Economic Condition For Real Estate Industry

8/6/2019 Economic Condition For Real Estate Industry

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Abstract

The real estate boom has been the major engine of the Chinas economic development during

recent years. However, Chinas real estate market is still in the budding period and immature. It

is a common phenomenon that many real estate projects failing to meet deadlines and profit

targets because the Chinese real estate corporations lack a scientific management technology to

deal with risks. The objective of this paper is to investigate the key issues and challenges of risk

management in Chinese real estate corporations and provide the solutions to improve the risk

management in China.

Chapter 1


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Introduction

1.1: Background of Research

In November 2009 France announced that it had successful come out of recession a phenomenon

that heralded a number of series of announcements of successful end of the economic crisis by

other countries. Significantly it was not until the end of the year that the United States of

America whose industries were said to have masterminded the economic recession announced

that it has also come out of recession. The real estate industry has throughout the period played a

major and leading role in the issues surrounding the causes and the solutions to the problems of

this economic recession which is considered to be the worse form after the great depression of

the 1920s brought to the global economy (Bernanke, 2010)

The real estate in China is one of the booming sectors in the economy drawing its strength from

massive infrastructure limitation of the country which has persisted for a long time. The massive

advance in the economy resulting in the presence of a number of larger multinational and

domestic institutions who are taking responsibilities for the housing needs of its workforce have

increased the demand for housing facilities and for that matter making it a very profitable

endeavor.

However, there are some potential risks with the development of real estate in China, and there

will be some challenges and threats appeared in this industry. Therefore, Chinese real estate

companies should introduce some effective and efficient management model to deal with all the

potential risk from now on. ERM is widely implemented by most organizations in developed

countries, and it also can provide significant contributions to this industry for managing the

potential risks as whole.


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1.2: An introduction to Chinese Real Estate Sector

Before the economic reform in 1978, China had adopted a welfare housing system for 28 years.

At the time, state-owned enterprises (SOEs) and the government had the responsibility to offer

all welfare benefits to their employees. However in late 1978, the Chinese government began to

consider allowing ordinary people to own property. In September 1980, Beijing Property

Development Company was established, marking the start of Chinas property market. In 1987,

the Shenzhen government sold land use rights for property development through a public

auction. This was the first time property was auctioned off to the public in China. Three years

later, Shanghai formulated a housing reform plan and a year after, became the first city to set up

a central provident fund system in China. From 1992 to 1993, China experienced its first real

estate boom (in other words, its first real estate bubble). A housing reform system was carried

out nationwide in 1992 and the following year, the State Council launched the Anju Project,

which aimed to provide more affordable housing to urban residents.

The graph below shows how investment surged in the early 1990s and plunged low in the later

decade, and remained low thereafter. A second graph shows the portion of investment that real

estate housing had in the entire Chinese Economy.


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Unfortunately, the excessive increase in real estate investment and other irrational investmentsled to serious inflation problems. Since 1993, China has begun to rein in the overheating

economy, with real estate being one of the key sectors targeted. As a result, the sector gradually

cooled down. In 1997, China even observed a negative growth in real estate investment when the

economic performance in general was at a historical low. The turning point was in 1998, when

the welfare housing system finally ended. As part of the reform, Chinas banks started to provide

mortgage loans to consumers. Coupled with rising income, Chinas property market began to

recover. After 2000, the increasing urbanization and population movements increased the

demand for housing, especially in major cities. From 1997 to 2002, the nations urban population

rose from 394.5 million to 502.1 million and the urbanization rate jumped from 31.9% to 39.1%.

1.3:The Current Situation

In 2007, investment in real estate development reached RMB 2.53 trillion, up 30.2% from 2006.

Residential property investment amounted to RMB 1.8 trillion, accounting for 71% of the total

investment an increase of 32.1% from 2006. By 2007, 478 million sq m of residential property

had been completed - 5% more than in 2006. The rising housing price was stable in the first half

of 2007 and saw a sharp increase from June till October. However, in November, the price

increase slowed down and 18 out of 70 cities showed negative growth in December.


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high-grade hotels, villas, office buildings, golf courses, and national tourist areas. These were not

eligible for full-funded foreign investment and only joint ventures were allowed. In the 2002

adjustment, the construction of ordinary housing was encouraged, while the block land

development and the construction and operation of hotels, villas and office buildings remained in

the limited category. In 2004, the Catalogue added the construction and operation of large

theme parks to the limited category. In some cities, the construction and operation of golf

courses and national tourist areas were also limited. Presently, although foreign investment in

real estate accounts for only 4.7% of the nations total investment in this sector, about 22.9% of

the nations total utilized foreign investment was in this industry. In 2007, the utilized foreign

investment in the real estate sector reached US$17.1 billion, up 107.3% over 2006, compared to

a 13.6% average growth in all the sectors. Despite the publication of regulations, foreign

investors rapidly entered the Chinese real estate market through various channels such as

purchasing property, and outflanking the second and third tier cities. In 2007, the foreign

investment scale on these cities exceeded 100%. More than 300 foreign-invested enterprises

were set up that year with the expectation of doors closing on overseas players wanting to invest

in the domestic real estate market in the future.

1.6: Nationwide property market cycles:

The first five years (1998-2003) since the private housing ownership became relevant saw only

Moderate increases in the nationwide property prices, consistent with a macroeconomic

environment where inflation was low or even negative and the economy was still recovering

from the impact of the Asian financial crisis. Chinas housing prices did not really experience a

large increase until 2003 when the economy experienced a short episode of economic

overheating. The property prices then started to increase at an unprecedented pace (namely at an

average of 7.4% per annum) till 2005. The macroeconomic tightening measures ensued seemed

to have worked to dampen the rapid rise in housing prices. However, the surges started again in

2007, possibly driven by rising capital inflows and faster appreciation of the RMB exchange rate.

This cycle peaked in mid 2008. The nationwide real estate prices have since decelerated fast and

started to decline since the end of 2008.


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Chapter 2

Conducting Research

2.1 Research Aims and Objectives

The objectives of the research are to be able to understand the nature of risk which confirms the

real estate sector in China and what management principles and adopted effective control them.

In order to find out the problems in Chinese real estate industry, there are three questions to be

concerned:

a. What is the nature of risk which is face by the Chinese real estate sector?

b. How ERM has been implemented and developed in Chinese real estate industry?

c. What measures can be put in place to ensure effective management of the risk in order to

maximize the prospects of the sector?

2.2 Methodology

This study is been carried out as a descriptive research which is targeting at analyzing the

frequencies in the responses to identify the trends within the different responses categories. By

making use of a survey and designing survey data collecting instruments respondents have been

selected from both consumer group and service providers in the real estate sector who will be

contacted. With that a description of the existing nature of risk and the problem it brings will be

known. The research paradigm is the positivist approach which upholds objectivity in research.

The study will collect both qualitative and quantitative data, and then based on the evidence to

make conclusions for the objectives which have been proposed above. The research has also

been designed to make analysis by collecting both primary and secondary data.

Population and Sampling

Two groups of respondents have been shortlisted. These are the real estate companies which

represents the supply side as well as consumers in the industry. The companies which will be

studied are China Vanke Co Ltd, Poly Real Estate Group Co. Ltd, Beijing North Star Company

Limited, Beijing urban construction investment & development Co. Ltd, China WUYI Co. Ltd.

The reached companies are in different position in the ranking of Chinese real estate industry,


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and this companies are located in different part of China. And the managers and staffs of this

companies will be contacted by a questionnaire to collect the required data.

On the other hand, the consumers will be selected by adopting the convenience sampling

method. In all one hundred respondent fifty of which will come from each group will be reached.

Ten respondents will be interviewed while the rest will be reached with the questionnaire.

2.3 Data Collection and Analysis

For critically analyze and evaluate the ERM in Chinese real estate industry, there are two data

collection instruments will be used in this reach. The first will be the interview guide which will

be a semi formally structured interview format to be used to collect qualitative data. The data

collected from those interviews will be analyzed and evaluated and the outcome will provide a

significant contribution to the this study.

Secondly, the questionnaire will collect the quantitative data from the remaining ninety

respondents. In order to be able to collect the data in a manner that can be graduated and

measured the closed ended approach asking question will be used, and in this case the Likert

scale five point answering scheme will be employed. After carrying out a pre-test to check the

validity and the reliability of the instruments hard copies of the questionnaire will be sent to the

respondents by an agreed means. When the questionnaires are returned, the SPSS and Microsoft

excel will help the researcher to extract the frequency distribution table and diagrams after

cleaned and coded.

2.4 Expected Outcomes

This researcher expected find out the important reasons which could support that ERM is worth

doing in Chinese real estate industry. In other words, this research could identify what is the

main threats that Chinese real estate companies have to face, and why ERM could help those

companies to improve the performance and turn those threats into opportunities. In addition, the

researcher might conclude the main factors which could increase the effectiveness and efficiency

in Chinese real estate companies by doing ERM approach.


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2.5 Limitations

The research is expected to have some limitation in respect of the generalization which can be

made from these findings. This is because the research will make use of only one hundred

samples which will be conveniently selected. The research will also take place in China and may

affect the extent to which it can be applied to other culture. The research will be limited to the

extent to which they respondents will be truthful. The use of secondary research will be limited

to the extent that most of the theories and the research which have been carried out also have

their own limitation

2.6 Ethical Issues

A number of ethical issues come up in this research. Obviously this research is designed to be

primary and secondary research, hence, human respondents would be very much involved. It is

the requirement of this dissertation to ensure that all information collected from these are kept in

absolute confidence and only used for the project purposes which have been disclosed in this

proposal. Secondly it is also noted that access to secondary data will be done in a credible and

open manner. While measures will be put in place to ensure that all secondary materials which

are used in this research are adequately and appropriately acknowledged to avoid traces of

plagiarism.


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2.7Time Table of Research

Activity Period

1. Read literature 08 March 2011

2.Complete proposal 08 April 2011

3. Devise research approach and strategy 03 May 2011

4. Draft questionnaire 15 May 2011

5. Administer questionnaire 20 May 2011

6. Analyze data and conclusion 01 June 2011

7. Complete remaining chapters 20 June 2011

8. Submit to tutor and await feedback 15 July 2011

9. Revise draft, format for submission 10 August 2011

10. Submit 26 August 2011

Chapter 3

Literature Review


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The literature review will include two areas: 1) the literature relating enterprise wide risk

management in industries; 2) The risk in Chinese real estate industry;

The Development of Risk Management Theory

In 1921, Marshall (Marshall, 1922) put forward the idea of Administration of Risk-Bearing, at

the same time he addressed two managing risks ways as Risk elimination and Risk Deviation.

During 1929-1933, The American entrepreneurs spread the enterprise management movement.

American Marketing Association (AMA) realized the importance of the risk analysis of

enterprise and established particular research and consultant departments. Risk Manager

established Insurance Buyers of New York in 1932. From that time, enterprises insurance

management began to be popular, and come up some managing risks ways.

In the 1950s, Risk Management gradually developed into a special academic course. In the 1950,

Mowbray and Blanchard (Song Mingzhe, 2003) first defined the concept- Risk management in

their book Insurance. Gallagher (1956) addressed the Risk management- new phase of cost

control. From then on, Risk management started to step into the historical stage.

In the1960s, Mehr and Hedgs (Liu XinLi, 2006) and Williams and Heins (Willams and Heins,

1990) led the study of risk management into a systematic way. Their masterpieces as Risk

Management in the Business Enterprise and Risk Management and Insurance made the idea --

Risk Management deeply into the popular life.

The term risk management was introduced by the risk managers around 1970s, at first, risk

management primarily focus on manage selected financial and hazard exposures and internal

controls. People always transfer the risk by purchasing insurance. However, due to the economic

disaster in 1990s, there were several companies failed, such as Piper Alpha and Baring Bank.

Risk manager introduced a new term, which is business risk management and it only focusing on

the business risk in the organization. Risk manager aim to deal with the business risk and turn the

competitive threat into business opportunities. But, under the rapidly changing business

environment, the traditional risk management is no longer adapting the current business

situation. Recent year, risk manager applied a new risk management approach to manage risk,


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which was called enterprise-wide risk management. It is a broadly focused way to deal with the

risk, for example, ERM see various risks as an integrated risk and deal with the integrated risk to

improve the organization as a whole, not only one particular part.

During the 1970s, most American universities opened the risk management courses. In 1983,

Risk and Insurance Management Society adopted Risk Management 101 in their annual

conference. The rules of 101 risk management have been the guides for managing risks, and used

up till now. In 1987, Professor Cooper and Chapman (1987) put forward the conceptRisk

Engineering. They considered that risk engineering as the integration of different kinds of risk

analysis technologies. Risk engineering is far-ranging and more flexible, and can compensate the

limitations of single model.

When time moved into 1990s, researches on the risk management have made a big progress,

establishing an integral system and an independent research field. Risk management has been

taken into consideration when making business strategies. Around 70 percent enterprises have

their particular risk manager and 90 percent enterprises have the risk management training.

Zhao Xuehong, 2006).

Marsh (2010) acted that ERM is a kind of approach which can supply a explicit and confidence

investment direction for the organization and can create values under the uncertain environment.

Many organizations are implementing ERM to increase the effectiveness and efficiency of their

activities in the developed countries. However, only the financial institutions are implementing

the ERM processes in China. (Basel II, 2004) Banks have been leaders in ERM adoption due to

the emphasis on risk management in the global regulation as a way to reduce minimum capital

requirements. (Bies, 2004) The US Federal Reserve Board has recently announced

expectations for expanded ERM processes in US financial institutions. (Whitfield, 2004)

Educational institutions also face significant regulation and have been strongly encouraged to

adopt ERM. and, Insurers have come to recognize enterprise risk management as fundamental

in creating and improving shareholder value through better risk-based decision making and

capital allocation (Tillinghast-Towers Perrin, 2004).
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The risk in Chinese real estate industry

The massive growth in the sector is supported by the required investment which makes the sector

very attractive for all industries. AbouRiz & Er (2004) have analysed the risk in the real estate

sector in China into different areas under two major categories which he calls the

macroeconomic risks and industry risk. In terms of the former, it includes risk which relates to

social environment risk ,political environment risk, , land policy risk, housing policy risk,

financial policy risk tax policy risk, urban planning risk, environmental protection policy risk,

GDP growth risk, inflation risk, urbanization risk, legal environment risk (Almgren & Berg,

2002).

The industry risks in Chinese real estate companies included the supply and demand risk, human

resource risk, the project risks in Chinese real estate corporations, land price risk, marketing risk,

financing risk, resettlement risk and new technology risk. To be able to exhaust all of these, it

will require extensive study which cannot be covered in this research. To this end the research

and study is going to be restricted to analyzing the demand risk in the sector. The reason for this

choice is the fact that economic growth which is expected to bring with it enhance standard of

living seems to be far ahead of the ordinary livings of the Chinese. Many are unable to afford

accommodation provided unless under very tight mortgage conditions which is increasingly

becoming unattractive (Brealey and Allen, 2005).


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A city by city look of Chinese Real Estate Industry

Beijing

The residential property price did not take off until 2003. It had since risen at an averaged 7.6%

until 2007. The property prices have started to cool down since the beginning of 2008, after a

sharp 11% increase in 2007 (Chart 4a). The peak of Beijings housing price is also coincided

with the peak of its real estate investment cycle.

Shanghai

Its housing prices started to rise in 2001 and peaked in 2003 after registering a yoy growth of

over 20%. Growth in the property prices on average soon dropped sharply and even declined by

2 to 3% in 2006. The price rebounded somewhat in 2007 and 2008 before declining again in

early 2009 (Chart 4b).

Shenzhen

Affected by the Asian financial crisis in 1997-98, Shenzhens housing prices stagnated for the

period of 1998 to 2002. After 2003, the housing prices rose sharply and peaked in 2006 and 2007

with a yoy growth at over 17%. The residential housing prices have since dropped sharply. The

price falls in Shenzhen have been the largest so far among the key cities in China with a large

negative yoy growth of 15.7% in February 2009 (Chart 4c).

Guangzhou

Affected seriously by the Asian financial crisis, Guangzhous property prices fell over the period

from 1998 to 2003. The decline in the residential property prices was the largest in 1999 with anegative 5%. The city saw a moderate recovery of housing prices between 2004 and 2007.

However, the rebound over the period was not very large. For example, the largest increase was

close to 7% in 2007. The prices then declined again in 2009 by as much as 5% in early 2009.


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Tianjin

The housing prices in Tianjin stood still for the period of 1998 to 2002. It took off sharply in

2003 and peaked in 2004 with a yoy growth rate of over 13% driven by central government

intentions to enhance Tianjins status as a high-tech and financial center for Northeast China.

Rapid growth in housing prices halted in 2005 and it had since been maintained at a yoy rate of

less than 6 until a large drop to a negative 2% in 2009. Despite price moderations, real estate

investment continued to rise at a fast rate. Indeed, the supply factor especially after the set up of

a new special economic zone in Tianjin in 2005 will continue to affect Tianjins property prices.

Chongqing

It appears that Chongqings residential housing prices had already experienced a cycle after its

naming as the fourth Municipality--a status similar to a province--in China in 1997. This cycle

bottomed in 2001; another cycle soon began and it was peaked in 2004 at a yoy growth rate of

14%. Although growth in property prices rebounded after 2006, it has dropped sharply after 2008

to an averaged negative 2% in early 2009. Chongqing is another city where real estate

investment has seen rapid increase after 2005.


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Sources: CEIC and BBVA estimates


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Chapter 5

Mortgage finance and interest rates

Mortgage finance also has a short history in China. Chinas mortgage

outstanding, though growing fast remains a small portion of bank loans at around 10% at the end

of 2008. Mortgage rates showed a negative relationship with property prices unptil 2003. This

relationship seemed to have changed for the period of 2004 to 2008, where there is a coordinated

movement between real interest rate and property prices. This suggests that some other factors

such as expectation of fast appreciation in residential properties and favorable credit conditions

were also driving the rapid rise in housing prices during this period. The negative relationship

returned after 2008.

For the time being, most mortgage loans are mostly on banks balance sheet and there is little

securitization of bank mortgages. Although the current mode of development appears to be

adequate to meet demand for mortgage finances, it also runs the risk of potential maturity

mismatch for the banking system, as the term structure of bank deposits is usually shorter than

that of mortgage loans.

Alternative mortgage finance methods such as covered bonds and mortgage backed securities

should also be developed. The on-going global financial crisis that originated from the subprime

mortgage crisis in the US shows the covered bonds approach may be more appropriate for China,

largely because the structure of the covered bonds is simple and the identification of the ultimate

risk bearer straightforward. The latest developments also show that the covered bonds do not

seem to be highly sensitive to changes in the underlying asset price.


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Source: Wind

Sources: CEIC and BBVA estimates


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Chapter 6

Housing Provident Fund

The housing provident fund is a unique form of housing finance institution in China: It is a fund

contributed by both employees and employers. Employees usually contribute 5% to 20% of their

salary to the fund with the equal amount matched by their employers. Participating in such a

fund allows one to enjoy lower mortgage interest rates than the market rates. In addition, through

monthly contribution, one can accumulate savings for a housing purchase that can be drawn as

down payment or use the savings accumulated to lower the loan amount.

Origins of Housing Provident Fund (HPF)

Before Chinas economic reform in 1978, there was little private housing ownership in China.

Housing had used to be provided by an individuals work unit in the urban area, known as state-

distributed housing system. Private housing ownership was allowed as early as in the beginning

of the 1980s.

However, the majority of households could not afford the high costs of privately-owned housing

in the early days of private housing ownership, largely because the wages were controlled at a

subsistence level at the early stage of Chinas economic transition.

In 1991, the housing provident fund was introduced as a pilot program in Shanghai. It was a part

of a large housing reform package adopted by the Shanghai municipal government. Similar type

of HPF schemes was established in Beijing, Guangzhou, and Tianjin in 1992. This scheme was

formally extended nationwide in the urban area in 1995. Through contributions made by both

employers and employees, the fund intends to make private housing affordable so that the state

can gradually phase out the state-distributed housing system. In 1998, the State Council decided

to completely end the old housing allocation system and elevated

HPFs role in financing private housing purchase. The State Council then issued the Housing


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Provident Fund Management Regulations in March 1999 as a legal framework to standardize

HPF contribution and fund management. All prefecture cities were required to set up HPF

schemes. In March 2002, the Housing Provident Fund Management Regulations were amended

by Decree 350 of the State Council. The amended regulations stipulated that all enterprises

(including state, private, and township and joint ventures enterprises), government agencies,

public institutions, and social organizations are required to take part in the HPF system.

Furthermore, the amended regulation has also standardized the fund usage, financial auditing and

supervision, and penalties on violations.

Typically, employees who join the program need to deposit a certain portion of their salary in the

range of 5 to 20% in the HPF account. The contributions are then matched one-for-one by their

employers. In Beijngs case, an employee usually contributes 12% of his/her salary monthly, at

the same time, the employer also needs to pay the same amount to the employees HPF account,

but the total contribution is capped at RMB 2392 no matter how high the employees salary

is.The contribution rate varies across the cities in China, for example, it is only 7% in Shanghai.

Once in the program, the employees need to pay for the monthly contributions to the HPF

account until they retire. In return, the participants of the HPF will be able to get housing

financing loans that enjoy below market mortgage rates from banks. If the employee doesnt buy

any housing, the fund can be drawn in a lump sum at retirement.


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Chapter 7

Comparison between commercial mortgage loans and HPF loans

After the Chinese government ended the housing allocation in 1998, HPF has been a major

policy tool to enhance housing affordability for urban residents, which provides a lower interest

rate (usually 200 basis points lower) than market-based commercial mortgage loans by banks

(Chart 1). For example, the current HPF loan interest rate for 6 to 30 years is 3.87%, while

commercial loan interest rate for the same maturity is 5.94%. Even the commercial loans interest

rate can be discounted 30% the most qualified customers, namely at 4.158%, they are still higher

than the HPF interest rate.

Therefore, if households want to apply for mortgage loans, the first choice could be to seek loan

applications from an HPF management center. If the loan amount is not enough to cover the

housing purchase, they can then go to banks for a second commercial loan to make up the

difference.

As shown in Table, the households that can obtain HPF loans only account for a small portion in

the population. As of 2007, total loan amount issued by HPF management centers is RMB 856.6

billion, while the mortgage loans from banks amount to RMB 2962.5 billion, or less than one

third of commercial mortgage loans. In term of amount, the commercial loan is much larger than

the HPF, and it plays a bigger role in financing the housing purchase.


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Source: Wind Economic Data


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Economic Condition For Real Estate Industry

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