chinese-developer-seeks-private-equity-investment

Chinese developer seeks private equity investment

Focus on second tier cities and cost control gives Xinyuan Real Estate a unique perspective on the government's efforts to reform the property market, chairman says in interview.
This weekÆs announcement of another round of government policies targeted at ChinaÆs property market may have spooked some equity market investors, but mid-sized developer Xinyuan Real Estate, which is currently on the road seeking private equity investors, is not worried.

ôThe new measures actually work in our favour,ö company founder and Chairman Zhang Yong tells FinanceAsia in an interview.

The reason for his optimism is the companyÆs strong cost control and the efficient asset turnaround that he says gives Xinyuan an edge over its competitors. But the companyÆs focus on building homes for mid-income earners in ChinaÆs second tier cities also fits nicely with the governmentÆs aim to increase the supply of small- and medium-sized housing to meet the rapidly growing demand in these cities - while at the same time trying to hold back soaring prices and limit speculative buying in the larger markets.

Its focus also sets, the company aside from most of the Chinese devlopers listed in Hong Kong, which tend to focus on residential or commercial developments in larger cities like Beijing, Shanghai or Guangzhou.

In the years between 2000 and 2005, approximately 20 million people moved from rural areas into urban centres every year with Tier II cities being a major magnet for this flow, according to the National Statistics Bureau. Another 100 million people are expected to follow the same path in the five years to 2010, which will create a demand for about 370 million square metres of housing in each of those years.

Xinyuan estimates that this will translate into a need for 1.5 million additional apartment units per year in Tier II cities, which typically have between 3 million and 7 million people. Henan's provincial capital, Zhengzhou is at the upper end of the scale with a population that now exceeds 7 million and is expected to reach 8 million by 2010.

ôThere are a few dozen Tier II cities with huge growth potential in the real estate sector,ö Zhang says, adding that these cities also have a ôhugeö supply of land with a few thousand pieces being auctioned by the local governments every year û an opportunity the company will continue to exploit.

All of XinyuanÆs existing projects are located in Zhengzhou City, and includes three already completed condominium communities with a total of more than 4,400 units, and four developments at various stages of construction which will add another 6,000 units.

It is now ready to replicate its business model in other Tier II cities and after conducting feasibility studies on 10 potential cities it has settled for three where it plans to start operations in the second half of this year. One of those is Jinan in Shandong Province where it has already acquired a piece of land.

Once it starts, the expansion is expected to be swift and the company projects it will see a 100% increase in revenue every year for the next five years from $61.5 million in 2005, supported by its clear growth strategy, strong management team and a high level of corporate governance and internal controls.

ôWe are very confident that we can achieve our goal, which is to become one of ChinaÆs Top 20 real estate developers within five years and to become top 5 within 10 years,ö Zhang says. A report published earlier this year by the state council and Tsinghua University put it among the top 100.

At the moment, no single developer has a 10% market share in Tier II cities, and most of them are only at around 5%, which means the competitive environment is fairly open.

ôWe expect there will be developers who can achieve a 10-20% market share within the next five years, but that will allow us enough time to be one of them,ö Zhang says.

Among the new policies announced this week, the government said it will confiscate land that has been lying idle for more than two years, which means it will be more difficult for developers to sit on a huge land bank and wait for property prices to go up before building anything. Especially since all land in China is now sold through a very transparent auction process.

ôThis means you cannot gain margin appreciation purely from land appreciation (and) in the future only those who have a strong ability to control their costs can excel in the market,ö Zhang says, noting that XinyuanÆs land development costs are about 5% lower than the industry average thanks to cost controls throughout the entire process from construction to sales.

ôThat is how we differentiate ourselves. Meanwhile, those developers who have reserved a land bank for a long period of time will face the possibility that the government will withdraw the land and could suffer losses that may be huge or even disastrous,ö he adds.

Xinyuan, on the other hand, which describes itself as an asset-light developer, aims to start construction shortly after it acquires the land. On the six pieces of land it has bought over the past two years the spade has been put into the ground within four months and on its completed three projects the time between land acquisition and key turnover has been only 14 to 18 months. The company has also consistently sold most of the units by the time construction is completed, ensuring a high efficiency in capital employment.

The quick asset turnover is resulting in a high return on equity, which in 2005 stood at an impressive 81%.

XinyuanÆs cost efficient development style and reproducible designs have also seen its net profit expand at an 87% compound annual growth rate since the company was founded in 1997 to $9.5 million last year and has propelled the company from a ranking as the 50th largest developer in Zhengzhou in 2000 to the number one spot in 2004 û a position it has since retained.

According to Zhang, his background as a university-educated construction engineer with 20 yearsÆ experience in the real estate business is rare among the countryÆs top 100 real estate enterprises and gives the company an edge when it comes to both cost control and market projections. More than 50% of the management team also have advanced degrees and an average of more than 10 years of real estate experience.

Cost controls aside, a key reason for the success is that XinyuanÆs developments of condominium communities with between 1,000 and 3,000 small- to mid-sized units, schools and retail outlets are also highly popular among mid-income earners. According to the company, the satisfaction rate among its customers is consistently above 95% and almost half of its new customers are recommended by people who have already bought one of its homes.

ôWhat we offer is a lifestyle and at Rmb3,000 to Rmb4,000 per square metre our price is lower than for other projects in the same area. Also, the size of our apartments caters to the market need,ö Zhang says.

He sees a steady increase of property prices in Tier II cities, which now ranges from Rmb3,000 to Rmb5,000 per square metre, over the next five years, but says it wonÆt be dramatic like in the Tier I cities such as Shanghai, Dalian and Shenzhen.

Aside from promoting supply, the Chinese governmentÆs new property policies are also aimed at curbing speculative buying by charging a 5.5% sales tax if a property is re-sold within five years of acquisition (extended from two years previously) and by increasing the downpayment for getting a mortgage to 30% from 20% on homes larger than 90 square metres.

More than 70% of XinyuanÆs properties û as well as Tier II city properties in general - are smaller than 90 square metres, however, which means most buyers will still be able to borrow 80% of the acquisition cost. Zhang also estimates that about 90% of the property buyers in second tier cities are end-users who intend to live in their new apartments, and therefore wonÆt be affected by the sales tax.

ôReal estate is a key industry for ChinaÆs GDP and the government will not implement policies that will stop this business,ö says XinyuanÆs Chief Financial Officer Zhang Longgen. ôThe focus is to improve the supply structure and also to control the high price with the purpose of providing society with reasonably priced high quality apartments.ö

To support its anticipated strong growth, Xinyuan is looking to raise at least $30 million from a private placement to one or two international private equity houses, and has hired US-based Burnham Securities as its underwriter. The aim is to find investors who are willing to establish a strategic partnership to support the company in its efforts to become an internationally accepted real estate developer.

XinyuanÆs results for the past three years have already been audited by Ernst & Young according to US GAAP and the company has added independent directors to its board and implemented strict corporate governance procedure and an internal control system that complies with the Sarbanes-Oxley guidelines in the US.

To prepare for an eventual initial public offering it has also set up a stock option programme as in incentive for its middle and senior management. The IPO is currently expected to be in the ô$70 million plus rangeö and the company is tentatively targeting a US listing. However, Zhang says the management will listen to any advise in this respect provided by its new private equity investors.

The private equity placement is expected to be completed by the end of July.
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