Chinese Cities Hooked on Land Revenue Fuel Housing Costs

Chinese cities, addicted to the money they raise by selling land to developers, are undermining the government’s multiyear campaign to contain housing costs.

Municipal residential land deals, measured by area, rose 26 percent in the first eight months of the year from the same period in 2012, according to China Investment Securities Co. The average price per square meter jumped 43 percent, pushing proceeds up 80 percent to 816.5 billion yuan ($133 billion).

Local officials rely on revenue from the sales to repay debt, especially as economic growth slows. Developers bid up prices because demand from homebuyers remains strong. The cycle is driving property costs higher, complicating Premier Li Keqiang’s task of preventing social unrest over the lack of affordable housing amid a massive urbanization program.

“If the momentum in the land market can’t be cooled down rather quickly, it’s actually a fairly dangerous signal,” Bei Fu, Standard & Poor’s Hong Kong-based property credit analyst, said in a phone interview. “Should it keep heating up, we’re worried there might be further policy tightening, and there could be consequences for the entire market that are unpredictable at this point.”

The government has been trying to cool the housing market since April 2010, following a 14 percent jump in new home prices the previous year. The most-recent curbs, introduced in March by Li’s predecessor, Wen Jiabao, included higher down-payment requirements and interest rates for second-home mortgages in cities with “excessively fast” price gains. Thirty-five provincial cities set price-control targets, mostly capping increases at the growth rate of local disposable incomes.

Li’s Hesitation

Li hasn’t taken additional steps as he seeks to rein in prices without hurting economic growth, which has slowed to less than 8 percent for five consecutive quarters. At the same time he has championed urbanization as a “huge engine” of China’s future economy, a campaign that requires affordable housing for the millions of Chinese moving from rural areas to cities.

His job is made harder as Chinese, disillusioned by financial markets, keep buying property. The benchmark Shanghai Composite Index is down 58 percent since the end of 2007. New home prices in China’s four major cities rose the most since January 2011 last month from a year earlier, led by a 19 percent jump in Guangzhou, the National Bureau of Statistics said Sept. 18. They jumped 15 percent in Beijing and Shanghai.

The central government’s efforts had a “limited restrictive effect” as local officials took “different attitudes” in implementing the requirements, according to a quarterly report on the Ministry of Land and Resources website July 16.

Land Banks

Builders have been buying more land to keep up with demand. China Vanke Co., the largest developer by sales, bought 3.4 million square meters (37 million square feet) of land in the first half of 2013, almost five times its purchases a year earlier, according to company filings. The average cost of land for new projects jumped 23 percent.

China Vanke has a “prudent” land purchase strategy and won’t assume large home-price gains in estimating profitability of projects, the company said in an e-mailed statement in reply to questions. Projects under planning as of June 30 remained at a “reasonable” level.

Sunac China Holdings Ltd., a Tianjin-based developer part-owned by buyout firm Bain Capital LLC, bought residential land in Beijing on Sept. 4 at 73,099 yuan a square meter of floor area, a record high for the country, according to Haitong International Securities Co. The price was “within our expectations,” Sunac Chairman Sun Hongbin said in a blog post on the day of the purchase.

Debt Pressures

Sun Hung Kai Properties Ltd., the Hong Kong-based developer that is the world’s biggest by market value, bought a site in Shanghai the following day for what S&P’s Fu said was a “shocking” 21.8 billion yuan. That was the most spent for a single parcel of land in China this year, according to Centaline Group, parent of the nation’s biggest real estate agency.

Moody’s Investors Service expects the 19 developers it tracks to “remain active in acquisitions in the coming 3-6 months, as they replenish their land banks to support their long-term growth plans,” Hong Kong-based senior analyst Kaven Tsang wrote in an Aug. 29 e-mailed statement.

That’s soothing news for city officials. An audit by the National Audit Office of 36 local governments, including Shanghai and Guangzhou in the south, found that some regions faced “growing pressures to repay debt.”

Four provinces and 17 provincial capitals borrowed 774.7 billion yuan as of Dec. 31, pledging repayment with land-sale proceeds, up 18 percent from 2010, according to the audit office’s report released June 10.

‘The Determiners’

Chinese local government financing vehicles’ reliance on land sales and rising land prices to repay debt creates “many problems,” People’s Bank of China Governor Zhou Xiaochuan wrote in a commentary published on the central bank’s website Sept. 9.

Average starting prices in residential-land auctions, set by local governments after consulting with companies evaluating sites, jumped 16 percent from a year earlier to 1,301 yuan per square meter in the first eight months of this year, according to SouFun Holdings Ltd., which monitors sales in 300 cities. That compares to an 8 percent increase for industrial land.

“Local governments are not just pushing the waves” behind the record prices, said Jinsong Du, a Hong Kong-based property analyst at Credit Suisse Group AG. “They’re the determiners.”

Kaisa Group Holdings Ltd., a Shenzhen-based developer, bought a site sold by Shanghai city government in June of last year for 6,990 yuan per square meter, compared to the 4,500 yuan starting price, according to Shanghai Hanyu Property Consulting Co. The project will feature two-bedroom, 80-square-meter apartments and three-bedroom units of 100 square meters, Kaisa said at the time.

Starting Prices

A developer affiliated with the government of eastern Anhui province bought a nearby site in July for 12,600 yuan a square meter, more than double the 6,000 yuan starting price.

A fax to Shanghai’s land bureau requesting an interview and phone calls to the districts where the parcels are located went unanswered.

The 8,804 yuan a square meter starting price in an Aug. 14 residential land auction in Beijing’s Daxing district that Sunac won was about 20 percent higher than that of a plot the developer purchased in September last year in the same area, according to data compiled by SouFun.

A study of six residential land auctions in Shanghai’s Pudong district showed that starting prices almost tripled in April from December 2009, according to Shanghai Hanyu.

“What we can see is that local governments are typically not very enthusiastic about supplying land when the market is weak, and tend to put more high-quality plots up for auction when the market heats up, like this year,” said Luo Yu, a Shanghai-based analyst at advisory CEBM Group.

Capping Prices

New residential sites available for sale in 300 Chinese cities rose 17 percent by area last month from a year earlier, according to SouFun. They sold for 43 percent higher than a year earlier and exceeded starting prices by 25 percent on average.

The land ministry in May 2011 required all counties and cities to report land sales where the selling price is more than 50 percent higher than the starting price. Regions reported 115 such “abnormal” transactions in the second quarter, 51 percent more than the previous three months, according to the land ministry. Those parcels were sold at an average 142 percent above the starting prices, it said.

Some cities, including Beijing and Hangzhou, have been capping prices at 50 percent above the starting price this year, though once the ceiling is reached, bidders can compete for the land by offering to build affordable housing or other projects for the government.

Lost Credibility

While such measures can lower land prices statistically, the additional costs for developers will be added to the final price of the commercial homes, according to SWS Research Co.

“The government has lost its credibility” with regard to the curbs, SWS Research’s Shanghai-based analyst Kris Li said. “In the past 10 years everybody feels that every time I believe home prices will fall, they end up going even higher.”

Sunac agreed to build a hospital for the government for free after paying 2.1 billion yuan on Sept. 4 for the site near Beijing’s National Agriculture Exhibition Center. With the hospital estimated to cost 2.2 billion yuan, that would push the total land cost above the average existing-home price of 60,000 yuan to 70,000 yuan per square meter in the area, according to Haitong International Securities.

Property Tax

It’s “not impossible” for Sunac to price homes at the project at 130,000 yuan per square meter or higher to earn a typical profit margin, assuming it would cost 40,000 yuan to develop the land, the brokerage’s Hong Kong-based analysts, led by Hugo Hou, wrote in a Sept. 5 report. Final pricing faces “very big unpredictability,” they said, citing pressures local officials face from central authorities to keep home prices in check.

A fax sent to the land ministry’s press office seeking comment was not answered. The press office of Beijing’s land bureau couldn’t immediately comment.

The government is considering expanding trials of property taxes as part of efforts to diversify sources of local revenues, though such reforms take time and can’t quench cities’ near-term funding thirst, said S&P’s Fu.

“The fastest short-term solution is still to get a few billion, or tens of billions of yuan out of the assets in your hand first,” she said.

‘Main’ Driver

Local governments’ land-sale proceeds totaled 2.67 trillion yuan last year, equivalent to more than half of their total tax revenue, according to data from the Ministry of Finance. Higher tax receipts from the real estate industry were the “main” force driving a 12.8 percent jump in local fiscal income in the first eight months of this year, the ministry said in a statement on its website Sept. 12.

The more than three-year effort to curb property prices also has included restricting home purchases in about 40 cities and imposing a property tax for the first time in Shanghai and Chongqing.

Some cities are struggling to meet price-control targets. Zhengzhou, the capital of Henan province, this month banned single residents younger than 20 years old from buying property to ensure “zero increase” in home prices on a month-on-month basis, Centaline Group said in a Sept. 9 report. Some Chinese parents have been buying properties in their young children’s name as prices surge and the government limits purchases.

The city’s new-home prices jumped 12 percent in August from a year earlier, compared with the 8.6 percent pace in urban disposable income in the first half, official data show.

“Land price today is home price next year -- that’s easy to understand,” Shanghai Hanyu’s research head Fu Wei said, citing the time needed to build the homes. “While on the surface the government keeps telling developers to be rational when buying land, what they actually do is a different story.”

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