'Land Kings': China's Frenzied Property Deals

On the first day of June, a central State-owned Enterprise (CSOE), Cindare Property, affiliated with the Ministry of Finance, placed a bid for the land in Gu Village of Shanghai at the price of 5.805 billion yuan. Its premium was over 303 percent, setting a record for the highest property deal and creating another di wang (land king). A di wang is commonly defined as a property project which has one or more of the following characteristics: land sold at the highest price per unit, highest total price, or highest premium price. For example, Zhong Yuan property defines a di wang as having a premium rate of over 40 percent and a total price exceeding 500 million yuan.

Since China liberalized its real estate market in the 1990s, strong competition among its companies has accelerated the pace of property development and created China’s real estate market boom. In the early 2000s, the government realized that over-reliance on real estate to generate economic growth did little to encourage innovation in the economy. The central government tried to nudge its CSOEs away from real estate, but had limited success.

Multiple directives were issued by the central government but they were either ambiguous or not rigorously enforced. In 2003, with limited success, the State Owned Assets Supervision and Administration Commission (SASAC) directed CSOEs to withdraw from the property sector and restricted their roles to seven designated industries.

In 2010, the China Banking Regulatory Commission required banks to impose stricter regulation when providing loans for property development. The government also issued the “Notice of the State Council on Resolutely Curbing the Soaring of Housing Prices” in some cities in January 2010. The notice clearly points out that the “relevant department in SASAC is required to further regulate SOEs’ real estate investment behavior.” In 2010, SASAC ordered 78 CSOEs to withdraw from the real estate sector — but without a specific timeline and without any further directives.

The central government also has a track record of inconsistently enforcing policies. In 2015, the government further relaxed its regulations on financing activities to encourage the firms to diversify their financing channels. In June 2015, China’s move to allow real estate developers to issue bonds on the domestic Exchange Bond Market lowered the cost of borrowing. This enabled developers to easily raise funds and in turn boosted the property sector. In February 2016, the government’s monetary stimulus and lifting of property curbs spurred a buying fever in some first- and second-tier cities.

More than a decade has passed since the initial efforts, but the central government remains hapless in reining in its skyrocketing property prices. In March of 2016, immediately after the conclusion of National People’s Congress and Chinese People’s Political Consultative Congress, CSOEs were involved in frenzied bidding wars in different first-tier and second-tier cities. For example, China South Industries Group Corporation’s core operations do not include real estate, yet it offered the largest bid per unit in Beijing Qimen Qiao. In a similar vein, China National Tobacco Corporation also set up a subsidiary to diversify its investment portfolio into property. Such purchasing fever prompted the official mouthpiece People’s Daily to warn against “panic” buying. But the CSOEs’ zeal in creating the next di wang continued unabated.

Ironically, the di wang phenomenon results from CSOEs’ attempts to deal with the central government’s call for reforms, and to cope with the ensuing chaos of reorganization and mergers. It is an unintended consequence of China’s SOE reforms, sparked by a number of converging factors.

First, the di wang phenomenon is often viewed as a panacea to address the high deficit faced by CSOEs. CSOEs’ investments in many of their original sectors are currently suffering from a prolonged period of low profitability. For SOE managers, this stagnation is detrimental to their careers. Property is one of the few remaining sectors which offers relatively high returns and generates considerable cash flows within a short period of time. With a performance evaluation system that favors high and quick returns, many CSOEs and SOEs decided to dive into property investment. As the SASAC acknowledges, this evaluation framework influences executives to make risky short-term investments as they seek fast returns to get promoted.

In September 2015, the State Council issued the “Guiding Opinion on Further State-Owned Enterprises Reform.” This only served to aggravate the problem. Past reforms indicated that smaller-sized firms are usually forced to merge with larger firms on unfavorable terms. Having a larger size confers advantages at the negotiation tables. Therefore, CSOEs are eager to bid for large projects, at the expense of profitability, as a way to boost their company assets and enhance their negotiating power during future reshuffling and reorganization.

Second, local governments are reluctant to give up the privileges which they have traditionally enjoyed. Historically, local governments and their affiliated firms have monopolized the usage and management of local land and property. Land lease sales have become a significant source of revenue for the local governments. Land lease sales spur local GDP growth and thus enhance the career prospects of local officials. In south China, for example, Guangdong Governor Zhu Xiaodan has hinted that his province is looking into allowing some large state-owned enterprises to purchase homes in order to reduce housing inventory. In addition, CSOEs are believed to enjoy privileges in financing activities as well as national policy support. Theoretically, the state is entitled to all of the SOEs’ after-tax profits. However, the Chinese government is believed to collect very little dividends from COSEs. The privileges are also extended to the acquisition of abandoned factories or farmlands at little cost to their subsidiaries.

The central government’s push for reforms is constrained by the excessive political influence wielded by local governments. Reforms are met with resistance or outright defiance from many CSOEs. Many CSOEs managers are considered equal to ministry-level officials in the government. Some departments in the SASAC have lower bureaucratic rankings and limited bureaucratic power to supervise the business of CSOEs, resulting in a lack of oversight. For instance, the Ministry of Land and Resources has limited administrative power to reclaim national land from the CSOEs and impose penalties on CSOEs  for land misuse. The local departments of land and resources often fail to comply with the law to report any unusual land-bidding activities to the Ministry of Land and Resources.

The di wang phenomenon thwarts the true spirit of innovation and productivity pursued by China’s SOE reforms. But di wang is merely a symptom of a larger problem—the central government’s inadequacy in monitoring and controlling the local governments. This inadequacy will have far-reaching implications for China’s long-term growth plans. Unless the challenges listed above are addressed, the positive impact of current reforms would just be a flash in the pan.