Foreign Investment In China, Part II: Can You Say Last Nail In The Real Estate Coffin?
By: Steve Dickinson
This is the second in a multi-part series on the changes to China's foreign investment laws as reflected in its 2007 Catalog of encouraged, restricted and prohibited investments. Part I of this series can be found, entitled, "Breaking News, China Changes Foreign Investment (FDI) Rules," can be found here.
The new catalog continues Beijing's trend to restrict foreign investment in Chinese real estate. This process started in 2006 when direct foreign investment in real estate was prohibited. All foreign investment in real estate was required to be made through a Chinese company, either a WFOE or a JV. In May of this year, the notorious Circular 50 was issued, closing many loopholes in that rule. Circular 50 requires all foreign invested real estate projects, no matter the size or nature, be approved at the national level in Beijing. This allows Beijing to turn the market on and off through its approval authority. In July, the State Administration for Foreign Exchange issued Circular 130, regulating and limiting the use of foreign exchange in real estate investments. After the 17th party congress, a number of officials indicated foreign investment in real estate was still viewed as a major problem. The problems were seen in two areas. First, foreign investment is believed to drive up real estate prices to the detriment of local citizens. Second, the flood of money into the real estate market was exacerbating China's excessive accumulation of foreign reserves. Many foreign investors do not agree with this analysis, but it is widely accepted in China. It is therefore no surprise the Catalog would include provisions restricting foreign investment in real estate.
The changes in treatment of real estate are as follows:
The 2004 Catalog put development of residential housing in the encouraged category. The 2007 Catalog removes this reference. Under the new investment policy, foreign investments not in the encouraged category are strongly discouraged. Since Beijing's approval of such projects is required, this change means approval of investment by foreigners in any form of housing development is unlikely. On the other hand, investment related to energy efficiency in all areas of real estate is strongly encouraged.
The 2007 Catalog includes three areas concerning real estate in the restricted category. Placement in the restricted category means the investment is strongly discouraged and is seldom approved. Foreign investment is restricted in the following:
Foreign investment in the development of raw land is restricted and limited to joint ventures. WFOEs for this purpose are prohibited. This change was expected, although the limitation to joint ventures is a surprise to me. Raw land development in China is a very sensitive issue, since it usually involves either expropriating the land of urban residents or converting agricultural land to use for construction. Foreign involvement in this highly political and sensitive process is now seen as undesirable. Though the restriction is understandable, the change does raise some important issues. Funds for building construction are plentiful within the Chinese system, but funds for raw land development are not. Provisions in the new Property Law make raw land development even more difficult. We have seen many local governments actively seeking the assistance of foreign investors to provide seed money for such projects. Now that this source of funding has been restricted or eliminated, it is not clear to me what source of funding will take its place.
Foreign investment in both the construction and operation of high level (luxury?) hotels, villas, high level (luxury?) office buildings and international convention centers is restricted. It is hard to imagine what the motivation was for this restriction since these have little to no impact on the domestic real estate market and little to no impact on foreign exchange reserves. These restrictions seem to have no relation to the stated reasons for limiting foreign investment in real estate. Further, these areas are inherently international and are expected to be funded by international investors in nearly every market in the world. Comments in the local press also express confusion about the motivation for this restriction. It seems counterproductive. For example, the second tier cities in China have no surplus of luxury hotels. Is it really the intention of the Chinese government to prohibit Starwood and Shangri La from building new five star hotels in any city in China?
Foreign investment in secondary market real estate sales and all real estate brokerages and consultancies has been restricted. Though many foreign brokerages have an active presence in China, this provision means no new brokerages will be permitted. This is consistent with the policy that foreign investors will not be permitted to invest in real estate development or purchase existing properties. With this restriction in place, what role is there for foreign owned brokerages or consultants?
Much of the Chinese press has reported these changes prohibit all foreign investment in real estate, but this is not strictly true since no area of real estate has been placed in the prohibited category. However, the effect of these provisions, when combined with the prior regulations, is to effectively eliminate most areas of foreign investment in real estate. Even where Beijing might approve a project, the requirement to seek such approval involves such a significant delay most conventional real estate projects cannot succeed. The practice in Beijing has been to simply fail to respond to requests for approval. In this way, a formal denial from Beijing is not required. The effect is a prohibition. I should note that no one in China is at all concerned about these restrictions. The Chinese real estate companies and brokerages are quite confident they can handle all of China's current needs in the real estate area. There is therefore little chance of a change in policy in this area in the near future.
UPDATE: Stan Abrams, China lawyer extraordinaire, has come out with a post pretty much affirming the death of foreign real estate investment in China, aptly entitled, Real Estate RIP? Check it out.
http://www.chinalawblog.com/cgi-bin/mt/mt-t.cgi/2244
Foreign Investment In China, Part II: Can You Say Last Nail In The Real Estate Coffin?:
Comments
I don't understand. Doesn't China have the right to prevent its real estate market from overheating? Wasn't a bubble caused in Asia's property sector a great contributor to the Asian Economic Crisis in the late 1990s? Is this ALL bad news?
Posted by: Paul M | November 13, 2007 9:12 AM
All very ironic since now what the US needs so badly following the subprime mortgage crisis is foreign investment money:
http://www.msnbc.msn.com/id/21739273/
Posted by: Paul Denlinger | November 13, 2007 3:32 PM
Paul M.,
We never said China didn't have that right. We never said they did. We never analyzed that question at all because that is far too complicated and would involve all sorts of international treaties, etc. We just express what the law is. Seldom do we have an opinion on it one way or the other.
Posted by: China Law Blog | November 13, 2007 5:53 PM
Chris D-E,
How have we gone overboard? We never expressed an opinion on the changes themselves.
You are right about most hotels and you are right about Starwood, but not entirely. For example, we have done work for a well known hotel chain that appears NOT to develop its properties or to own them, but rather to just manage them. But, in reality, it uses allied companies to develop and to own and I think that is fairly common. So it may not be Starwood itself that owns the properties, but there is still a good chance that some of its properties are owned by companies with a close Starwood connection. I don't know if this is true of Starwood, but I think this is true of many hotels.
Posted by: China Law Blog | November 13, 2007 5:58 PM
Paul Denlinger,
Perhaps as investors see China's prices falling....
Posted by: China Law Blog | November 13, 2007 5:59 PM
Steve has emailed me with the following:
1. Some of the comments make it sound like I am opposed to the new changes. Actually, I think the overall new policy is very good. I don't know what I said in the first post to give that impression and it bothers me somewhat.
2. The only thing they are doing that I don't understand is this thing with luxury hotel properties. Why target that? As you say [in an email I wrote to Steve], there is really no surplus of high end hotel rooms in China. They are slamming the brakes, but in a crude way. They are adopting a policy that might be appropriate for Shanghai but that does not apply to most other places in China. The technique is more sophisticated than it looks, however. By not placing the items in the prohibited category but by forcing all decisions through Beijing, they think they can turn things on and off at will. However, the real estate market does not work that way. Deals come and go too quickly to wait for the whims of Beijing.
Posted by: China Law Blog | November 13, 2007 6:27 PM
Chris D-E,
I ain't buying it. Are you saying that as things now stand, the companies developing the five star properties for companies like Starwood are Chinese companies? I don't think so. I think that are foreign companies that develop 5 star properties for companies like Starwood in various places around the world. We actually have done work for an architectural firm that does work for one of the big hotel chains and I understand from that that the same players typically do this sort of thing over and over again.
Is it the Chinese developing these properties and then bringing in the Starwoods or is it foreigners? I think it is foreigners.
Anyone?
But, we are getting away from the point here and the point is that this is funny area for China to now restrict.
Posted by: China Law Blog | November 13, 2007 9:30 PM
Personnally, I see nothing wrong in the new guidelines. Who cares about golf courses? Nobody use them in China, they waste a lot of water and land, etc... I precise I am an avid golfer back home in the French Riviera.
About contract management in hotels, by talking to my friends in the Accor Group, I can tell you in most of the cases they are contract managers bu they were trying to manage their own ones especially for Sofitel.
For info, Shanghai is only for 2007 building 12 new five-star hotels while currently the city has only 8. No wonder they want to cut back on luxury ones but Shanghai is not China.
I personnally think it is not manageable to run five-star hotels in China, they are all short of staff and when they have, they can barely speak English. Thanks god most of us, speak Chinese!
Posted by: China and I | November 13, 2007 10:45 PM
From what I'm told, the land deals are all but gone even for locals. Someone in Zhuhai mentioned getting in on the last of the cheap land last August.
A friend went to central China on a land deal with the municipal government, but now his money is stuck there because the local government never sought approval from Beijing. Now he's forced to salvage what he can, and wait.
And too many golf courses is actually a good thing for those of us who play. There are many junkets out of HK that play the courses in Shenzhen/Guangzhou.
Posted by: Charles Liu | November 13, 2007 11:51 PM
Stupid question, but it seems like an appropriate place to ask it...
Can foreigners buy an apartment in China? I know we're talking much bigger peanuts here in the article than just a 100 sq. meter apartment, but still. Am I forever doomed to renting?
Posted by: Matt in Chongqing | November 14, 2007 1:28 AM
China and I,
Accor is certainly huge. Who is developing their hotels in China though? A Chinese company?
Posted by: China Law Blog | November 14, 2007 8:18 AM
Charles Liu,
Your description of someone getting their money stuck is absolutely typical. But stuck is probably better than completely gone, which is also absolutely typical.
Posted by: China Law Blog | November 14, 2007 8:19 AM
Matt,
Not a stupid question. Not at all. As a lawyer, I find 99.9% of all stupid questions are asked after someone has done something and there are almost no stupid questions asked regarding what to do in the future. My favorite stupid question is the one where the client (or, more usually the potential client) says, I just invested $3 million and now I have just heard that my investment was completely illegal and I will never get my money back.... How can this be?
Foreign individuals who have been legally resident in China for at least one year while employed or as a student can buy one residence. There are somewhat less restrictive rules for residents of Hong Kong and Taiwan. This was the rule around six months ago, but I vaguely recall reading that it has been bumped up to two years. Is that true, anyone?
Posted by: China Law Blog | November 14, 2007 8:28 AM
To answer your question. I think they do both now. They have had some problems as contract managers with some owners like the Beijing Xinqiao Hotel (Chongwenmen)so they try (until now) to develop their own projects.
Posted by: China and I | November 14, 2007 4:32 PM
China and I,
That's what I thought. I also checked in with someone I know at another big US hotel chain just starting up in China and he told me they too usually like to develop their own properties. See Chris D-E, this is going to have an affect on hotel building.
Posted by: China Law Blog | November 14, 2007 10:46 PM
To Matt: You are allowed to buy one property for your personal use once you have met the residency requirements. I hadn't heard anything about it being raised to 2 years from 1, but I also haven't looked into this recently. In addition, you are supposed to live in this residence and are not allowed to rent it out. You may ask, how would 'they' know? Well, I can think of a couple of potential issues:
1) If you rent to foreigners, they will need to register with the PSB. I believe that the PSB will ask to see the rental contract and check the property owner's credentials. If so, then you will get busted here. I suppose you could tell the PSB that they are friends of yours just over for a visit. However, if your renters are smart they will realize that their contract is void and demand concessions.
2) If your renters ask for an official tax receipt, you also won't be able to provide one.
That said, if all you're after is to avoid paying rent, you'll not be saving much by buying at current prices. That is, unless you are banking on a continuous rise to the moon in property values on the mainland. :)
Posted by: Gerald | November 14, 2007 11:50 PM
Ladies and Gents - does anyone have a translation of the new catalog yet ?
Posted by: Paul O'Driscoll - pod | November 20, 2007 5:29 AM
PLEASE HELP!!
Hi everyone- I invested in 2 properties in Beijing in 2006 (March) and wired the money over. The building is just being finished now. I am still waiting for the deeds. Can anyone tell me legally what I should do? Can I sell the properties and transfer the money? should I just keep them vacant for now and sell later. What would you all suggest. I just want to follow all of the laws- but I am unsure how they apply to a purchase made before the changes.
Andy
Posted by: Andy Wilks | December 6, 2007 2:51 AM