Chinese Online Property Market Appears Set For Lengthy DownturnComments Off
China’s online property market industry appears set for a prolonged downturn that will last far into 2017 and potentially beyond, according to analysts who say government policies intended to steady the housing sector have depressed sales and have had the expected effect of reducing demand for the online property services.
The projection of an extended downturn in the online property sector follows years of both growth and contraction, and the volatility in the market is one of the reasons that the government is imposing strict rules to avoid a housing market crash. If China were to experience a housing market bubble that burst, it would create significantly greater economic problems affecting more sectors than a narrower decline affecting just the property market.
According to a report released this week by economic analysts Alvin Jiang and Alan Hellawell from Deutsche Bank, the declining Chinese property market “is entering a long winter for at least six months.”
The South China Morning Post notes that the analysts believe that this downturn will last through to end of 2017, which could mean it lasts even longer — potentially into 2018. The analysts say that the decrease in the market can be directly connected to government policies that aim to avoid a housing market crash by imposing strict requirements on several important factors such as managing property prices and limiting transactions. 
In their report, the analysts said, “Both the online property transaction business and the related listing business are suffering from the cold property market. Continuing strict policies have frozen transactions and hurt the desire of property agents to spend,” which has led to major drops in property transactions. For example, the report says that the volume of property transactions in China’s top 10 cities dropped 25 percent in October.
The Chinese Online Property portals
Given the downturn, the analysts decided to downgrade their rating of the online property portal sales SouFun to “sell,” citing “continuing weakness” in the sector as well as the company’s apparent “scaling down” of operations. The analysts also downgrade 58.com — another online property sales portal — to “hold” rather than “buy” for similar reasons, because it “reflect[s] our concern on the continuing weakness in the property segment.”
However, a blog post on Barron’s Asia notes that the analysts’ report appears to be late in coming, because the property market was already experiencing a freeze before the release of the findings. 
“Isn’t Deutsche a bit too late to the game?” asked the blog post, which noted that SouFun had already dropped 60 percent in value and 58.com had experienced a similar 50 percent decrease this year.
The conclusions on the downturn in the market are in contrast to news reports earlier this year which said that SouFun was among several online property companies enjoying a rebound of growth.
For example, Bloomberg Technology reported as recently as March this year that due to a combination of government stimulus funding and a growth in the property market SouFun recovered 25 percent on the Bloomberg China-U.S. Equity Index compared to February this year. 
The Deutsche Bank analysis underscores the unpredictability and volatility of the housing market, and suggests that online property companies might need to rethink their strategies for 2017.
China barriers to entry(0)
There remain some challenges for foreign investors in this sector, however. Not least, because :
Earlier this year, for example, one of our clients faced financing difficulties because the SAFE refused to allow conversion of a payment in HKD to the owner of their desired property into RMB.
Another client, who had bought several floors in a building in Shenzhen in 2003-2004 without difficulty, came across new problems this year when they attempted to buy another floor in the property, relating to the name of their company.
Company names must not be overlooked in China. Article 9 of the Implementation Measures on Registration and Administration of Enterprise Names (promulgated on 8 December 1999, revised on 14 June 2004) requires that an enterprise name be in the following form – ?City or Region + Trade Name + Business Sector + Form of organisation?.
In real estate, the choice of business sector is critical. Both the AIC (Administration for Industry and Commerce) and BOFTEC (Bureau of Foreign Trade and Economic Cooperation) require registered capital of USD30m If the term ?Investment? is included in the company name. Companies that cannot achieve this financial threshold must opt for a different nomenclature, as ?real estate property management?.
Under Article 1 of the Regulations on Establishment of Foreign-Funded Investment Companies, if a foreign enterprise or individual intends to purchase property, they shall apply to setup a FIE. Only after obtaining the approval and registration from competent authority can they conduct related activities in accordance with the approved business scope. BOFTEC has to approve the firm?s business scope and according to interpretations by BOFTEC and AIC in recent cases, ?real estate intermediary service? means real estate transaction (sale and purchase), and leasing.
However, when a company engaged in management of property other than its own it must have the special qualification of ?property management?, however, investors can get round this rule and use instead the term ?property management? if it adds also ?management of own property?. It is almost a formula, where the first term is restricted by the second term.
In the end, the best solution for our Shenzhen client was to incorporate a FIE.
Current rules and regulations for foreign investment in real estate(0)
How may the foreign investors operate in the Chinese property market ? There are three entry channels.
Direct investment by foreign individuals
Foreign individuals and some foreign investors directly purchase property without any separate legal entity in China. In other words, they just buy and sell after the property has appreciated in price ? it is estimated that some USD10bn has entered the market in this way in recent years. The Chinese government has realised that this can be harmful to the industry?s healthy development, and such speculation is regarded by the local media and public as one cause of recently rising property prices. The government is also concerned about the possible loss of tax revenues if too many people use this method of investment.
Alternatively, foreign investors could simply become a shareholder in a reputable Chinese developer.
Foreign Direct Investment
Under this model, foreign investors either set up a WFOE as a property development company, property management company, property sale company or property brokerage company, or setup a JV with local developers. It is estimated that some USD6bn has entered the market by this route in recent years, and it is now the government?s preferred option.
Real estate investments made by foreign investors have recently been further regulated by the Circular Jianzhufang 2006, Opinions and Regulating the Entry into and the Administration of Foreign Investment in Real Estate Market, the so-called Circular No.171 issued on 24 July 2006. Foreign investors wishing to enter the Chinese real estate business now have to establish an onshore legal entity in China. This must be either a joint venture with a domestic company that has an appropriate business licence, or establish a WFOE.
The choice will depend on what type of development is involved ? the ?development and construction of ordinary residential houses? falls under the ?encouraged? category for FDI, under the terms of the Catalogue for the Guidance of Foreign Investment Industries, and thus a WFOE is allowed. However, other types of development, notably ?construction and operation of high-ranking hotels, villas, high-class office buildings and international exhibition centres? and ?development of pieces of land? are in the ?restricted? category and require a JV.
The rules also state that foreign property investors have to prove their financial suitability to the authorities and those with a troubled past might be forbidden to engage in real estate activities. This is not unreasonable ! Standards of scrutiny may vary from area to area, however. In addition, local governments are forbidden from offering new incentives to foreign real estate investors and any current illegal incentives have to be corrected.
The new regulation does not allow a ?fixed return? clause in the Articles of Association or JV contract for this kind of enterprise. This provision has already had an impact on a number of projects in China and has reduced values on assets previously offering fixed returns. In addition, if a foreign investor acquires an equity stake of a Chinese real estate enterprise, the purchase price must be paid in full, that is not out of borrowed funds.
Real estate WFOEs have to respect some thresholds regarding minimum capitalisation. When the total investment is lower than USD10m, the WFOE has to be capitalised for at least 50%-70% of total estimated costs of the property investment, whilst the threshold is 50% for higher investments. Until the minimum registered capital is fully paid, Chinese banks cannot issue RMB loans. In addition, the WFOE cannot convert foreign currency loans into RMB. However, despite regulations, foreign companies will probably set up alternative structures in order to avoid such borrowing restraints.
Barriers to entry
Buying, selling and renting property(0)
Once there is change of ownership, both parties should go together to the land bureau to submit documents for the ownership transfer procedures. The bureau also defines the exact borders of the property.
The first table provides a summary of the steps required for an individual buying or selling property, either new from a developer or on the second-hand market.
We discuss financing issues later, but in most cases an individual would need to put down around 30-40% of the purchase price as cash, with the rest funded by a mortgage.
Due diligence is important, as ever in China, like in all other markets – the principle of caveat emptor (?let the buyer beware?) applies here. If you wish to invest in a foreign market, you should pay close attention to examining and understanding the true condition of the property, and/or seek the assistance of a real estate professional before purchasing. There are international real estate agencies and expert valuers in China who can assist you to judge whether the purchase price of a property is fair, and whether it is structurally sound. The more due diligence, the better, as taking legal action if something goes wrong is much more difficult than in countries with more developed rule of law.
You will also need to understand the tax implications of buying and selling, too. You get hit on both sides of the equation ? for details of current tax rates and applicability see below. Rental is still very common in China, of course. Owners are free to choose their tenants, and there are no longer any restrictions on where foreign companies or individuals can rent property (apart from some next to sensitive government buildings). However, tenants should ensure the building they choose has the correct status, whether industrial (for factories), commercial (for offices and shops) or residential (for private homes).
Current rules and regulations for foreign investment in real estate
The status of land in China and the importance of due diligence(0)
State land includes mainly construction land in the urban areas, but also a small amount of agricultural land in the rural areas. State land is the main source of industrial and commercial construction land, and if the foreign investor wants to acquire state land, they must obtain the relevant rights granted to them by the local bureau of the Ministry of Land and Resources. Collective land includes land in rural and urban areas that does not belong to the state, mostly agricultural land with some construction land.
Requisition is the main method of converting collective land into state land. If people who are not members of a village collective wish to use collective land, they must first make an application to the government. If this is approved, the government requisitions the collective land and turns it into state land, and then grants the land to the other party for an appropriate fee. If the targeted land is collective agricultural land, provincial level approval is required for the conversion to industrial land.
At present, most foreign-invested enterprises (FIEs) will build factories on state construction land. There are two channels to get the land use right – land grant contract, that is getting land from the government, and land transfer contract, that is getting land from users other than government.
There are two types of land use rights :
For obvious reasons, granted rights are more expensive than allocated rights. Granted rights mean you can profit from any increase in the value of the land if you develop it, whereas with allocated rights this is not the case. A certificate is also issued demonstrating the owner has legal title.
If you are offered a piece of land, you should conduct proper due diligence. If you need to know what kind of land it is, the easiest way is to ask the landlord for their land certificate. If they cannot provide it, this may mean there is a problem. If this is the case, you need to ask the landlord to provide other supporting documents to prove the land?s status.
Foreign investors should take into account the following issues :
Buying, selling and renting property
Post Registration Matters as a Structural Concern(0)
One of the most common, and most serious, problems with WFOE applications, especially for small businesses, is the issue over registered capital. This is a much misunderstood area. Confusion exists, and many ill-advised investments are made in China due to misinterpretation of the local governments term ?minimum registered capital?. This is meant as a guideline only, and is not supposed to be a ruling on how much you need to invest.
Additionally, there is often conflict here between the local government ? keen on securing another foreign investor in order to meet its targets ? and other government departments, responsible for monitoring and managing China business issues, especially the tax bureau and customs.
It is important to note that tax collection is administered centrally, while the approvals process is at a local level. This means conflicts can and do arise between what the local government says in order to attract your investment, and what the tax bureau then says in dealing with any lack of compliance. And by then it?s too late ? you?re already committed ? and you have no choice other than to go through additional pain and hassle to get things put right, usually involving more investment capital.
In fact, some local government officials are downright reckless when using ?minimum registered capital requirements? as a sales pitch. The amounts they may state may not be in compliance with the actual needs of your business or other government department requirements ? the classic obfuscation that so often blurs the thinking and otherwise competent planning by international investors. There are also many, many consultants out there who are also either blissfully unaware and ignorant of the real importance of registered capital and how to cater for it properly, or downright calculating, knowing that under-capitalisation can drive additional business their way from the unfortunate investor if they play the scenario correctly.
Registered capital is a key issue when structuring your investment and planning its financing ? you need to get this right or face serious problems ? either immediately, or later on. They can be avoided.
Actually, the amount of registered capital needed in the business depends on a number of different factors :
The above steps take between six to eight weeks. If you have already run out of operational money, you by now have not paid staff for two months, your suppliers, and possibly your utilities. In effect, your business has been throttled before it even had a chance to breathe. It is vital you properly capitalize your business in China, in accordance not just with government guidelines over ?minimum registered capital? but also pure economic and operational realities.
Businesses can and do go broke in China because of this issue. Unscrupulous consultants may not always advise on the matter as they seek to gain more fees from you in terms of sorting the problems out when they arrive, or because they are just in the business to make a quick cheap buck out of handling your registration processes without putting any thought into the business aspects of your operations.
Important Registered Capital and Tax Issues That Are Commonly Misjudged
Manufacturing Company :
Trading Company :
You need to ensure, if you fall into this scenario, that you have sufficient registered capital to hand to fund this cashflow gap.
Customs Deposit on Imported Raw Materials To Be Subsequently Exported
Other Government Departments That Require Attention
Administration Matters as a Structural Concern(0)
Here are some of the key articles and issues that need to be identified.
Scope of Business Article
Production Scale Article
Total Investment Article
Board of Directors Article
General Manager Article
Profits Repatriation Article
Trade Union Article
All companies in China have the right to form a ?grass roots? labour union if there are at least 25 employees (including foreign workers). This structure is part of a massive national reporting and monitoring union that has its ultimate powerbase firmly within the National People?s Congress, so this is a powerful organization.
If a union is formed, then the elected representative has the right to attend company management meetings, and the company must fund also the union, with 2% of all employees? salaries, each month (staff must also make a small contribution). It is not uncommon for these funds to be misused, and for the union representative to become a bit of a nuisance as well. Funds should be used for workers education, welfare and entertainment, and many of the factory basketball courts you see in China have been funded in this manner. Funds may also be used to provide legal support to employees with grievances against the company.
Management interference can be minimized by restricting the union representative access only to the portion of meetings during which staff and workers rights are to be discussed, while budgets for the use of union funds can also be agreed upon and implemented. We recall a case a few years ago when union funds were used to buy the representative air conditioning at his home and a car !
Mergers & Acquisition Articles
Post Registration Matters as a Structural Concern
Operational Matters as a Structural Concern(0)
For services, there are many structural options. However, for entities such as these, no tax holidays are available. This means you are liable for profits tax from the first year of operations ? and that means tax planning is needed at the pre-incorporation stage to work out how legally to minimize this. Trading FICE also need proper investments for working capital ? have you considered all your working capital needs ? Issues such as registering a bond with the customs bureau for initial imports – often for the first 6 months of trading – also need to be considered. Or how to apply for VAT rebates on export ?
WFOE Applications – Manufacturing
These and many other questions start to bite when looking at manufacturing in China. Of particular consideration are the arrangements that need to be made if you are generating income ? that puts you firmly into the Chinese tax payer bracket and you need to know how to deal with this to your best advantage.
Location Issues as Pre-Investment Planning
Land Use Rights
Administration Matters as a Structural Concern
Customizing your China wholly foreign owned enterprise(0)
Yet recently, a slap-dash, ?cookie-cutter? approach to structuring such entities has become increasingly prevalent, and more than ever before, we are having to bail out increasing numbers of foreign investors by revising documents or even completely restructuring the investment.
While this on one hand is good news ? we make money out of handling client difficulties ? the reality is no professional firm likes to see such problems, and it is expensive and unnecessary for the investor to have to go through this pain, when all that was needed was more attention to detail. We prefer to see happy and successful international investors with profitable businesses. There is no reason why the current spate of shoddily-invested businesses should have begun to appear over the past couple of years. After all, WFOEs have been around since April 1986, and the first regulations to manage them appeared over 20 years ago.
However, in the rush to get into the China market, many consultants, investors and other so-called ?experts? have been advising, or have been advised, in a poor and simplistic manner. The quality of some recent work from some of the new-to-China international lawyers, professional services firms and other consultants has left rather a lot to be desired. Equally, international businessmen themselves have still shown themselves to be incredibly naïve on occasion when it comes to dealing with business operations in China.
Cheap advice is just that. Do your research?professional firms are there for a reason ? depth of knowledge and understanding of China business and operational quirks and idiosyncrasies. As we shall demonstrate, investing in China requires a great deal of attention to detail. In this article, we shall provide tips as how to make your investment work for you ? save more money, make more money, and get the most out of your investment dollars. Your investment needs customizing to get the most out of it.
A BRIEF HISTORY OF WFOE STRUCTURES
However, from about seven years ago, that began to change. Local governments, seeing investment opportunities from the international services industry, began to interpret the ?manufacturing? aspect of the WFOE law in increasingly ambitious ways, permitting the regulations to include executive search firms, maintenance businesses, architects and so on.
There were problems with this. Firstly, the implementing rules didn?t actually support such applications. Customs, the tax bureau, and various other government departments were at a loss with how to treat a services firm under a manufacturing regulation. The central government, caught between giving local government?s foreign investment targets to meet, yet not really recognizing the services industry, ended up with many anomalies and absurdities.
There were problems with foreign investors too, and increasingly, amongst the bona fide manufacturers. Limited to sales in China of their own manufactured product, they found they were barred from importing and distributing spare parts from overseas, as that was considered a service. Products broke down. Getting spare parts through customs was a nightmare. Invested manufacturers started to grumble. End users found themselves with unserviceable machinery. Meanwhile, architects and headhunters amongst other service industries ignored the rules and poured in, under the dubious guise of ?building contractors? and even ?human resource advancement producers?.
This mess continued for some time ? an unholy pot-pourri of trying to get service business scopes into manufacturing recognition, and a stand off between local governments wanting to approve service licenses and the central government not having the supporting legal infrastructure, let alone the political problems with allowing foreign investment into the domestic services industry.
But in summer 2004, China finally unveiled its long?awaited regulations for the provision of ?Foreign Invested Commercial Enterprises? (FICE), which took the heat off the somewhat abused WFOE law and catered, in full, for international investment in the service sector.
Operational Matters as a Structural Concern
Putting Them In Control Of Everything
Is it normal business practice ? anywhere – to have one person in control of all aspects of your country operations ?
No, it isn?t. And with very good reason :