What Cinda’s financing model means for the property sector

Is this the new normal? State-owned enterprises using their financial muscle to amass land as an asset rather than for its development potential

PUBLISHED : Tuesday, 12 July, 2016, 3:01pm
UPDATED : Tuesday, 12 July, 2016, 7:40pm

When little-known mainland developer Cinda Real Estate snapped up a plot of land in suburban Shanghai in June for four times the starting bid price, it highlighted a new normal in the real-estate business — state-owned enterprises using their financial muscle to amass land as an asset, rather for its development potential.

The growing number of examples is now causing serious concern among traditional developers, who fear they will continue to lose out to deeper-pocketed state rivals who have access to cheap funding, and who do not necessarily need to show a quick return on their investment.

And their wider fear, is the ongoing practise will push up land prices to levels that private firms simply cannot afford.

There is even speculation, too, that some state firms are already teaming up with local governments, to push up property prices.

“Companies like Cinda are not gobbling up land under the logic of developers, but under the logic of asset allocation,” said Zhang Hongwei, research director of Tospur Real Estate Consulting.

“The driving force is they are bullish about asset prices in first-tier cities,” he said.

The previously obscure Cinda has since been absent from any more so-called “land king” deals, after state firms were warned by regulators in mid-June to refrain from such aggressive purchases, fearing they could stoke further public aggravation.

But the overall enthusiasm for inflated land deals is showing few signs of waning, as evidenced recently again when fierce competition for several plots in Nanjing actually halted bidding, at what turned into a chaotic auction.

One commentator said afterwards: “Cinda didn’t come, but its spirit lives on.”

Cinda beat 23 bidders on June 1 to pay 5.8 billion yuan for the Shanghai plot, just five days after it beat 17 rivals with a 12.3 billion yuan offer for a plot in Hangzhou.

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The Shanghai deal, particularly, appears to defy basic industry logic.

In tandem with government policies, the company will end up paying nearly 48,000 yuan per square metre, and property agents estimate it would have to sell any apartments it built there for above 80,000 yuan to earn a standard profit. That would represent a 74 per cent premium on the current price of homes nearby.

Sun Hongbin, chairman of developer Sunac China Holdings, said the current bidding frenzy is not making a lot of financial sense.

Companies like Cinda are not gobbling up land under the logic of developers, but under the logic of asset allocation
Zhang Hongwei, research director of Tospur Real Estate Consulting

“The maths shows, you’ll make a loss, even if home prices in Beijing and Shanghai are to rise another 50 per cent,” Sun said.

But Cinda appears to be doing its own maths.

Experts say that although regulations bar developers from hoarding land, it could still keep part of the land undeveloped to wait for prices to rise, or change plot ratios to sell more properties in the same space.

The risk could also be shared with others, after the company invited more-experienced developers to co-develop the plot.

Cinda’s recent burst of investment is its latest in a string of costly purchases since 2015, which represents a relentless effort by the developer to leap from third-tier cities and poorer second-tier cities, to potentially richer second- and first-tier cities.

Since last year, it has spent 35 billion yuan on land acquisitions, according to industry consultancy CRIC, even though its market capitalisation was just 7.3 billion yuan at the end of June.

The company’s land bank, at 5.3 million square metres, is much smaller than other industry giants. State-owned developer Citic Real Estate, for instance, has land reserves of 31.55 million sq metres.

While Cinda is not the first to pivot towards first-tier cities, its latest moves are certainly the boldest of its real estate peers. And its background story is very different too.

Its parent is China Cinda Asset Management, a Hong Kong-listed company which is controlled through Cinda Investment.

China Cinda is 67.8 per cent owned by the Ministry of Finance, which overseas all local government land sale revenue.

As one of four asset management companies set up to absorb bad assets in the late 1990s, China Cinda Asset Management has grown into a business empire worth 714 billion yuan, with operations in virtually every sub-sector of finance.

Its estate branch was initially established to dispose of non-performing property assets, but it has also invested heavily in third- and fourth-tier cities.

Its returns, however, have been poor.

It had negative net operating cash flow from 2012 until the first quarter of this year, with Chengxin Credit Rating putting its total debts at 31.58 billion yuan by March 31, the equivalent of 315 per cent of its net assets.

Despite that, China Chengxin still gives it an “AA” rating, and a “stable” outlook, based on its improved sales in 2015, strong “optimisation” of its land-reserve structure, and its strong financing ability.

The parent company has continued to provide generous support to the real estate unit, through a combination of entrusted loans, equity-pledged loans and new share sales. China Cinda extended 4.93 billion yuan of entrusted loans to Cinda Real Estate in December 2015 and January this year, through a proprietary fund, according to CRIC.

The real estate company also demonstrated its own financing power when it sold 2.5 billion yuan in five-year corporate notes at 3.8 per cent in the first quarter, and another eight billion yuan through a private placement in the second quarter – very attractive, when you consider private developers’ borrowing costs usually range from 6 to 15 per cent.

Cinda Real Estate has also been financing its projects through private equity funds.

In the last six months it has set up 10 such funds in cities such as Shenzhen, Ningbo and Wuhu, often with partners who are part of China Cinda.

These funds have invested heavily in real estate. China Cinda bought a majority of the funds as a priority investor, meaning it is guaranteed a basic return.

“Through private equity funds, Cinda Real Estate can leverage a small amount of money for much larger investments. It and its parent company can receive returns both as a developer and a fund investor,” said one private equity fund manager, who is unrelated to any Cinda funds, but who wishes to remain anonymous.

Cinda’s practises are more aligned with those of insurance companies, which seek asset allocation to match their liabilities, analysts say.

“China Cinda needs asset allocation, especially assets in which it can park large, one-off sums of money,” said Fang Ling from CRIC.

“The property arm contributed just 6 per cent of the group’s profit. Its significance as an ‘asset creator’ is much larger than as a profit earner.”

The flip side of its private equity fund model is that leverage also amplifies risk.

If the units eventually built on the expensive land cannot be sold for as much as expected, the losses can be amplified two to three times, over a project that does not involve private equity funds.

There may also be a wider agenda behind Cinda Real Estate’s aggressive buying, according to some analysts. By boosting its property business, it might avoid being pushed into a merger with other state firms, as part of the government’s consolidation plans for state-owned enterprises.

Previous experience shows state firms with small real estate businesses usually end up becoming merged.

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Whatever the motives, Cinda and other similar state-owned developers with a financial background, are rewriting the playbook of China’s estate industry.

As expertise becomes less relevant, the wider worry for the sector is that skyrocketing land costs will eventually lead to surging home prices.

“How can you compete?” asks Si Zhi, vice-president of Soufun Holding, attempting to highlight the growing ambivalence among private developers.

“If you don’t grab land, you will definitely die. If you do, you at least have a chance to survive.”