New Regulations: Real Estate Investment

Monday, July 17, 2006 8:23

It looks like the regulations released on June 1 of this year were not enough as AP, and others (IHTBloomberg and China Daily) are reporting that the Ministry of Commerce are now drafting more regulations to curb investment in the real estate sector.

While earlier in the year, the government increased the length of investment needed for 5 years from 2 to avoid a gross sales tax, the amount of money coming into the real estate markets around China has continued to come in… and this has the government scared.

As seen in the articles, the primary language of these new rules focuses on developers who are using foreign investment to continue to build at their torrid pace.

However, in part, this situation was created by the government through their previous actions that restricted the amount of loans and types of developments local developers could access. Prior to May 2004, only the smallest developers who were considered too risky were unable to gain access to capital through the state banks, however following the May Day holiday of 2004, the central government (and PBOC) issued guidance that discouraged further debt issuance to local developers unless strong previous sales and approved plans could be assessed.

During this time, foreign investors had a difficult time of gaining access to development risk and equity deals that were favorable, however following May 2004 the door opened up to mid market players who were then unable to get loans based on the projections of future developments. Larger developers were still inaccessible on the development side, but they were beginning to offload shares in successful developments to raise the capital necessary to fund future projects.

In the last year though, the pipeline for quality equity investments has increased significantly, and as such the amount of foreign investment has risen.

Implications of these new regulations:
1) Short term, until the new regulations are finalized, will see a rush to market of foreign money and a spike in local market pricing

2) More so than the June 2005 or 2006 regulations, the development market will cool off short term (6 – 9 months following finalization) as developers are unable to access foreign capital.

3) Small investors will look to other areas of investment while larger investors will set up China based structures

Conclusions:
It is not surprising to see the government take a more aggressive stance against the perceived overpricing in the market, but again they have implemented a macro level policy where city level regulation and oversight is really needed. Many 2nd and 3rd tier cities are only now beginning to benefit from the foreign investment entering the real estate sector, and that money is needed in those markets.

Additionally, with the cost of setting up a China based structure being marginal in the grand scheme of things, the draft will be a wake up call for law firms who need to ramp up their property groups as investors will begin coming to them for advice and structuring.. Tax wise, structures have previously been proven to separate the various taxes and project the property group vs. the management team, so that will go unchanged as well.

As always, there will be a period of wait and see. Many developers will close project financing now, but following finalization will rest for 6 months to work with their local agencies to define and implement the proper loop holes.

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3 Responses to “New Regulations: Real Estate Investment”

  1. All Roads Lead To China » A Rough 6 Weeks for Real Estate Investors says:

    August 9th, 2006 at 11:08 am

    […] Relevant Posts:Â June 19; July 17 […]

  2. All Roads Lead To China » What Goes Up…Must Keep going Up.. says:

    November 3rd, 2006 at 4:04 am

    […] (2) The holding term will have to be increased to avoid payment of taxes that were implemented in June and July of this year, as we analyzed in our previous posts a A Rough 6 Weeks for Real Estate Investors and New Regulations: Real Estate Investment. For long term investors those (say those that take on development risk 2-3 years before a building is open), this may not even factor in. […]

  3. More Real Estate Hurdles Coming Soon for Investors in China says:

    July 29th, 2007 at 11:51 pm

    […] a minor inconvenience… the second measures that came out June 1, 2006 were a bit steeper (see New Regulations: Real Estate Investment) and went a long way to taking out the small investor, but following the implementation of the […]