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Annual Conference 2014, Boao Forum for Asia Session Summary Session 27 April 11, 2014 Real Estate: From Administrative Control to Market-Oriented Reform Moderator: WAN Li, Xinhua News Agency Panelists JIA Kang, Director, Research Institute for Fiscal Science, Ministry of Finance LI Xiaoming, President, DESEA Investment Holding Group Co., Ltd LIU Xiaoguang, Chairman, Beijing Capital Land Co., Ltd Chris MARLIN, President, Lennar International ZHANG Yuliang, Chairman, Greenland Holding Group Key points: Property tax implementation is likely to factor in the length of ownership and to exempt basic living space requirements. A rule for extension of land use rights is recognized as needed to reassure owners. Any future decline in real estate markets will vary by market segment, but the government will likely act if a broad-based downturn is too steep. City complexes are defended as stimulating both consumption and job creation. Some real estate developers may consider investing in financial services, but only where profits are attractive. International expansion is about internationalization, not abandonment of domestic markets. The expert panel addressed many pressing issues for Chinese investors. Moderator WAN Li of Xinhua News, referring to the Chinese government’s shift toward market-oriented reform, asked Mr. Jia Kang of 1 the Ministry of Finance to speculate on what steps would be taken in real estate policy. Mr. JIA focused on the shift from administrative control to market reform (which he later reiterated as “a dominant role for the market”); property tax reform (“as soon as possible”); and steps to increase homeownership for low-income households. On the third item, he advised that 66 million affordable houses should be built. People should own, not rent their homes; and should be incentivized not to immediately sell their homes. Property tax implementation In response to whether property tax might increase the tax burden, and what relevant rules might be enacted, Mr. JIA replied that the property tax and the fee will be merged. The fees will be reduced through reduction of the transaction fee as well as of commercial and property taxes. The length of time in which the property is held will decide the sales tax rate. During the holding period for high-end residential apartments, the tax rate should increase with the size of the apartment. Mr. JIA argued for equitable application of property taxes to owners. Although the tax burden will not be high in the foreseeable future, property owners should pay the tax. Irrespective of income levels, exemptions will apply to the first property, however, the excess value of high-end property and other second properties will be taxed, although there are measures to exempt a certain proportion of space or area as measured in square meters. Residential markets There were some diverse views among the panel on the outlook. Mr. LI Xiaoming, President, DESEA Investment Holding Group expressed confidence that housing development will progress stably and soundly. He supported the view that the overall price level is being supported by distinctive factors in each location that are driving real estate purchasing decisions nationwide. He also challenged the notion that a steep decline is inevitable, doubting that the government would allow a steep price fall, in consideration of the likelihood that property-owners would default on resulting underwater loans, and 2 would not be satisfied with a hands-off government policy that allowed such loans to default. While Mr. ZHANG Yuliang, Chairman of Greenland Holding Group, did not advocate government intervention in the event of a precipitous decline across markets, although he regards such a broad-based decline as unlikely. Specifically, Mr. ZHANG did not rule out sharp declines in some markets depending on market segmentation, but he believed that areas with large populations would not suffer serious price cuts, especially those with dense clusters of services. However, he did not expect prices to rise as rapidly as in 2013. In ex-urban areas such as the Fifth Ring Road in Beijing, last year’s price increases of 50% have pulled forward real estate demand, but that demand would not be the basis for the next price increase. On the issue of oversupply, Mr ZHANG believed a price reduction of 50% was possible where supply was already excessive and out of balance with employment and purchasing power, especially in regional cities. Additionally, restrictive measures by the People’s Bank of China (PBOC) could reduce liquidity in the residential loan market. If the PBOC were to require commercial banks to reform their policies, these banks would size up the cost of loaning money, and find other projects that would offer them a better return with the result that commercial loans would draw money away from the residential market. Mr. LI saw market segmentation rather than specific districts and regions as the key factor, and whether the location of the property was well supported by services and amenities. Mr. LIU Xiaoguang, Chairman of Beijing Capital Land, observed that the health of the industry can only be assured when investors have learned to look at the differences between and within residential and commercial real estate properties, and the specifics of different properties, resources, and services. Chris MARLIN, President of Lennar International saw the situation as similar to the U.S., where the most in-demand, land constrained markets—San Francisco, New York City, etc.—did not experience depreciation as extensively as in other parts of the U.S. He added that real estate prices in these markets have bounced back strongly from their lows. Among the local market factors that Lennar looks at when investing, job creation is especially important and it is targeting its investment in areas 3 where jobs are being created. Mr ZHANG concurred that China’s central government is increasingly aware of this dynamic. Diversification into financing The panel also looked at the matter of recent share purchases in banks and financing channels by real estate developers. Mr. ZHANG replied that real estate companies have a strong presence in the financial sector. Investment banks are very profitable, and real estate developers want to invest in these banks. He noted that each company’s situation is different, and that they all face different considerations when investing in banks. Mr. LIU was concerned that developers' interests in investing in banks might be to expedite financing, and that it would be more appropriate for them to invest in mortgage banks. Mr. MARLIN noted that the practice of real estate developers investing in banks was not favoured in the U.S. although developers would have benefited from access to banks during the downturn. Mr. MARLIN also mentioned the critical role played by the Federal National Mortgage Association (FNMA or “Fannie Mae”) and the Federal Home Loan Mortgage Corporation (FHLMC or “Freddie Mac”) in supporting home finance in the U.S. through low-cost incentives, without which mortgage companies in the US could not have survived. City complexes enable China’s shift to consumption The panel was asked to consider the oversupply of city complexes, and the growing number of ghost cities and cities which lacked services. Mr. LIU defended his company’s strategy of focusing on such complexes, pointing to post-war real estate development in the U.S. as an example to follow. It took the US half a century to supply homes to 200 million people. China's challenge of catering to many more people should be considered in this context. He also pointed to the transformation in Chinese shopping habits over the past two decades as an example. In contrast to earlier times when people went to shops to make necessary purchases, nowadays going to the shopping mall is a social as well as functional event which may include a restaurant, a movie, karaoke, or children's activities. In many cities, the city complexes that offer these services are still just being developed, and their creation would give rise to job creation which might mitigate the societal damage that had resulted from compensating farmers for expropriation of their property without providing the means for their employment. 4 Mr. ZHANG told of being personally invited by many governors and ministers from overseas nations, each with the intent of attracting investment to their countries, but advocated that the Chinese government should turn inward, taking up the responsibility of nurturing the environment for industry. City complexes, he said, could be very helpful in this respect. Using the US as an example, Mr. Marlin described the redevelopment of the decommissioned Hunter’s Point military base in the city of San Francisco, which had for 40 years sat unused, generating a blighted neighbourhood. Lennar entered into a partnership with the government which gave Lennar the land in exchange for a commitment to redevelop the neighbourhood. The deal included bond issuance and sharing of the tax benefits with the residents of that neighbourhood. While the scale of this investment is unusual in the U.S., it is not uncommon at all in China, and while there may be approaches that can be adopted, China should ensure it customizes it approach for its particular circumstances. Optimism for international expansion The final area of consideration was overseas expansion. Mr. ZHSANG described China Greenland’s recent investments and outlook on the future, reporting investments in nine countries. He expects RMB 20 billion in revenue this year and RMB 40 billion in the next, but emphasised that it was not abandoning the domestic market, and was an extension of its business, in line with the trend of Chinese companies globalizing and, as such, China Greenland is not restricting its investments to cities popular with Chinese travellers, will need to set up an international team, find international partners, and generally co-operate well with other markets. This will take time and there might be friction that needs to be addressed but the company is very optimistic about overseas markets. Openness to extended land use During the question-and-answer phase following the session, one audience member asked whether the land-use period might be extended to promote long-term investment. Mr. JIA answered that after the land use right expires, it can be extended. Government will not confiscate the building. However, it will be necessary to certify continued use, so that the owners who have bought houses now can put their minds at ease. Acknowledging that a rule for extension is needed, Mr. JIA said that the 5 Ministry of Finance would push forward this logic, and deal with any uncertainties. 6