Date
22 October 2018
Most Chinese property developers are heavily dependent on pre-sales to secure their cash flows, putting the firms at risk in the event of a change in government policy. Photo: China Daily
Most Chinese property developers are heavily dependent on pre-sales to secure their cash flows, putting the firms at risk in the event of a change in government policy. Photo: China Daily

Home pre-sale system: Why it matters so much to China developers

It’s rumored that Guangdong province is considering a proposal to scrap the home pre-sale system. If that indeed becomes a reality, it could deal a heavy blow to the cash flow of Chinese property developers.

The rumor was triggered by a document originating from Guangdong’s housing authority on September 21.

The pre-sale system had been adopted since early 90s after being approved by the National People’s Congress, and has been running smoothly most of the time, thanks to the largely upward trend of the property market and a relatively fragmented industry structure, which meant limited systemic risk.

But things have changed dramatically over the years. Currently, a top property developer could easily hold over 500 billion yuan of pre-sale funds and it may have over a thousand development projects under construction at any time.

If any of such sizable developers have liquidity issue, due to, for instance, a sudden collapse of the property market, it could threaten the financial system.

Given such concern, it’s reasonable for the central government to consider tightening the pre-sale system, if not scrapping it altogether.

Currently, regional pre-sale system varies. In some regions, developers can obtain the pre-sale permit just by just providing the design paper. In other places, developers are required to complete the foundation or as much as one third of the development before applying for pre-sale permit.

Most Chinese property developers are heavily dependent on pre-sales to secure their cash flows. Their net profit margin now stands at 10 to 15 percent, thanks to funding from pre-selling their projects.

Tighter rules on the pre-sale system would raise interest expenses and erode their profit margin. (Developers typically have to pay 6 percent interest per annum for loans).

How likely is it for the rumored cancellation of pre-sale system to actually happen?

First of all, the Guangdong housing authority is neither a legislative or enforcement body, but rather an advisory body. Therefore, the document is only intended for collection of opinions.

The Ministry of Housing and Urban-rural Development has indeed quickly dismissed the rumor that the authority is considering scrapping the pre-sale system.

Meanwhile, any change to the pre-sale system, which is a national policy, needs to be approved by the legislative body.

Even if the authority decides to go ahead with the reform, it typically has to start with a pilot scheme in certain regions before getting the approval of National People’s Congress to issue the change as a national policy.

As such, the removal or amendment of the housing pre-sale system may take at least three years to roll out nationwide.

Existing projects are also likely to be grandfathered when the new rule starts to apply. Therefore, the domestic developers should feel limited impact in the next few years.

Nevertheless, the report of possible restrictions on pre-sale system has come as a wake-up call.

That’s perhaps why Vanke, Country Garden and other leading developers all are slowing down their development pace.

It’s inevitable for real-estate players to get prepared now by trimming their leverage gradually.

Over the long run, introduction of such a new rule may also hurt small and medium-sized developers more, especially those with less financial resources, leading to another round of industry consolidation.

This article appeared in the Hong Kong Economic Journal on Sept 26

Translation by Julie Zhu

[Chinese version 中文版]

– Contact us at [email protected]

RC

Hong Kong Economic Journal columnist

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