Rapid development has transformed China’s skyline. Skyscrapers and modern buildings occupy space once used for farming. PHOTO BY TOM CHRISTENSEN.
China is experiencing one of the greatest real estate booms in history despite a prohibition on private ownership of land, a stated adherence to Marxist principles, and the absence of a national property law until 2007. Although China’s formal legal system still has some catching up to do, its informal legal practices illustrate how real estate professionals have been able to thrive during the past two decades.
China has enjoyed a tremendous real estate boom in recent years, though operating under a different system of laws and customs than those familiar to Westerners. The Property Rights Law of the People’s Republic of China, China’s first modern property law, became effective on 1 October 2007, but there remains considerable confusion regarding its implementation.
While it is not possible to own Chinese land, an investor can acquire a land-use right. Like investors in Western nations, Chinese investors must consider the type of ownership entity they wish to use and also must address site selection.
Rule-of-law principles continue to grow in importance, but China’s strong cultural tradition of reliance on personal relationships (guanxi) remains a key factor in many business interactions. There also are significant gaps between what China’s few written laws state and how they are enforced in practice. When examining Chinese doctrine, the question is not only what the law says, but also how it actually operates.
In 1988 China amended its constitution to allow the right to transfer the use of land. That right was further strengthened by a 2004 amendment requiring the government to pay compensation when it expropriates land. Nowhere, however, do these amendments allow private ownership of land. Instead, these constitutional provisions, along with laws that were enacted to implement them, clarify that the government may grant land-use rights for a specific term. This compromise created opportunities for sustainable economic growth and the flourishing of a private real estate market without formally abandoning Marxist principles.
The government may transfer land-use rights to residential property for a term of up to seventy years. For commercial property the maximum term is forty years. Industrial and other types of land-use rights may not be granted for terms greater than fifty years.
Land-use rights are limited by statute. Article 25 of the Law on the Administration of Urban Real Estate, for example, states that the land-use right may be reclaimed without compensation if the initial holder has not developed the land within two years, a rule that is frequently ignored. Rights holders may pay an additional fee to extend the term beyond two years, may initiate minimal construction before the two-year period expires as a means of formally meeting the statutory requirement, or may seek extensions of this two-year term, which seem to be readily available.
The initial and subsequent nongovernment holders of land-use rights may further transfer them, with certain limits. For instance, the initial holder of a residential land-use right may not resell the right to a second holder until the initial right holder has completed at least 25 percent of the proposed construction. This rule apparently is ignored with great regularity, often because of confusion about exactly how much construction has been completed. The holder of the land-use right also must own the building constructed on that land. In addition, in parts of China, buyers have been unable to use borrowed funds to acquire a land-use right.
Despite apparent similarities, the Chinese granted land-use right differs significantly from the ground lease familiar in the West. Chinese land can be owned only by the government, so the granting of a land-use right, by definition, severs ownership of the land from ownership of the building constructed on that land, just as the Western ground lease does. In China, however, the holder of the land-use right also must own the building constructed on that land, which forces the developer to incur the capital expense of acquiring the land-use right in its entirety at the beginning of the construction process. The ground lease, by contrast, permits the developer to avoid all or most up-front land acquisition costs. The Chinese land-use right, in short, is not a financing device.
Sales of Land-Use Rights
The process by which the government sells a land-use right, like so many other procedures in Chinese law, derives from a combination of formal written rules and informal practice. Shanghai’s procedure serves as a useful illustration of these granting practices. The government initiates the sale process by deciding on the requirements and specifications for a tract. It asks the Department of Land Administration to place a value on the property, and this administration sets a minimum price for the land-use right. The government publicizes these requirements and specifications and makes the relevant documents available to prospective bidders, which then submit sealed bids. Each bid from a developer is solely a price bid, as the government already has established all of the specifications in advance.
Shanghai’s government is not required to select the highest bidder, a fact that leaves it open to charges of favoritism or corruption. Concerns about favoritism are widespread. The government’s response is that it is concerned with a bidder’s reputation, experience, skill, financial strength, and general capacity to complete the project, and not just with the amount of its bid. The government argues that there is greater public benefit if the project is actually completed, even if the government receives less money in the short run. Nonetheless, bidders who have good personal relationships with highly placed officials are widely perceived as enjoying an edge, and these perceptions are further enhanced by a belief that the specifications themselves sometimes seem to have been drafted with particular bidders in mind.
Shanghai’s method of auctioning land-use rights has improved dramatically in recent years. Before 2002, the municipality would negotiate privately with several reputable developers and then choose one, a process that still is followed in some of the less commercialized provinces. Whatever their flaws, Shanghai’s current procedures generally are recognized as among the most impartial in China.
The Chinese land-use right system serves as a rudimentary zoning arrangement. When the government transfers land-use rights, it executes a formal document with the acquirer. In this document, the government limits the uses to which the land may be put.
The price for a land-use right is a function of the total buildable area that can be constructed on the land. If that number changes as the project moves forward, the price is adjusted accordingly. This fact illustrates the tension that local governments face between regulating land uses and maximizing revenues: A bigger building that may be undesirable for planning reasons will generate greater revenue.
Municipal planning bodies may devise land-use plans restricting certain types of developments in specified areas. These bodies are also aware of the tremendous revenue-raising possibilities from the sale of desirable land to developer
s who may wish to improve it in a manner that conflicts with those land-use plans. Pressure is mounting both domestically and internationally for China to place greater emphasis on protecting the environment, and Shanghai officials regularly note the increasing amount of green space that is available to residents of that city. But if land that is slated for a downtown park proves to be considerably more valuable than anticipated to its government owner, there may be huge financial incentives to convey the right to use that land to a developer.
The Chinese real estate boom has made land-use rights extremely valuable in many urban areas. Governments in these regions often treat land-use rights as assets to be sold whenever the need for cash arises, and many provincial and municipal governments employ the sale of land-use rights as an indispensable means of keeping themselves solvent. But if they transfer too many land-use rights too quickly, they will impair the government’s long-term financial viability. The national government recognizes important reasons to slow the real estate market down, and because it is less dependent on revenues from the sale of land-use rights, it suffers less than the provinces and municipalities if it accomplishes this goal.
Business Entities Owning Land-Use Rights
Most real estate projects in Shanghai are owned by domestic limited liability companies formed in accordance with China’s Company Law. If a new limited liability company wants to develop real estate, the first thing it must do is obtain land-use rights. This company often is partly owned by a private developer/manager and partly by a unit of government, a fact reflecting the reality that a government entity controls the use of the land the developer needs. The government provides the land-use right to the company as its contribution to that company. The local government’s control of the land ensures that it can retain an interest in the company that will develop the land. The government’s partial ownership of the project allows it to control and profit from the development, with the other partner providing the professional know-how and much of the cash.
The government also may benefit by acting as a subdivider. It is quite simple for the government to profit in this role when it controls the right to use desirable land and holds the power to determine how that land can be used. In some less densely populated areas, a municipal government will establish a first-level developer company in which it holds a large ownership stake and then convey land-use rights to this company. This company subdivides the land, breaking a larger parcel into smaller ones and installing necessary infrastructure. It then transfers the land-use rights to the smaller lots to the real estate developers that actually will build on them.
State-owned enterprises (SOEs), like governmental units, may own land-use rights, or they may obtain these rights from local governments at little or no cost. These SOEs then contribute the land-use rights to a development entity that they jointly own with a local developer or, occasionally, a foreign partner. SOEs often are highly inefficient manufacturing operations that have difficulty competing against private businesses in the modern Chinese economy. They historically have been a key part of the “iron rice bowl” social service network, typically offering their workers a guaranteed job, housing, schools, and health care. Any time an SOE fails, the government must step in and provide these benefits, or else the SOE’s former employees will suffer the type of reduction in comfort and security that can lead to more generalized social unrest. The government obviously has a strong political interest in seeing that these SOEs survive, and SOEs that successfully diversify into real estate enhance their long-term prospects.
Just as SOEs have sought to profit from real estate investments, private companies that are not primarily engaged in the real estate business have been seeking to diversify their portfolios, and real estate has proved to be one of the most successful investments in recent years. The government has become so concerned about competition from these private companies that it has started limiting their ability to invest in real estate, even taking steps to encourage them to sell their real estate assets to state-owned real estate holding companies.
Guanxi and Real Estate Development
Although the government clearly profits from participating in real estate transactions, government units that wish to invest in development may not have the expertise to do so. Professionals who possess this skill and are willing to share the gains with the government—or with certain officials within the government—are more likely to obtain the land-use rights they need. Even when there is no outright corruption, those professionals who master the nuances of a fluid, fast-changing legal system—and maintain amicable relationships with the government workers whose approval they need—hold a huge edge over their less well-connected competitors. Personal relationships, or guanxi, matter enormously in a nation in which laws are evolving rapidly and being applied inconsistently.
A local government sometimes will convey a land-use right to a company in which it holds an ownership stake for less than the fair market value of the land. The development company then can resell a portion of the land-use right at a higher per-square-meter price (reflecting the true market value) and recover all or most of its total cash investment before construction even begins. The restriction on reselling land-use rights for land that has not been developed does not appear to impede transactions of this type. The result of this two-step transaction is that the company obtains the right to develop its remaining land at little or no cost. In many of these cases, the private co-owner of the company is someone with close personal connections to the government, such as a former government official. Concerns about this type of corruption, or at least the appearance of corruption, are beginning to lead to change. For example, public auctions of land-use rights are becoming more common.
Some of the more established investors have even sought to cement their advantage by lobbying for legal changes that would reduce the very type of corruption from which they appear to have benefited themselves. Having built a huge lead under the original rules, they now seek to level the playing field. For example, the government may limit the bidding for desirable land-use rights to those developers who have demonstrated in their previous work that they have the skills to complete larger transactions, a group that often consists of the same first-generation developers who were able to acquire land-use rights under the more opaque procedures that were in place just a few years ago.
The importance of guanxi and experience helps to explain why so many developers in China are Chinese. The little foreign investment that there is in Chinese real estate mostly comes from overseas Chinese in Hong Kong, Taiwan, and the United States. Well-known Western corporations have also begun to enter China’s real estate market, recently acquiring trophy properties in desirable areas such as the Lujiazui Trade and Finance Zone in Shanghai’s Pudong New Area.
When a Chinese real estate developer is deciding where to build, its choice is influenced by both the profit motive and government inducement or compulsion. Developers seek to acquire land-use rights and build structures in locations that will be profitable. At the same time, the government uses its power, including its ownership of the underlying land, as a means of channeling development where it wishes. If the government is seeking to intensify devel
opment in a thinly populated area, it benefits as well from the fact that it is advantageous for private developers to build on land from which they will not have to remove current occupants and structures, a controversial and expensive undertaking.
Chinese government entities do engage in land-use planning and zoning. Land-use plans in China are developed in a top-down manner, with little or no citizen input. Some government entities do invite public comment, but citizens’ suggestions are followed only rarely. Citizen input may have more effect on changes to existing land-use plans than on the initial enactment of those plans.
But it appears that the land-use planning process is becoming more transparent if not more citizen based. Practices in Shanghai again serve as an example of the multiple levels of planning. Step one is known as open planning, in which Shanghai’s municipal government comes up with a proposal that must be approved by both the Shanghai National People’s Congress and the State Council. Following completion of this first step, the Shanghai Municipal People’s Government (or, for less significant projects, the Shanghai Urban Planning Administration, an administrative arm of the municipal government) next specifies requirements for individual blocks of land. Subsequent rezonings, while occasionally available, are difficult to obtain. In step three, technical specifications are proposed for individual buildings. Steps four and five consist of bidding on the transfer of land-use rights and the execution of a contract with the successful bidder. These steps are not completely alien to the American real estate practitioner, but the Chinese process allows virtually no opportunity for input from outside the government, even by those considering bidding.
In the earliest days of the real estate boom in Shanghai, investors considering acquiring land-use rights could become involved in the planning process sooner. During the 1990s the government would ask developers to locate a development site and propose a project for it. This method is rarely used today. Instead, the government either makes its planning decisions in the manner described earlier and invites proposals from developers who must comply with these detailed specifications, or it invites proposals for specific blocks that it has designated but not yet planned in great detail so that the developer can participate in the later stages of the planning process. This newer approach allows the government to retain greater control over land-use policy and may reduce opportunities for improper behavior by government officials and bidders.
The question of whether to slow China’s real estate surge offers a prime example of a conflict between the central government in Beijing and the government of a province or municipality. Lower-level government entities enjoy huge benefits when they grant land-use rights. They retain 70 percent of the proceeds from sales of land-use rights, while Beijing receives only 30 percent. China has no system of periodically taxing property according to its value, so municipalities must fund a significant portion of their ongoing capital and operations budgets by selling land-use rights.
Experts in China argue that China’s vast stock of government- and collective-owned land ensures that the Chinese economy will not collapse any time soon, as some Western experts have nervously predicted. The government can simply keep transferring land-use rights on the ever-expanding urban fringe at hefty prices that reflect the land’s increasing value for urban residential or commercial use. These experts argue that as long as the government has land-use rights that it can sell, it will never run out of cash.
Meanwhile, the central government, which receives less than one-third of the sales proceeds, fears that an overheated real estate market fueled by this sort of local government behavior may lead to social turbulence. Fear of upheaval may be the most important reason why the central government has tried in recent years to slow the real estate market. Developers and many private citizens, however, wish to see hot markets persist at least long enough for their next investment to pay off. Lower levels of government, which have their own economic incentives for wanting to see good times continue to roll, use their enormous control over local markets to encourage further growth.
An Exciting Market
China has accomplished much despite a prohibition on private ownership of land, a stated adherence to Marxist principles, and the absence of a national property law until 2007. Although China’s formal legal system still has some catching up to do, its informal legal practices illustrate how real estate professionals have been able to thrive during the past two decades. Overall, China is gambling that its central planners will be able to control the pace of growth in the real estate market and that its legal system eventually will attain the same level of maturity that its markets seem to be reaching.
China’s leaders have made significant progress, especially considering how recently they began this task and how stagnant the Chinese economic and legal systems were when they embarked on this project. For the interested real estate practitioner, it is difficult to imagine a more exciting market than China’s in the early twenty-first century.
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Property Law (Wùyè f? ???)|Wùyè f? ??? (Property Law)