Beijing’s attempts to rein in bank lending have focused in part on stemming the flow of money into real estate developments. The problem here is not so much the large-scale, listed developers that have long-term strategies and increasingly diversified portfolios; it is the smaller and less reliable players.

Controlling the industry is no easy task because a) it is so fragmented (China Vanke, the biggest developer, has a market share of only about 3%); and b) developers are very savvy when it comes to getting their hands on cash.

A recent conversation with an industry professional threw up several (of what must be many) ways of finding funds:

1) Often relying on well placed contacts, developers position themselves in the right place at the right time to secure a parcel of land. Then they go to a construction firm and say, “You have the cash flow so you cover all the costs. Once we start selling off the units we’ll give you a cut of the profits.” This arrangement works on the assumption that both the construction firm and the developer have the funds to see the project through to completion. Sometimes they don’t and that is why half-finished buildings are not an uncommon sight.

2) Selling off the plan – i.e. selling units early in order to generate cash that can be used to finance other parts of a project. By putting down money for a property before it is completed an investor obviously runs the risk of the project not being completed or being completed to a low standard. The government has introduced measures to limit this – developers can only get sales proceeds from banks for mortgaged buyers once the building has been completed; the developers also have to put up at least 35% of the project financing themselves to qualify for a bank loan to cover the rest – but it’s unclear how effective they are.

3) A lot of the smaller players in the market didn’t start out as real estate developers. The stellar returns on property investments in recent years have drawn in many an individual investor. The same is true of companies. Having got rich on exports, it’s not uncommon for a trading company to diversify into real estate – in fact, it is often a sensible and natural move (expanding firm acquires new land but doesn’t need all of it so decides to build some apartments). Should it get in deeper, a company can always rely on income from its primary business to supplement the secondary one (i.e. property).

Encouraging developers to find alternative sources of funding is not necessarily a bad thing – it’s just that if you are not a large-scale player that can, for example, dip into the corporate bond market, the channels become increasingly opaque. Furthermore, the strategies upon which these fundraising activities depend are less likely to be vetted by an informed third party. This increases the risk that developments will turn bad.

Andrew Ness, executive director at CBRE Research for Asia, explained why China real estate investments are so special, and why markets like Beijing, which hit 161% growth year-on-year in 2006, remain money magnets, even though everyone is scared of a property bubble.

Ness said investors aren’t looking just at yields, which have been dropping globally for the past decade as investment had driven prices up. Instead, they’re looking at total returns. In China’s case, total returns are particularly good. Its advantages are threefold: Capital appreciation is strong, rents are underpinned by solid demand, and the RMB will be appreciating steadily for the foreseeable future.

Institutional investors and REITs, especially from abroad, don’t need a fourth reason to pour into the Chinese market.

Just attended a press briefing by CB Richard Ellis in Shanghai on cross-border transactions in various property markets.

One interesting nugget came during a presentation by CBRE’s regional director of research for the ‘Pacific’ (that is, Australia, New Zealand and the Pacific Islands) region, Kevin Stanley.

He produced some figures that showed office property growth rates in Western Australia cities like Perth and Brisbane going off the charts. Brisbane grew 27% while Perth went up 20% (Sorry, I think it was year-on-year but I could be wrong).

Growth rates will continue to be high if things go as expected; Stanley put projected growth rates at 30%. According to him, the market is still in the accelerating growth phase, but the next four months should see a slight slowdown.

China, of course, is behind this monstrous growth.

“China has had a massive impact on the growth situation. The commodities sector is at a record high level both in terms of prices and volume,” Stanley told me after the presentation. “Two and a half years ago, vacancy rates were 13% — now they are at 2%.”

He said that Australian companies were taking up a lot of the space, while global firms were also significant factors, because of the globalization of the commodities supply chain. He placed the beginning of the growth trend at 2002.

See also: Chalco’s recent deals to develop a bauxite mining site in Queensland, Australia-China trade levels, The Daily Reckoning Australia’s analysis of China’s commodity demand — its ‘new Silk Road’

The Editors suggest the following links:

• The Real Deal on China’s New Mega Fund - Standard Chartered’s Stephen Green on the new agency to manage China’s foreign exchange reserves
• FT.com / Asia-Pacific / China - Couple challenges Chinese property laws - Developers dig a 10-meter hole around the home of a couple who won’t move; wife uses a pulley system to get food and water into the house; kung fu master husband fights off eviction gangs. You couldn’t make it up
• Google China spamming bloggers? - Per Sam Flemming, Google misfires in attempts to engage in online social media in China by sending out messages rather than joining the conversation.
• China - Education - Schools - Re-education - Ann Hulbert - New York Times - In-depth look at changes in the Chinese educational system

My 92-year-old grandmother’s house rests in one of the most convenient areas of Shanghai, as well as one of the most expensive. Each month, she pays a mere RMB77 to the government for her cozy French concession home near Xiangyang Park. Two years ago, a Western couple who wanted buy the house from the city for a temptingly high price nearly forced her and my grandfather to move from their home of almost 70 years. Thankfully, the deal was not completed.

My grandmother’s experience magnified my sympathy for the recent events of the “nail house” in Chongqing, which was a far worse situation. The condemned house, occupied by a man named Yang Wu, was destroyed Monday night after Yang had held out against plans for demolition as. Though the government called Yang’s protest a display of stubbornness and inflexibility, I view it as an act of bravery to protect personal rights. The actions of Yang and his wife, Wu Ping have attracted national and international attention, since local media have been forbidden to cover the story. Today, land seizures and people being dumped from their homes in the name of commercial development are commonplace in China. In this case, the Chongqing nail house represents a larger group of historical buildings to be destroyed in China within the next 50 years. This includes those who have been relocated during the construction of the Three Gorges Dam in the past and also the destruction of more than half of Beijing’s hutongs to pave way for a green Olympics. The couple’s defiance gives hope for the many in David-and-Goliath battles for not only private property rights but also personal rights.

Long awaited rules curbing foreign investment in China’s real estate market have apparently been released to real estate firms although they are yet to be officially announced.

Under the rules, individuals must reside in China for one year before buying property, while companies – and institutional buyers – must be registered in China, with registered capital of 50% of the purchase price, up from 33%.

Morgan Stanley, which plans to triple its investment in Chinese property to US$3 billion this year, is apparently the first to lose out under the new regime. According to a well-placed source, the company has been ordered to comply with the new rules before the regulator will give approval for an acquisition that the institutional investor likely felt was already in the bag.

The move comes as Beijing tries to dampen investment in speculative high-end property and encourage the development of affordable housing.

A Ministry of Construction survey this year found the average size of new flats in 16 main cities was more than 120 square meters, much bigger than what an ordinary household could afford. Homebuyers have grown increasingly annoyed at soaring prices - a Beijing Normal University study found 70% of China’s urban residents could not afford to buy a new apartment, based on average housing prices in east China.

Overall housing prices in 70 large and medium-sized cities rose 5.8% year-on-year in May, after climbing 5.6% in April and 5.4% in March. Prices for new properties climbed 6.1% year-on-year in the same period. At the same time, 123 million square meters of real estate remained unsold at the end of March, up 23.8% on the first quarter of 2005. In the residential sector, 69.8 million square meters of housing lay empty, representing about 700,000 unoccupied apartments.

As prices get further and further out of the grasp of domestic buyers, and apartments remain unsold, developers are increasingly trying to target offshore buyers. The strategy has proved successful, with foreign investment transactions in the mainland real estate market totaling US$5.4 billion in the first quarter this year, more than triple the same period last year.

It is this flow of money that the regulator feels is creating a situation whereby prices are climbing despite market force of supply and demand. In the absence of a market correction, the government feels it has a duty to step in.

It is easy to blame foreigners when the going gets too good. Rather than clamping down on the free flow of capital, the government should move faster to open up alternative investment channels.

According to a report by Jones Lang LaSalle last year, some 21.1% of China’s newly rich urban citizens - a total of about 15 million individuals - said they preferred to invest in real estate than bank savings or stocks.

Alternative investment instruments provide a much better hope for cooling real estate flames than any amount of government tinkering and finger pointing.

Watch now as the foreign investors find a way around the new barriers, and watch as prices continue to rise - just as fast as the new, unoccupied apartments.