Making sense of nonsensical land prices

August 3, 2016 / By  

The cost of staying in the game

What does RMB 45.6 billion or the equivalent of USD 6.8 billion buy you in China these days? Not much actually, and the answer is just two pieces of undeveloped land in Shenzhen.

The inflation nonsense goes on with Gemdale Group outbidding 20 rivals on July 27, when it paid RMB 8.8 billion (USD 1.3 billion), or an eye-popping 286 percent premium over the reserve price, for a 140,252 sqm site at Shanghai’s Pudong area. Two weeks ago, Future Land Development paid RMB 3.7 billion (USD 554 million), or a 77 percent premium, for 19,959 sqm of land at Shanghai’s Hongkou district. The list goes on with land auction prices in other cities going through the roof, as developers are betting strong demand will continue.

Using Gemdale as an example, it paid the equivalent of RMB 33,000 per sqm of buildable area for the land that is 48 kilometres away from downtown Shanghai. To cope with local regulations, Gemdale is required to set aside 20 percent of the homes built for the government’s affordable housing programs. Doing the math, this translates to a cost per sqm of buildable area of about RMB 41,000. Add in the construction costs and other expenses, Gemdale will need to sell its Pudong property for about RMB 60,000 per sqm to make a decent profit, which is more than double the price compared to second-hand homes in that area.

What is fueling prices?

So what’s causing developers to irrationally outbid each other?

For one, compared to oversupplied ghost cities, the risks in tier-one and some tier-two cities are relatively low and developers are still willing to make bets. Based on China’s National Bureau of Statistics (NBS), the value of total new homes sold in 1H16 reached RMB 4.2 trillion (USD 626 billion), which is a 44.4 percent year-on-year jump. With property demand remaining strong, to stay in the game, overpaying becomes a non-issue.

Another reason is the low cost of funding. Back in February, with aims to increase liquidity, the People’s Bank of China (PBOC) unexpectedly cut banks’ reserve requirement ratios (RRR) by 0.5 percentage point. Combined with the previous RRR cuts, this has effectively flooded the market with money, a key reason why developers are enjoying a low cost of funding, paying less than 5 percent on the principal borrowed.

Finally, as private capital is receding, state-owned enterprises (SOEs) are stepping up. According to NBS, total fixed asset investments in 1H16 reached RMB 25.8 trillion, or a 9.0 percent year-on year gain, of which state-sector fixed asset investments rose 23.5 percent from a year earlier, and private sector growth was a mere 2.8 percent. This partially explains why over half of the most expensive land auctions in 1H16 went to state-owned developers.

All said, until policies that result in credit controls or higher interest rates are imposed, the spending spree of the developers will likely continue. For now, investors can sit back, relax, and enjoy the show while it lasts.

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