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That sounds suspiciously like a pyramid scheme: the only thing financing the current construction are payments to new construction. How did they get into this s

by tremon 3y ago

That sounds suspiciously like a pyramid scheme: the only thing financing the current construction are payments to new construction. How did they get into this situation? By continuously selling under cost, or perhaps by siphoning off profits?

NhanH 3y ago
Land price keeps increasing caused this problem. You can just imagine land price to increase 50% YoY (hypothetical number) and you will understand the situation. Basically you can not have enough cash on hand to purchase the next piece of land for your development, but you want to always plan for the next step.
- benterix 3y ago
  The first time it happens, you can call it a mistake. But second, third? Is int't it obvious that, seeing this trend, you should calculate the risk and factor in the land cost increase when pricing your offer?
  - NhanH 3y ago
    It's a different issue than what you are imaging. It's not that they sell the property for less than the relevant land cost, it's that the increase is too steep that they can't buy and build the next one without pre-selling the lot, the company just doesn't have enough cash.
    - jjoonathan 3y ago
      The magnitude of land speculation profits is not dictated by physics. If companies weren't able to pay what they did, the speculators (local governments in this case?) would live with less. Developers compete with each other, so they will always take as much leverage as allowed, but the rules are adjustable by lenders. Lenders compete too, but they usually wind up backed by a central bank or other political entity, and that's the point at which changes can actually be made. Of course, there is no guarantee these changes won't create problems (Three Red Lines were a decade too late) but they can be made.
  - jjoonathan 3y ago
    Try doing that and someone who does take the leverage will simply outbid you for the land.
reisse 3y ago
The way OP described it, yes, it sounds like a ponzi, but in reality it's more like crowdfunding. First, the developer takes credit from a bank and uses own money to buy a land. Then, in order to start construction, the developer sells what is basically an obligation to build real estate and transfer the rights to buyer. These obligations are obviously cheaper than the expected price of real estate in the future, and also cheaper than already-constructed real estate now. The developer does not sell all the future real estate at once, because as the time goes by, and construction comes closer to a finish, the obligations become more expensive - it sells only the amount necessary to fund the next step of construction. After the construction is finished, developer sells leftover real estate with a markup big enough to finance its next project. When the housing market is good, this scheme brings real estate costs down, because you can buy cheaper "not-yet-build" flats or houses, and the developer can seek funding without overpaying on the bank loans. But if the housing market tanks, the development freezes, and the first buyers take a loss. I don't know about China, but in some countries such obligations are mandatory insured from the default, so people can get at least some of their money back. In others buyers are left with a piece of land with unfinished building.

by tremon 3y ago

NhanH 3y ago

Land price keeps increasing caused this problem. You can just imagine land price to increase 50% YoY (hypothetical number) and you will understand the situation. Basically you can not have enough cash on hand to purchase the next piece of land for your development, but you want to always plan for the next step.

benterix 3y ago
The first time it happens, you can call it a mistake. But second, third? Is int't it obvious that, seeing this trend, you should calculate the risk and factor in the land cost increase when pricing your offer?
- NhanH 3y ago
  It's a different issue than what you are imaging. It's not that they sell the property for less than the relevant land cost, it's that the increase is too steep that they can't buy and build the next one without pre-selling the lot, the company just doesn't have enough cash.
  - jjoonathan 3y ago
    The magnitude of land speculation profits is not dictated by physics. If companies weren't able to pay what they did, the speculators (local governments in this case?) would live with less. Developers compete with each other, so they will always take as much leverage as allowed, but the rules are adjustable by lenders. Lenders compete too, but they usually wind up backed by a central bank or other political entity, and that's the point at which changes can actually be made. Of course, there is no guarantee these changes won't create problems (Three Red Lines were a decade too late) but they can be made.
- jjoonathan 3y ago
  Try doing that and someone who does take the leverage will simply outbid you for the land.

reisse 3y ago

The way OP described it, yes, it sounds like a ponzi, but in reality it's more like crowdfunding. First, the developer takes credit from a bank and uses own money to buy a land. Then, in order to start construction, the developer sells what is basically an obligation to build real estate and transfer the rights to buyer. These obligations are obviously cheaper than the expected price of real estate in the future, and also cheaper than already-constructed real estate now. The developer does not sell all the future real estate at once, because as the time goes by, and construction comes closer to a finish, the obligations become more expensive - it sells only the amount necessary to fund the next step of construction. After the construction is finished, developer sells leftover real estate with a markup big enough to finance its next project. When the housing market is good, this scheme brings real estate costs down, because you can buy cheaper "not-yet-build" flats or houses, and the developer can seek funding without overpaying on the bank loans. But if the housing market tanks, the development freezes, and the first buyers take a loss. I don't know about China, but in some countries such obligations are mandatory insured from the default, so people can get at least some of their money back. In others buyers are left with a piece of land with unfinished building.