May 13 (Bloomberg) -- Chinese developers’ profit margins are set to shrink as they build public housing projects to stay on good terms with the government.
China is aiming to add a record 36 million units of affordable or social housing in the next five years, to cover 20 percent of the country’s residential market, the government said. Building these homes will cut developers’ profit margins to a range of 3 percent to 8 percent, down from at least 10 percent from private residential properties, according to Royal Bank of Scotland Plc’s estimates.
Developers such as China Vanke Co. are taking part in the plan even as they struggle to profit from the projects: Vanke said it will take 57 years for the company’s first social housing project to break even. Soho China Ltd. has warned that at least half of the country’s developers will go out of business if they are forced to embark on such projects.
“Developers won’t do social housing if they can make more money in high-end,” said Donald Straszheim, Los Angeles-based director of China research at International Strategy & Investment Group. “The government’s job is to make sure that the system works whereby they can’t get land for high-end without doing enough social housing.”
About 10 million of those homes are planned for this year and next, almost twice the 5.8 million target for 2010, the government said.
Developers “are willing to take on these homes in exchange for later goodies from local governments, such as favorable policies when they bid for land in new cities,” Du Jinsong, a Hong Kong-based property analyst at Credit Suisse Group AG, said in a phone interview.
China is accelerating the development of affordable housing after home prices climbed for 19 straight months to December 2010, and increased in almost all 70 cities the government tracked in the first three months. The 36 million homes will house about 80 million people, Du estimates.
Local governments will lead the development of affordable homes based on the central authority’s targets. The capital Beijing has packaged some land sales where a portion needs to be set aside for social housing projects. The eastern city of Hangzhou has outsourced affordable projects to private developers, while Chongqing and other cities use government-owned builders, Du said.
At least 70 percent of land put up for sale should be allocated for social housing, the government said in its 12th five-year plan released in March.
A large number of these homes will be rented out based on income limits, the government said.
Premier Wen Jiabao visited an affordable housing construction site in Beijing during the May 1 Labor Day weekend and reiterated the promise to bring down property prices. President Hu Jintao also urged local governments to increase capital investment and land allocation for these projects, the official Xinhua news agency reported.
Affordable homes, usually built on the city’s outskirts and on locations with lower land values, are priced at a fraction of private apartments, according to Credit Suisse. RBS estimates that affordable homes are between 30 percent and 50 percent cheaper than private apartments within the neighborhoods.
China’s construction of low-income homes will boost supply and stabilize the housing market like a “sedative,” Vice Premier Li Keqiang said, according to a summary of a speech posted last month on the website of Qiushi, the official Communist Party magazine.
Vanke, the largest developer by market value, plans to build more of these homes even though it hasn’t found a profitable model, President Yu Liang said in a March 10 briefing.
“We are building social housing projects mainly because we are a responsible leader in the industry,” Yu said, according to a transcript of the press conference posted on SouFun Holdings Ltd., China’s biggest real estate website owner. “We only request for 1 yuan of profit for these homes, because we need to tell our shareholders that we didn’t lose money on these.”
Evergrande Real Estate Group Ltd., the country’s second-biggest developer by sales, will build affordable homes as part of its corporate social responsibility program and not for profit, Chief Executive Officer Xia Haijun said on March 14.
“Local governments need help from developers in building social housing,” said Jeffrey Gao, a Shanghai-based property analyst at RBS. “Those that helped at the early stage will probably get some benefit from the government later on.”
Shanghai Greenland Group Co., which announced plans on Dec. 8 for a 30 billion yuan ($4.6 billion) development that will be the world’s third-tallest building in the central Chinese city of Wuhan, said the same day it would build 500,000 square meters of social housing for the city.
“Developers might not make much money from social housing in the short term, but when the market expands, the early birds with good branding will not be left out,” said Danny Ma, Shanghai-based senior director for CB Richard Ellis Group Inc.
Beijing may require developers set aside as much as 30 percent of the land they buy for affordable homes in the city, said Mao Yaqing, vice president of Beijing Urban Construction Investment & Development Co., a state-owned company. Margins for such homes are less than 3 percent, and he’s counting on private apartments to lift the average earnings, he said.
“When you go to neighborhoods with mixed-projects, you’ll find the social housing apartments in the worst location of each site, the ones with the afternoon sun and those facing noisy streets,” Mao said. “Developers will have to do that because of the margins, and the government knows that.”
The government imposed new curbs this year including higher minimum down payments for second homes and residential property taxes in Shanghai and Chongqing. Local governments in Beijing and Guangzhou followed with restrictions on housing purchases. The central bank also raised interest rates four times since October and yesterday increased the amounts banks need to set aside as reserves for an eighth time during that period.
“The government’s social housing plan is not for controlling home prices but bridging the gap of demand that the private market couldn’t meet,” said Nicole Wong, a Hong Kong-based property analyst for CLSA Asia-Pacific Markets. “Households under subsidies living in those rental homes will accumulate equity and move up the ladder to private market within years.”
The Chinese government plans to use some of the dividends it gets from select state-owned companies to fund the construction of affordable housing, the 21st Century Business Herald reported on May 5, citing an unidentified State-owned Assets Supervision and Administration Commission official.
Affordable homes have had mixed results worldwide, from U.S. lawmakers debating on funds to clean up decrepit public housing, to Singapore, where the government said 82 percent of the resident population live in state-built apartments, with 95 percent owning their own properties.
“The social housing plan is a very big cake, but not many developers would want to take a slice,” said Gao from RBS. “They might be forced to eventually. Only a few are proactively taking part for such a low margin.”
China earned 2.9 trillion yuan from land sales in 2010, according to the Ministry of Finance. That was 40 percent of the local government’s revenue, according to China Real Estate Information Corp.
Pan Shiyi, chairman of Soho, the biggest developer in Beijing’s central business district, said at least half of developers will go out of business within two to three years as the government increases construction of affordable housing. The increase of such housing will give the government control of more than half of the supply of new homes on the market during the five-year plan period from 2011 through 2015, Pan said.
Longfor Properties Co., the fourth-biggest among Chinese developers listed in Hong Kong, posted a loss after completing 6,000 units of affordable homes last year. Powerlong Real Estate Holdings Ltd. said it’s reluctant to bid for such projects.
“It is very difficult at the moment for us to participate in building affordable homes unless good policies are offered, such as tax breaks,” You Xiaodi, Powerlong’s general manager of capital management center, said in an interview.
China State Construction International Holdings Ltd., a state-owned Hong Kong listed builder, is seeking more of these low-cost housing projects, including two developments in Chongqing, Chairman Kong Qingping said in an interview.
“The rate of return in building social housing is low, but it also has low risks,” Kong said.
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