Real estate reality check

“Sometimes I think I am very lucky. I made mistakes when I was young, or at a time when I still had the chance to make amends,” Sun Hongbin told Global Entrepreneur magazine in an interview in 2010. Then only 47, Sun added that the successful IPO of his property company Sunac wouldn’t have been possible without the failure of Shunchi, his first venture in the real estate sector, three years earlier.

One of the earlier mistakes that Sun was referring to was the aggressive way he grew Shunchi. Founded in 1994, Shunchi had threatened to become China’s biggest property firm in the subsequent decade – but much of that growth was fuelled by debt that was piling up at an equally rapid clip. Sun was also tipped for the title of China’s richest man, after announcing his goal that Shunchi would overtake Vanke as China’s biggest homebuilder. His ambition was stratospheric. The industry leader was making less than Rmb7 billion ($968.52 million) in sales a year in 2004 but Sun said that Shunchi could top Rmb100 billion in revenues by 2007.

But Shunchi didn’t make it that far. Several rounds of policy tightening created a liquidity crisis in the sector and Sun was forced to cede control of his company to Hong Kong infrastructure firm Road King.

Also on the brink of collapse at that time was Sunac, a separate firm that Sun had created in 2003 to manage a series of joint venture projects. Sunac survived the crunch thanks to a $200 million lifeline made by Lehman Brothers in 2007 (ironic, given that Lehman would go under itself soon after).

Foreign investment firms were trying to get more access to China’s property market and Lehman’s Asia team was betting on Sun to turn his fortunes around. “The biggest asset of your company is the many mistakes and hefty losses you’ve made. And you never give up. What we are investing in is a comeback story,” Lehman is said to have told Sun, according to remarks by the property mogul in the same Global Entrepreneur article.

Sun’s business did survive and he grew Sunac into one of the country’s biggest developers in sales terms, often by taking control of firms floundering in financial trouble themselves.

But the strategy saw Sunac run up spectacular liabilities of its own, putting it in a position in which it seems to be heading for a similar fate to Shunchi all those years ago.

What’s been happening at Sunac in the last few weeks?

News broke on October 27 that a safe that Sunac shares with local trust firm Zhongrong – the custodian of funds related to two of Sunac’s major residential projects in Wuhan – had been broken open.

According to news website Jiemian, someone stole the business seals and supporting documentation needed to facilitate as much as Rmb1.56 billion in subsequent transfers. The bulk of the money was channelled into bank accounts controlled by the Wuhan government, with a minor amount transferred to Sunac to pay off a debt to a construction company.

Zhongrong confirmed that it had already reported the matter to the police. When asked about the situation, Sunac tried to focus attention on directives from the central government that stated local governments be held responsible for ensuring completion of construction on housing projects mothballed by cash-strapped developers. The Sunac company funds in question had been managed in a way to comply with strict requirements set by the Wuhan government, Sun’s firm insisted.

The response insinuated that the local government was involved in the case – at least in giving an implicit nod to the cash transfers – in order to protect the buyers of Sunac’s unfinished projects in Wuhan.

In doing so they may have damaged the interests of Sunac’s other creditors. Bloomberg reported this month that Sunac is one of at least six property firms facing winding-up hearings in Hong Kong in the next few months. These actions could result in the forced liquidation of property giants like Sunac and the even more indebted Evergrande. Such a threat has seen a number of local governments freeze the bank accounts of the most over-leveraged developers (many of which have relied on presale payments for unfinished condos for their operating cashflow).

The risk from the local government perspective is the total collapse of the most stretched developers, with senior creditors getting first grab at whatever is left of their financial resources.

City officials are then left with the double disaster of local neighbourhoods that are dotted with “rotten-tail buildings” – property projects that haven’t been completed – and angry homeowners demanding their money back as a result of the defaults on home purchase contracts.

In a similar vein, Evergrande stunned investors in March this year by announcing that about Rmb13.4 billion of cash held by Evergrande Property Services, its property management unit, had been seized by banks as security for third-party pledge guarantees.

Trading in the shares of Evergrande and Sunac, both of which had defaulted on offshore bonds earlier this year, has since been suspended in Hong Kong as shareholders wait to see whether a white knight might ride to the rescue of two of China’s biggest developers.

Sun, the rescue specialist…

There are few businessmen more experienced than Sun in assessing the value of distressed assets in the real estate sector. Or, perhaps, the trustworthiness of property bosses mired in debt trouble.

Over the last 10 years the 59 year-old has bailed out a number of financially troubled firms – so much so, in fact, that analysts have come to regard Sunac’s skills in taking control of distressed assets as its core commercial edge.

Sun’s track record as a serial white knight can be traced back to June 2014, when Sunac agreed to acquire a controlling stake in Greentown, which was sitting on one of the most valuable land banks in the financial hub of Shanghai, for about Rmb6.3 billion.

Sunac’s intervention gave Greentown some breathing space to stave off a liquidity crisis, although its boss Song Weiping later decided to part ways with his rescuer.

Song eventually bought back most of Greentown’s stake at a premium, although Sun held onto a few of Greentown’s best assets, including a joint venture project with Sunac.

Some in the sector thought Sun had been treated poorly when the deal unwound with Song, but the arrangement made Sunac’s name in a frenetic industry. Less than a year later, Guangdong-based developer Kaisa admitted that it was on the brink of going out of business too. Sunac stepped in again, agreeing to acquire a 49% stake in Kaisa, which owned the rights to develop some of the largest urban renewal projects in Shenzhen, for about $585 million.

Sunac was then forced to scrap the takeover bid, however, after Kaisa’s offshore bondholders objected to the restructuring plan.

Something similar happened in 2015 when Sunac mooted a potential bailout of Yurun, a pork processor with some valuable real estate assets.

Sunac walked away from these two lapsed deals relatively unscathed. However, it was scarred two years later when it intervened in the financial implosion of LeEco, the media-to-electric vehicle conglomerate founded by Sun’s fellow Shanxi native Jia Yueting.

In early 2017, Sun surprised the market by ploughing Rmb15 billion into various units of Jia’s debt-laden group. But the investment ended disastrously as Sunac wrote off most of its capital injection within a year and Jia fled the country.

“I’d never had any regrets in my entire life until I invested in LeEco,” Sun told a press conference in Hong Kong, fighting back tears.

The fiasco saw Jia become one of the leading examples of a laolai, a person blacklisted by the Chinese courts for defaulting on their debts. Incredibly, Jia soon found another backer while he was in the US – turning to China Evergrande. The latter’s investment in Jia’s latest idea – electric vehicle venture Faraday Future – was supposed to form the basis for Evergrande’s boss Xu Jiayin’s own EV start-up, through which he hoped to broaden his company’s business.

The setback with LeEco did not seem to deter Sun’s enthusiasm for bailing out companies in trouble. Also in 2017, Sunac brokered arguably the most groundshaking deal yet in the Chinese real estate market. The party in trouble this time was Wang Jianlin, another tycoon that has held the title of China’s richest man at various points in his career.

Sun again stepped up, announcing a massive investment in which Sunac would take over the bulk of Wanda’s real estate assets. Sunac splashed Rmb44 billion to assume control of 13 mega ‘cultural-tourism projects’ from Wang’s Wanda, while Guangzhou R&F would acquire 76 hotels from the Dalian-founded conglomerate.

The bailout rescued Wanda from disaster. After shedding the majority of Wanda’s real estate assets – and the capital commitments required to develop them – Wanda boss Wang was later described as “the happiest tycoon” in the sector, especially as most of his former rivals started to feel the effects of the central government’s remorseless efforts to deleverage the sector.

The impact of the deleveraging campaign, which has made it much harder for China’s property firms to find new sources of financing, has put companies like Guangzhou R&F in peril, for instance. Nor did it help that R&F had risked much of its remaining cash trying to remake itself as China’s biggest hotel operator just two years before the tourism sector was ravaged by the Covid-19 pandemic.

To stay afloat the Guangzhou firm has been forced to sell its coveted property management unit, as well as trying to offload a few of the five-star hotels it acquired five years ago.

For Sunac, things had looked a little rosier in the period following the mega deal with Wanda. Sales from the so-called ‘cultural-tourism projects’ (typically theme parks and exhibition centres coupled with exclusive residential complexes in scenic areas), lifted the company towards the top of the rankings as a best-selling developer. Contracted home sales rose from Rmb73.4 billion in 2015 to nearly Rmb600 billion by 2020, which was a comparable performance to that of the ‘Big Three’ in the industry: Country Garden, China Evergrande and Vanke.

Emboldened, Sunac expanded into movie-making as its involvement in the cultural sector deepened. But one of its first major investments – in the highly anticipated Born to Fly, a film modelled on Tom Cruise’s Top Gun – was pulled from the lucrative National Day holiday period at the last minute.

Now it is Sunac that needs rescuing?

Sun’s readiness to get involved in the rescues of floundering companies has seen his company nicknamed ‘The Fifth AMC’, a reference to the big four state-run asset management firms (AMCs) – which include Cinda and Huarong – created to mop up the soured assets of state lenders. (In the fund management industry, there’s also a saying which goes that investment cycles in Chinese companies go through “seed-round, angel-round, pre-A round, A-round, B-round, C-round, D-round, BAT-round, IPO-round and the Sun Hongbin-round”.)

A report in the Hong Kong Economic Journal in 2018 claimed that nearly 70% of Sunac’s land bank was acquired through M&A with other companies, for instance, while it had also been active in bidding at land sales hosted by local governments.

Sunac might have been expected to take a step back in the summer of 2020, when the central government launched the ‘three red lines’ policy that has restricted developers from raising more debt. Yet it actually seems to have stepped up its spending. In the first half of last year alone, Sunac splashed nearly Rmb100 billion on land acquisition, Jiemian reckons. The spree increased the company’s debt to about Rmb1 trillion – still only half that of Evergrande, but with a gearing ratio that’s just as eye-popping.

Commentators have been wondering why Sun didn’t slow down when sentiment was darkening. One possibility is that he regarded the changing mood as a commercial opportunity – and that despite his setback with Shunchi, Sun hadn’t given up on the ambition of heading China’s biggest property firm.

Another possibility is that he thought he could call in favours if the financial situation became too fraught. When Sun ceded control of Shunchi to Road King he salvaged little from the firesale. But the deal did win him a reputation among creditors, especially the state banks, as Shunchi stayed afloat. Some of his later rescue bids would have kept lenders happy too. Might some of those banks and PE firms be prepared to return the favour and throw him a lifeline now? Or will a man with a reputation for bailing out fellow billionaires prove unable to rescue his own company?

His personal wealth has already taken a hit. When the Hurun Rich List was announced this week, Sun had fallen more than 100 places down the billionaire ranking to 287. He may drop further down the list.

In the meantime, Sunac is readying itself for a winding-up petition in Hong Kong, with a court hearing scheduled for November 16. The likelihood is that more property firms could soon be in a similar situation. The auditors of at least 14 mainland developers listed in Hong Kong have resigned this year and several property firms are still to publish their long-delayed financial results, reports Reuters.

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