Credit: Visual China

An insider of Country Garden, the largest property developer in China by sales, told the media on Tuesday that the company is “under periodic liquidity pressure.” Last month, Evergrande Group, China’s second largest property developer by sales, reported that its total debts reached 2.44 trillion yuan, sending shockwaves through the economy.

To this point, it is known to all that Country Garden is in the final countdown to default.

The outbreak of the Country Garden’s crisis follows a typical procedure. First of all, suspicious moves, including the executives’ sudden reduction of their shares and the major shareholders’ donation of large amount of money to foreign countries, sent rumors flying. Then conversation screenshots without specific sources and vague words on the social media arouse heated discussion, finally leading to the decline of both stocks and bonds. Without vigorous and decisive measures, Country Garden may repeat the fall of Evergrande.

Having seen many defaults of other real estate enterprises, the onlookers have no surprise about such event. But many may still raise a question: how can massive wealth of China's real estate market and the high profits of real estate giants accumulated in the past twenty years end in smoke overnight?

So, where did the money go? As an old hand in the real estate sector, I'll provide you some possible answers.

First, land.

Before the wave of defaults across the industry, the land reserves of private real-estate companies were valued at about three times their annual sales, so that they could meet the development needs within three years. Then the companies could keep purchasing new land while developing their residential buildings on the old, and kept rolling over.

This land hoarding model was attributable to the continuous rise in land prices and housing prices in the past 20 years, and real estate giants were all the beneficiaries of this model.

The sales peaks of Evergrande and Country Garden were 600 to 700 billion yuan, respectively, so the value of their land storage was estimated to be about 200 million yuan based on the “three times” rule. Evergrande's 2022 financial report, which was posted in July, revealed that as of December 31, 2022, the company had a land reserve of 210 million square meters, which could be valued at almost 2 trillion yuan if one square meter of housing is sold for 10,000 yuan.

Evergrande focuses on the second, third, and fourth tier cities. With large amount of land acquisition and strong negotiation ability, the company’s

land could be acquired at a 20% discount, which was about 40 billion yuan. Considering the current sluggish economy, the 2 trillion yuan is no longer worth what it was.

Second, financing costs.

Take Evergrande. Among the 2.44 trillion debt, there are 72.1 billion yuan of contract liabilities for the pre-purchased houses, or the uncompleted buildings. Interest-bearing liabilities are around 1.72 trillion yuan.

It was not easy for radical real estate companies like Evergrande to get enough bank loans even before the default, and they also raised money from the market. For example, before the introduction of restricitve policies, trusts were a major channel for real estate companies for financing. Other ways included U.S. dollar bonds, employee financing, commercial invoices, all with interest rates above double digits.

The companies paid interest for those interest-bearing liabilities as usual

before their defaults. With double-digit interest and rolling principal and interest repayments, the financing costs that have been paid over the years are estimated as hundreds of billions of yuan.

Third, high taxes. The real estate industry has long been known for profiteering, and it is also the target of policy regulation. Therefore, it has long borne high taxes and fees.

It is calculated that the ratio of Vanke's profit to tax is 1:2.68, which means that if the company makes 1 yuan, it has to pay taxes and fees of nearly 2.68 yuan. Property developers like Evergrande and Country Garden can be similar in this way.

Fourth, high dividends.

Even the real estate companies that have defaulted handed out high dividends to shareholders three or four years ago. A big surprise!

Since the real estate enterprise has a pre-sale system, it takes one to two years before sales are transformed to revenue, so there is a lot of room for financial operations. Although the profit may be false, the dividend must be true. As the equity of the private housing companies is relatively concentrated, major shareholders often hold more than half of the equity, and consequently most of the dividends fall into their own hands.

According to statistics, Evergrande's cumulative dividends were 9.39 billion yuan from 2016 to 2020. Its chairman Xu Jiayin, who holds about 75% of shares, took away three-quarters of the dividends. For example, for Evergrande’s dividends of 1.86 billion yuan in 2018, Xu took 1.4 billion yuan.

Even just before the default in the first half of 2021, Evergrande was still discussing dividends. Let that sink in.

Fifth, a variety of high tuition fees.

There is a joke saying that “better a spendthrift than an unprofessional investor”. It is most suitable for real estate companies that pursue diversification.

Evergrande built cars and launched its own mineral water and Country Garden engaged in creating robotics. Each project costs millions of dollars in research and development expenses. For example, Wanda Group engaged in the network technology group years ago, and then decisively stopped the loss, with costs of tens of billions of yuan. Its chairman Wang Jianlin also said that he regretted giving Qu Dejun, the head of internet technology group, too much money.

That’s understandable. Beer and skittles won’t cost that much, after all.

Sixth, high salary.

Xia Haijun, former president of Evergrande, once earned the name of "King of Workers" with an annual salary of 270 million yuan.

But it's not the ceiling. There are rumors that relying on co-investment mechanism, a regional president of a top real estate company has raked in

annual income of 1 billion yuan.

Although not all real estate companies are spendthrifts, it is the industry norm that the annual income of executives are millions to tens of millions yuan, directors, one or two million yuan, managers, four to five hundred thousand yuan, and the monthly salary of management trainees starts at more than 10,000 yuan.

The large number of employee headcount contributes to the high expenses in salary. Both Evergrande and Country Garden have over 100,000 employees. Real estate enterprises whose market value exceeds tens of billions yuan are likely to have more than ten thousand employees, and there are various management positions. This expenses need to be reckoned with. That can explain why the executives will leave right away when the company teeters on

the brink of meltdown.

Seventh, high costs.

When the companies see rapid growth, it’s like pouring oil on the flames and adding flowers to brocade. Various expenses on management, marketing and all kinds of banquets can be covered. It is inevitable that there are misappropriations of company funds and corruption, which is also common among the executives.

The marketing expenses of many projects are about 1% of sales, and as real estate projects are relatively large, the amount of money is also considerable in total.

Now you may understand that these necessary and unnecessary expenditures of real estate companies are possible only in the upward market with rising house prices. Once the situation reverses, it is no wonder that the company will default.

(Note: 1 U.S. dollar equals 7.2 Chinese yuan.)