Not so fast Batman
The central government curbs foreign investment in Chinese Real Estate
After mutterings in the press for the last few months about the impact of foreign investment on China¡¯s booming property market, Circular 171 issued by the central government this month, took concrete steps to further cool the sector, by placing restrictions on foreign investment and ownership of property. This article will look at the main provisions of the new ruling and discuss what their likely impact will be on both the market in general and foreign investment in particular.
The key points of Circular 171 dealing with foreign investment in China¡¯s real estate sector, considers who may own properties and how purchases may be financed. Broadly speaking the three different types of foreign ownership options which existed prior to Circular 171 still exist. They are as follows: (i) Offshore institutions (ii) Onshore institutions (iii) Individuals. However, the scope and circumstances of ownership for each have now been limited or changed.
Offshore institutions used to be able to own property either for their own use or investment purposes. The new regulations state offshore institutions may purchase and hold title to property in China for ¡°self use¡± if they have been duly approved to set up branches or Representative Offices in China. Offshore institutions may not hold title to China property for non-use investment purposes. This will effect tax structures used by foreign investors holding Chinese property assets. However, the ruling will not effect those companies purchasing and using property for their own use.
For foreign enterprises wishing to invest in China property, they must now establish a legal entity in China (i.e. a Wholly Foreign Owned Enterprise ¡°WFOE¡± or Foreign Invested Enterprise ¡°FIE¡±). The legal title to the property will then be registered with this onshore enterprise. Such an enterprise must have a registered capital representing no less than 50% of its total investment amount, if the total investment amount is US$10 million or more. The main issue here, is the significant rise in the amount of equity which has to be invested in property acquisitions (many investors would use gearing of 70-80%).
Concerning foreign individuals, they may now only purchase residential property for ¡®self use¡¯ providing they have been working or studying in China for more than one year. While it is not clearly stated, it is assumed Hong Kong, Macau and Taiwan residents are exempted from the above residency requirement. They are however, also restricted to the purchase of property of a ¡®certain floor area¡¯ for ¡®self use¡¯. While the drafting is not entirely clear, the meaning is. The Central Government is aiming to restrict the number of residential properties which may be owned by foreign individuals. For non-Chinese origin persons, it seems the provisions are less ambiguous than for those of Chinese nationality or origin.
The above are a general outline of the provisions of Circular 171, they do not attempt to provide a definitive overview. For further information on this interested persons should contact their legal or financial advisors.
For foreign companies who have been and are planning to actively invest in China the new provisions will likely cause some tax and financing headaches. However, like most headaches they tend to be easily curable. For individuals the same is likely to be the case (it is not impossible those determined to own more than 1 residential property would simply use a legitimate corporate entity to own the properties).
Let us presume those foreign corporations and individuals were able to find ways to operate within the new legislation. What would the likely impact be on the Chinese real estate sector? This is probably the most interesting question and the most difficult to answer. Previously published data gives some clues.
According to the Ministry of Commerce, Foreign Direct Investment in 2003 was US$53bn of which Real Estate accounted for US$5bn. Assuming exponential growth of the real estate element to US$10bn for 2005 out of total FDI of US$60bn, this provides an estimate from which to try and understand the impact of foreign capital on China¡¯s commercial real estate market. According to the Central Bank, commercial real estate lending by Chinese banks during 2005, stood at US$383bn. If we assume the total FDI investment for 2005 of US$10bn, against which purchasers borrowed 70% from the Chinese commercial banks, this gives a figure of US$23bn lent by commercial banks to foreign investors, equal to 6% of total lending. Indicating foreign involvement in China¡¯s commercial real estate is pretty insignificant compared to domestic investment.
In the case of private investment, it looks like the situation may be different. According to the Central Bank, lending to individual homebuyers by China¡¯s commercial banks in 2005 totalled US$230bn. Again, assuming a debt to equity ratio of 70:30 and an average purchase price of RMB15,000/m2, this implies purchases by 116,000 foreigners would have accounted for 10% of all mortgage lending by the commercial banks. Including Hong Kong and Taiwanese residents, this is not an incredible figure for the number of mainland units being purchased by foreign buyers. Foreign individuals may be fuelling the residential market, particularly at the higher end.
The above assumptions only consider lending by the main commercial banks. But they do give a feel for the potential impact of foreign capital on the Chinese market. For commercial property, it looks like foreign investment is still relatively benign, for residential perhaps less so. Probably the biggest challenge facing the central government is getting the balance right between the eastern provinces and cities and the less developed central and western areas of the country. With bank lending in Shanghai accounting for an estimated 20% of mortgages countrywide, this is a particularly pertinent issue. Regardless of its merit, it is likely national legislation brought in to control actual and perceived real estate investment by foreigners, has actually been targeted at a handful of east cost cities. You know who you are.
