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Bidders, please be rational: China land hunt sparks price surge

[SHANGHAI] In a tower with a golden facade that the local government uses as a venue for land auctions near Shanghai's business district, a dozen Chinese developers were involved in a frenzied bidding war in October. Within 25 minutes, they pushed the price of a plot of land an hour's drive from the city centre almost 50 per cent higher.

"Everyone, please be rational in bidding," the auctioneer cautioned.

The warning fell on deaf ears. Almost 100 bids and four warnings from the auctioneer later, the 1.4 million-square-foot plot was sold for 7.3 billion yuan (S$1.6 billion) on Oct 25 to Cinda Real Estate Co, almost double the asking price and setting a record in the financial hub's suburban Yangpu district.

Developers anticipating rising home prices are driving a surge in land costs in Beijing and Shanghai, where prime plots are scarce. With returns at the lowest in six years, that's a wager they can ill afford: At current land prices, profits will be squeezed even if home values continue to rally, according to one of China's biggest property companies.

'SIMPLE MATH'

"If you do the simple math, you would know you'll make a loss even if home prices in Beijing and Shanghai are to rise another 50 per cent," Sun Hongbin, chairman of high-end residential developer Sunac China Holdings Ltd, said Jan 5.

That is why Sunac last year focused on second-tier cities where land is more affordable, he said. "Risk control is becoming truly crucial for us," Sun said, adding that Sunac will only buy land in Beijing and Shanghai if prices fall.

Developers' margins have been under pressure amid a nationwide property slowdown, which the government is seeking to turn around through interest-rate cuts and easing credit. Return on equity, a measure of profitability, at 20 of China's biggest developers tracked by Bloomberg Intelligence declined to 14.1 per cent in the first half of 2015, the lowest level in six years, the latest available data show.

Still, developers are betting that easing measures by authorities will spur home prices, especially in the biggest Chinese cities. New-home prices climbed in 39 Chinese cities in December, compared with 33 in November, among the 70 cities tracked by the government, the National Bureau of Statistics said Monday. Home prices in Shanghai rose 1.9 per cent last month, and prices in the capital city of Beijing advanced 0.4 per cent.

BIGGEST COST

In both Shanghai and Beijing, land cost increases outpaced home price gains by a wide margin last year, according to official data.

That means developers intent on expanding there must further sacrifice profit margins that are already at the lowest since at least 2009, according to Bloomberg Intelligence.

"It would be the biggest headache for developers when the land prices grow faster than home prices," Eva Lee, a Hong Kong-based analyst at UBS Group AG, said. "If a developer invests in super-costly land in first-tier cities, its gross margin could be squeezed in 2016 and 2017."

Land is the biggest cost for developers, taking up about half of what they can sell homes for in Beijing and Shanghai, realtor China Real Estate Information Corp estimates.

BACKING OUT

Some developers are getting cold feet. Major Hong-Kong listed builders tracked by Citigroup Inc on average spent 27 per cent of their contracted-sales revenue to replenish land from January to October last year, compared with 41 per cent in 2014, according to a Nov 23 report.

In November, state-backed China Resources Land Ltd and China Merchants Land Ltd backed out of purchasing a site in Beijing, and Country Garden Holdings Co also decided not to buy two sites in the capital after final prices exceeded budgets.

While larger developers are becoming more mindful of costs, smaller builders continue to amass land. Chongqing-based Longfor Property Co spent 38 per cent of its contracted sales revenue to expand its land bank in the first 10 months of 2015, according to Citigroup. It paid 4.7 billion yuan for a suburban Shanghai plot last month even after its gross margin and return on equity narrowed in the first half.

Almost all the land acquired by Cifi Holdings Group Co in the first 11 months of 2015 was in first- and second-tier cities, increasing the developer's total debt by 70 per cent to 24 billion yuan by the end of last year, Fitch Ratings said in a Jan 7 report.

Longfor, which acquired more than 20 plots last year, said the purchases were "highly focused" in first- and leading second-tier cities, which enables it to support future gross margins, according to an e-mailed statement. Representatives at Cifi didn't return calls seeking comment.

There may be little reprieve even for developers looking beyond Beijing and Shanghai. In the fourth quarter, land sales values in regional capitals surged 38 per cent from a year earlier and jumped 32 per cent in third- and fourth-tier cities, according to Mr Lee at UBS.

"Developers need further home-price recovery to support higher return on equity," said Wang Yi, a Shanghai-based analyst at Goldman Sachs Group Inc.

BLOOMBERG