, while a less desirable plot in the suburbs was sold after just 174 rounds of bidding at the lowest bid. Essentially, all real estate companies now prioritize ensuring their cash flow does not collapse, rendering the land acquisition and investment criteria that were effective in the past ineffective. The entire industry is in the process of re-establishing new rules for survival.
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Detailed Analysis
1. The "abnormal" results of recent land auctions are not due to real estate companies making misjudgments
In the past, the value of a piece of land was determined by three key indicators: its location in a core area, its high density (which allowed for more buildings and thus higher profits), and the completeness of surrounding amenities. Using these criteria, the outcomes of land auctions were generally predictable.
However, recent auctions do not follow this logic. For example, the Zhenru plot in Putuo, Shanghai, located between the inner and middle rings, a core area, was offered for auction at 15 billion yuan, but only one company bid at the lowest price; in contrast, a smaller plot in Songjiang, a suburb, was auctioned 16% over its initial price after multiple rounds of bidding by several companies. In Beijing, a prime plot within the fifth ring, near Wangjing, was not even bid on, while a less desirable plot in the suburbs was sold after 174 rounds of bidding with a 12-billion yuan increase.
The issue is not that real estate companies have suddenly decided suburbs are better than city centers; rather, the old criteria failed to account for a new factor of utmost importance: **how long it will take to recoup the invested money.* This factor now carries ten times more weight than location and amenities, making the old criteria inadequate for explaining the new auction results.
2. The most stringent aspect of the new policy is not the restrictions on loans or purchases; it is the change in the "payback timer" for real estate companies
Many people think the new policy merely relaxes restrictions on home buying. However, the most significant change that affects real estate companies has gone virtually unnoticed by the public. The new regulations require that for projects to begin pre-sales, the main structure of the building must be completely finished.
Previously, real estate companies could start pre-sales almost immediately after acquiring land, collecting buyers' down payments and bank loans within about six months, allowing them to quickly acquire new land with a 20% investment. This high turnover enabled them to expand rapidly. Now, the payback period has been extended by 1-2 years. Companies must cover all costs related to building, purchasing materials, and paying workers' wages before they can start earning money. The additional time required for capital to be tied up means that the interest alone could erode several percentage points of their profits. Before acquiring land, companies must calculate whether they have enough funds to last until the completion of the building. Without this capability, even the most attractive plots are off-limits.
3. New preferences for land acquisition by real estate companies
A new unwritten rule has emerged among companies: they prefer smaller plots in the suburbs over large, core plots. Two main characteristics define this preference:
- They prioritize plots with lower total prices; few companies in China have the funds to invest tens of billions to complete a large, core plot like the Zhenru plot in Shanghai.
- They prefer plots with lower density, suitable for building small houses and villas. These plots can be completed in 3-5 years, much faster than high-rise buildings, allowing for quicker cash flow and less capital strain. Not all low-density plots are sought after, though. For example, a plot near the Wenyu River in Beijing, surrounded by luxury villas, was auctioned 174 times over because it had a stable market demand.
4. The biggest challenge for real estate companies is not acquiring new land but managing existing plots
The more difficult issue is dealing with the existing plots that were acquired before the new policy. Companies calculated their profits based on the old rule of quickly generating cash after construction began. Now, with delayed payments, additional interest and upfront costs could result in losses. If they continue developing these plots, they must use the funds to acquire new land, putting significant strain on their cash flow. If they choose to sell the plots, the substantial land deposits made earlier will be lost. Solutions include partnering with other companies to share the financial burden or negotiating with local governments to split large plots into smaller ones for phased development, or adjusting the required commercial and public facilities to reduce initial investments.
5. Two trends relevant to the public are already clear:
- In the future, land auctions will unlikely see super-large plots worth billions or even trillions. To facilitate sales, local governments will likely divide large plots into smaller ones, leading to more smaller, well-designed buildings.
- The likelihood of buying unfinished buildings will decrease significantly. Projects must be completed before they can be sold, so buyers can expect to move in within about a year. The proportion of ready-to-move-in homes will increase, as companies prefer to sell them quickly to generate cash.