Ponzi Real Estate: Contractors Finance Developers

China's surging home prices reflect the rapid money supply growth from earlier in 2016, not a rebound in the economy. If the economy were picking up, developers would be seeing rising profits, but instead profits are falling such as at Cinda Real Estate, where rising finance costs cut into earnings. One way around high finance costs is to force your contractors to lend you money at low interest rates.

SCMP: Brick and mortar facade buries real truth about China’s property sector
But beneath the impressive numbers lies a different story, especially when one factors in the views of less glamorous players in the sector like contractors.

George is one of them. “We are paying more to win projects,” the veteran industry player said.

No, you are not reading some typos. Contrary to the general practise under which a developer will pay a contractor to undertake the work, it is the contractors who have to pay.

...This is how the system works. Say an apartment building costs 1 billion yuan to build. George will provide the developer 300 million yuan as “facilitation money” at an interest rate of about 4 per cent to win the job. The latter will then give George 80 million yuan for the services rendered.
This might be a Ponzi because the developer is using the money to pay off contractors and suppliers. Everything relies on ever rising home prices to bail everyone out. If home prices fall or sales freeze again...
George, however, does not have any shareholding in the project, whatsoever to cover his back. Neither is he assured that the facilitation money would not end up in the stock market.

All George can do is pray and hope that the apartments sell well and he gets his money back with interest plus the construction costs.

Despite the risk, there has been no dearth of interested players. As George puts it, it has been getting worse. His state-owned rivals are now offering “facilitation money” of up to 50 or even 60 per cent of the construction cost. Some are even pitching in with zero interest, while others are promising to help in eventual sales.
How about the aforementioned Cinda?
The obvious question that comes to the mind is why are developers willing to pay record amounts to own a piece of land, or as some suggest pay more for the flour (land) than the bread (flat). But then the land parcels are not really meant to be the flour for the bread.

A good case is China Cinda Asset Mangement, which has invested more than 61 billion yuan in property during the past 12 months.

...The record-breaking land prices support the property market and therefore the repayment of the multi-billion yuan of loans via shadow banking that Cinda and other state firms are loaded with. So overpayment seemed perfectly okay.

The punchline: no one cares about the prices.
The same benefit applies to private developers albeit in a different way. In the jungle, the private players survive not with prudence, but aggressiveness.

A record land bid pushes up reputation and revaluation. When you are borrowing $9 with a $10 asset, you will get $1.1 loan and the asset gets marked up to $11. Bankers don’t ask any questions.
This is now a simulacra market: prices are completely detached from any reality other than what is being fabricated by the players. Price is driving prices, a self-referential reflexive cycle, the crack-up boom. Money supply growth is already slowing and some analysts are looking for a correction in the next six months, and as soon as September or October.

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