Research on Investment and Financing of Real Estate Companies under the “New Normal”

Time:  Nov 25.2021    |    Source:  JJTZ

I. Current situation of investment and financing of real estate companies
From the financing data in the first half of 2021, the total financing scale of the real estate industry has continued to decline. Among them, the scale of debenture bonds financing has dropped significantly, and so does the cumulative financing amount of traditional financing models, making it increasingly difficult for real estate companies to raise funds. In fact, since its inception, real estate companies have always assumed the dual role of real estate investment and financing. On the one hand, it is necessary to carry out investment activities such as real estate development and construction. On the other hand, it is necessary to continuously carry out financing activities such as raising and financing funds. Financing activities are the lifeblood of current real estate companies. The current traditional investment and financing models of real estate companies include:

(a) Bank Loans
As the main financing channel of the real estate industry during its operation, bank loans not only solve the operational problems of the real estate industry, but also ensure the effective improvement of the risk resistance of the real estate industry through the form of risk-sharing. The real estate industry realizes the optimal allocation and utilization of funds through bank loans, which are run through all links, including real estate development, land transactions, land reserves and real estate sales. Recently, affected by the supervision of the "two red lines"(Proportion of real estate loans and Proportion of individual housing loans) of bank loan concentration, many developers have difficulty obtaining bank development loans, and the top 100 real estate companies are no exception. At present, state-owned banks and city commercial banks have basically narrowed their counterparties down to the top 30 or 50 developers, while the approval authority for development loans of joint-stock banks has basically been tightened to the head office, leaves no room for business operations. In addition, there are other problems, such as bank loan quota and slow bank lending.

(b) Listing & Financing
Listing & Financing is a kind of equity financing, which divides all the capital of the operating company into equal stock shares, and is listed for circulation and publicly issued after approval by the securities regulatory commission. Its forms include IPO financing, additional issuance and share allotment financing, etc. By going public, companies can obtain huge amounts of capital in a short period of time. This capital can also be used as registered capital for permanent use, without the burden of fixed repayment periods. However, the upfront cost of carrying out IPO financing activities is large and this option is generally not available to SMEs. Even some listed companies are currently restricted from obtaining refinancing approval at all.

(c) Financing through pre-sale
The way real estate companies obtain funds by pre-selling their houses also allows them to achieve financing purposes in their business activities. This mode of operation is relatively simple and less expensive, yet the enterprises are subject to a series of restrictions and requirements, such as the existence of conditions for pre-selling houses, lower profits due to the restriction on the purchase of houses, or that the income from pre-sale can only be used in construction activities, etc.

II. Investment and financing dilemma of real estate companies
(a) Single investment and financing channel
At present, the most common form of financing for real estate companies is "equity funds + bank loans", of which bank credit funds account for a relatively high proportion. Considering the fact that enterprise's self-raised funds in other domestic financing, deposits and pre-receipts will also have part of the bank loans, the real estate investment in bank funds may actually be higher. This would suggest that indirect financing is still the main channel, while real estate investment and financing channels are relatively narrow. However, due to the supervision of the "two red lines" of bank loan concentration, it is currently difficult for many developers to obtain bank loans for development.

(b) The lagging of financial innovation for real estate investment and financing
In developed countries, the financial products supporting the real estate industry are complete, such as equity financing, project financing, funds, bond issuance, trusts and mortgages, etc. However, there are very few products on China’s financial market. Although there are trusts, listings and corporate bonds available for the current market, they are subject to various conditions. In the context of strong supervision such as "Houses are for living in and not for speculative investment", "three red lines" and "ownership of land funds", the options left to real estate companies, especially small and medium-sized real estate companies, are very limited. In the absence of financial innovation and financial products, the efficiency of market allocation of resources is greatly hindered, making it even harder to form a market order with fair competition.

(c) The ability of the real estate industry to respond to international and domestic capital shocks urgently needs to be improved
In recent years, with the opening of China's financial industry, high rate of return and huge demand in the domestic real estate market have attracted many overseas investors. Although till now, the proportion of overseas funds in total real estate investment funds is relatively small, analysis suggests that the sharp rise in real estate prices in several major cities is directly related to the influx of overseas funds. Therefore, it has become a necessity to prevent the impact of international capital on China's real estate industry, especially the overall risks brought by the speculative nature of "hot money" to China's real estate industry must be carefully guarded against.

III. Other investment and financing channels with development potential
The golden age of real estate companies in China has come to an end, and the investment and financing environment has undergone major changes. Under the new situation, real estate companies need to make full use of other innovational investment and financing channels, such as:

(a) Real estate trust
Real estate trust refers to a trust in which the property that the trust company accepts entrusted operation, management and disposal belongs to real estate and related financial affairs. Trust companies are commercial intermediaries that are entrusted to manage assets or operating funds on behalf of clients. Trust financing is not only different from indirect financing which banks absorbing short-term deposits and issuing short-term loans, but also different from direct financing in the capital market. After the Central Bank's "Document 121", the financing conditions for REIT products are relatively loose, and they can be specifically designed according to actual needs, and hence have achieved greater development. However, since the scale of financing trusts has been depressed and new regulations for the management of capital trusts have been issued, trust development loans have drastically reduced, and the quota of financing trusts has become scarce for developers.

(b) Real estate securitization
In 1990, Nobel laureates Sharp and Miller proposed through empirical analysis and logical deduction that real estate securitization will become the focus of future financial development. Practical experience also shows that real estate securitization financing is one of the most effective means to improve corporate financing capabilities. On the one hand, it can solve corporate financing dilemmas; on the other hand, it can also allow the benefits of investment activities to be shared in a better way. Therefore, real estate securitization can expand the scale of other financing and is no longer limited to intermediaries. Real estate securitization allows funders to raise funds directly through the capital market without having to borrow or overdraft from banks. Meanwhile, its lower financing costs also contributes to the efficiency of capital market operations. However, the difficulty of securitization lies in the need for a complete legal system and a mature capital market system, including mature intermediaries. At present, the problem of real estate securitization in China is that the credit system is not sound, the background of " Houses are for living in and not for speculative investment" and the huge amount of NPA (non-performing assets) of banks are also obstacles to securitization.

(c) Overseas real estate funds
The high return of China's real estate industry has attracted many overseas funds, such as Morgan Stanley Real Estate Fund, CapitaLand "China Development Fund", MGPA (a fund company of Australia Macquarie Media Group), and Hines, etc. are vying to enter the Chinese market. They make large-scale purchases of large shopping malls, office buildings in prosperous areas of major cities, or equity investment in real estate construction projects, some even develop real estate projects independently.

(d) Other forms
At present, most small and medium-sized real estate companies have difficulty obtaining development loans. Therefore, these real estate companies generally look for some mortgage financing products as soon as they obtain the land certificate. These financing products have also replaced the functions of banks and trusts to develop loans to a certain extent. Currently, a more common financing product can be:

1. “Factoring + Mortgage” Products: The general contractor of the real estate companies provide factoring financing for its accounts receivable to the project company, and the project company provides land mortgage and equity pledge.

2. Collateralized Financing: It is mainly operated by some small-loan companies, some directly apply for mortgage loans to the project company, and some are established through real estate companies or looking for non-housing entities as financing entities, and then the funds flow from the non-housing entities to the project company. Of course, the land is under the name of a small-loan company.

3. FAE (Financial Assets Exchange) Products: Mainly some financial holding platforms, asset management companies provide financing for developers through issuing non-public targeted financing plans on FAE. But most of them will introduce guarantees and require the project companies of real estate companies to apply for land mortgages and equity pledges under the name of the guarantee company. It is worth noting that the regulatory authorities have always maintained a high-pressure supervision posture on FAE-oriented financing products. Therefore, whether there will be subsequent compliance problems in the future is yet to be verified by the market.

4. Private Equity Funds: as a high profit-seeking private force, in the high-return industries such as the stock market and the real estate market, private equity funds are everywhere, and even act as the culprit of large fluctuations in housing prices. Private equity financing is not very standardized and hard to regulate. According to estimates, private equity funds have invested more than hundreds of billions RMB in the real estate industry, of which Jiangzhe capital and Chaoshan capital are particularly active.

5. Mortgage Financing: In the process of short-term micro financing, mortgage financing has played its flexible role, but compared to the huge financing needs of real estate companies, the amount is too small and the financing cost is high. It is generally applicable to land bond financing or short-term bridge loan.

The proportion of bank loans in real estate financing remains high, while commercial banks would not be able to meet the various multi-level capital needs of the real estate industry. Additionally, the current situation of poor financing channels has threatened the development of large private real estate companies and the survival of small and medium-sized real estate companies, due to changes in regulatory policies. The scattered funds of small and medium-sized investors cannot directly enter the real estate industry, which has large capital barriers and high professional and technical requirements. Real estate companies should seek for new financing channels, raise development funds through trust financing, equity cooperation, capital market financing, private financing, and other channels. They should innovate the use of various real estate financial instruments, standardize the use of financing methods in capital market, and guarantee the cash flow safety of real estate companies while complying with the constant stream of regulatory policies.