Hedging their bets

Dispute points to trouble in the property sector

Hedging their bets

Long way down: but China's builders hope slump won't last

Few things smell worse than a Chinese public toilet, but the mainland’s property market is currently making some investors feel equally queasy.

After a decade of double-digit growth, the property sector has taken a downward turn. To jumpstart consumption, the government has lowered mortgage rates, reduced downpayment limits and cut transaction taxes. Sales have picked up in some locations since then, but the country’s property market is still plagued by a larger problem, namely oversupply.

Based on analysts’ forecasts, the country still has 14 months of excess supply of residential housing to work off. Beijing, way over the country’s average, is sitting on 26 months of supply; Chengdu has 29. Half-finished construction is everywhere. New projects are being put on hold.

The recent difficulties have put enormous pressure on China’s property developers and many of their foreign partners. Agile, the Hong Kong-listed mainland property developer is currently in dispute with Aetos, a US-based hedge fund, which invested Rmb1.2 billion ($175 million) in an equity stake in a Huizhou development called Huizhou Bailulu. This project was to be developed by Agile.

The original plan was signed in November 2007 with Agile to hold 75% of the Huizhou Bailuhu project and Aetos to hold the remaining 25%. However, Aetos is now demanding its money back plus accrued interest. Why exactly has not been made public by Aetos. But in an announcement posted on the Hong Kong Stock Exchange’s website in January, Agile claims that Aetos’ refund demand is “wrongful and invalid” and has commenced arbitration in Hong Kong, in line with the initial partnership agreement.

According to an article in Caijing magazine, Aetos wants out because the project faces rising risk in a slumping market. Industry observers expect similar disputes, with foreign hedge funds and private equity firms weary of waiting for the market to turnaround.

Things weren’t always so hostile. In the good old days when the property market was thriving, foreign banks and private equity groups were investing billions of dollars in Chinese property developers and glistening real estate projects. Mainland developers who had snapped up land were desperate for cash to build more houses. It was a perfect marriage. “In a bull market, there is a lot of room for hedge funds to manoeuvre due to a huge demand for hot money,” a foreign investor said to Caijing. “Things are totally different now. Hedge funds are in a quandary, facing angry clients and trapped investment.”

As the property market in China continue its downward spiral, market observers reckon that foreign institutions will start demanding more of their money back. If successful this will further exacerbate the developers’ problems.

One possible outcome: the current downturn could prompt a wave of mergers and acquisitions, in which smaller cash-strapped developers are absorbed by larger firms. China has hundreds, if not thousands, of residential developers in what has traditionally been a very fragmented industry; consolidation is long overdue.

Already, Soho China – a high-profile Beijing developer – has secured a Rmb10 billion five-year loan from Bank of China. The money will be used to finance potential mergers and acquisitions, says China Daily. With property values declining across the country, there should be plenty of bargains to be had.

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