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Abstract
The real estate boom has been the major engine of the Chinas economic development during
recent years. However, Chinas real estate market is still in the budding period and immature. It
is a common phenomenon that many real estate projects failing to meet deadlines and profit
targets because the Chinese real estate corporations lack a scientific management technology to
deal with risks. The objective of this paper is to investigate the key issues and challenges of risk
management in Chinese real estate corporations and provide the solutions to improve the risk
management in China.
Chapter 1
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Introduction
1.1: Background of Research
In November 2009 France announced that it had successful come out of recession a phenomenon
that heralded a number of series of announcements of successful end of the economic crisis by
other countries. Significantly it was not until the end of the year that the United States of
America whose industries were said to have masterminded the economic recession announced
that it has also come out of recession. The real estate industry has throughout the period played a
major and leading role in the issues surrounding the causes and the solutions to the problems of
this economic recession which is considered to be the worse form after the great depression of
the 1920s brought to the global economy (Bernanke, 2010)
The real estate in China is one of the booming sectors in the economy drawing its strength from
massive infrastructure limitation of the country which has persisted for a long time. The massive
advance in the economy resulting in the presence of a number of larger multinational and
domestic institutions who are taking responsibilities for the housing needs of its workforce have
increased the demand for housing facilities and for that matter making it a very profitable
endeavor.
However, there are some potential risks with the development of real estate in China, and there
will be some challenges and threats appeared in this industry. Therefore, Chinese real estate
companies should introduce some effective and efficient management model to deal with all the
potential risk from now on. ERM is widely implemented by most organizations in developed
countries, and it also can provide significant contributions to this industry for managing the
potential risks as whole.
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1.2: An introduction to Chinese Real Estate Sector
Before the economic reform in 1978, China had adopted a welfare housing system for 28 years.
At the time, state-owned enterprises (SOEs) and the government had the responsibility to offer
all welfare benefits to their employees. However in late 1978, the Chinese government began to
consider allowing ordinary people to own property. In September 1980, Beijing Property
Development Company was established, marking the start of Chinas property market. In 1987,
the Shenzhen government sold land use rights for property development through a public
auction. This was the first time property was auctioned off to the public in China. Three years
later, Shanghai formulated a housing reform plan and a year after, became the first city to set up
a central provident fund system in China. From 1992 to 1993, China experienced its first real
estate boom (in other words, its first real estate bubble). A housing reform system was carried
out nationwide in 1992 and the following year, the State Council launched the Anju Project,
which aimed to provide more affordable housing to urban residents.
The graph below shows how investment surged in the early 1990s and plunged low in the later
decade, and remained low thereafter. A second graph shows the portion of investment that real
estate housing had in the entire Chinese Economy.
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Unfortunately, the excessive increase in real estate investment and other irrational investmentsled to serious inflation problems. Since 1993, China has begun to rein in the overheating
economy, with real estate being one of the key sectors targeted. As a result, the sector gradually
cooled down. In 1997, China even observed a negative growth in real estate investment when the
economic performance in general was at a historical low. The turning point was in 1998, when
the welfare housing system finally ended. As part of the reform, Chinas banks started to provide
mortgage loans to consumers. Coupled with rising income, Chinas property market began to
recover. After 2000, the increasing urbanization and population movements increased the
demand for housing, especially in major cities. From 1997 to 2002, the nations urban population
rose from 394.5 million to 502.1 million and the urbanization rate jumped from 31.9% to 39.1%.
1.3:The Current Situation
In 2007, investment in real estate development reached RMB 2.53 trillion, up 30.2% from 2006.
Residential property investment amounted to RMB 1.8 trillion, accounting for 71% of the total
investment an increase of 32.1% from 2006. By 2007, 478 million sq m of residential property
had been completed - 5% more than in 2006. The rising housing price was stable in the first half
of 2007 and saw a sharp increase from June till October. However, in November, the price
increase slowed down and 18 out of 70 cities showed negative growth in December.
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high-grade hotels, villas, office buildings, golf courses, and national tourist areas. These were not
eligible for full-funded foreign investment and only joint ventures were allowed. In the 2002
adjustment, the construction of ordinary housing was encouraged, while the block land
development and the construction and operation of hotels, villas and office buildings remained in
the limited category. In 2004, the Catalogue added the construction and operation of large
theme parks to the limited category. In some cities, the construction and operation of golf
courses and national tourist areas were also limited. Presently, although foreign investment in
real estate accounts for only 4.7% of the nations total investment in this sector, about 22.9% of
the nations total utilized foreign investment was in this industry. In 2007, the utilized foreign
investment in the real estate sector reached US$17.1 billion, up 107.3% over 2006, compared to
a 13.6% average growth in all the sectors. Despite the publication of regulations, foreign
investors rapidly entered the Chinese real estate market through various channels such as
purchasing property, and outflanking the second and third tier cities. In 2007, the foreign
investment scale on these cities exceeded 100%. More than 300 foreign-invested enterprises
were set up that year with the expectation of doors closing on overseas players wanting to invest
in the domestic real estate market in the future.
1.6: Nationwide property market cycles:
The first five years (1998-2003) since the private housing ownership became relevant saw only
Moderate increases in the nationwide property prices, consistent with a macroeconomic
environment where inflation was low or even negative and the economy was still recovering
from the impact of the Asian financial crisis. Chinas housing prices did not really experience a
large increase until 2003 when the economy experienced a short episode of economic
overheating. The property prices then started to increase at an unprecedented pace (namely at an
average of 7.4% per annum) till 2005. The macroeconomic tightening measures ensued seemed
to have worked to dampen the rapid rise in housing prices. However, the surges started again in
2007, possibly driven by rising capital inflows and faster appreciation of the RMB exchange rate.
This cycle peaked in mid 2008. The nationwide real estate prices have since decelerated fast and
started to decline since the end of 2008.
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Chapter 2
Conducting Research
2.1 Research Aims and Objectives
The objectives of the research are to be able to understand the nature of risk which confirms the
real estate sector in China and what management principles and adopted effective control them.
In order to find out the problems in Chinese real estate industry, there are three questions to be
concerned:
a. What is the nature of risk which is face by the Chinese real estate sector?
b. How ERM has been implemented and developed in Chinese real estate industry?
c. What measures can be put in place to ensure effective management of the risk in order to
maximize the prospects of the sector?
2.2 Methodology
This study is been carried out as a descriptive research which is targeting at analyzing the
frequencies in the responses to identify the trends within the different responses categories. By
making use of a survey and designing survey data collecting instruments respondents have been
selected from both consumer group and service providers in the real estate sector who will be
contacted. With that a description of the existing nature of risk and the problem it brings will be
known. The research paradigm is the positivist approach which upholds objectivity in research.
The study will collect both qualitative and quantitative data, and then based on the evidence to
make conclusions for the objectives which have been proposed above. The research has also
been designed to make analysis by collecting both primary and secondary data.
Population and Sampling
Two groups of respondents have been shortlisted. These are the real estate companies which
represents the supply side as well as consumers in the industry. The companies which will be
studied are China Vanke Co Ltd, Poly Real Estate Group Co. Ltd, Beijing North Star Company
Limited, Beijing urban construction investment & development Co. Ltd, China WUYI Co. Ltd.
The reached companies are in different position in the ranking of Chinese real estate industry,
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and this companies are located in different part of China. And the managers and staffs of this
companies will be contacted by a questionnaire to collect the required data.
On the other hand, the consumers will be selected by adopting the convenience sampling
method. In all one hundred respondent fifty of which will come from each group will be reached.
Ten respondents will be interviewed while the rest will be reached with the questionnaire.
2.3 Data Collection and Analysis
For critically analyze and evaluate the ERM in Chinese real estate industry, there are two data
collection instruments will be used in this reach. The first will be the interview guide which will
be a semi formally structured interview format to be used to collect qualitative data. The data
collected from those interviews will be analyzed and evaluated and the outcome will provide a
significant contribution to the this study.
Secondly, the questionnaire will collect the quantitative data from the remaining ninety
respondents. In order to be able to collect the data in a manner that can be graduated and
measured the closed ended approach asking question will be used, and in this case the Likert
scale five point answering scheme will be employed. After carrying out a pre-test to check the
validity and the reliability of the instruments hard copies of the questionnaire will be sent to the
respondents by an agreed means. When the questionnaires are returned, the SPSS and Microsoft
excel will help the researcher to extract the frequency distribution table and diagrams after
cleaned and coded.
2.4 Expected Outcomes
This researcher expected find out the important reasons which could support that ERM is worth
doing in Chinese real estate industry. In other words, this research could identify what is the
main threats that Chinese real estate companies have to face, and why ERM could help those
companies to improve the performance and turn those threats into opportunities. In addition, the
researcher might conclude the main factors which could increase the effectiveness and efficiency
in Chinese real estate companies by doing ERM approach.
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2.5 Limitations
The research is expected to have some limitation in respect of the generalization which can be
made from these findings. This is because the research will make use of only one hundred
samples which will be conveniently selected. The research will also take place in China and may
affect the extent to which it can be applied to other culture. The research will be limited to the
extent to which they respondents will be truthful. The use of secondary research will be limited
to the extent that most of the theories and the research which have been carried out also have
their own limitation
2.6 Ethical Issues
A number of ethical issues come up in this research. Obviously this research is designed to be
primary and secondary research, hence, human respondents would be very much involved. It is
the requirement of this dissertation to ensure that all information collected from these are kept in
absolute confidence and only used for the project purposes which have been disclosed in this
proposal. Secondly it is also noted that access to secondary data will be done in a credible and
open manner. While measures will be put in place to ensure that all secondary materials which
are used in this research are adequately and appropriately acknowledged to avoid traces of
plagiarism.
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2.7Time Table of Research
Activity Period
1. Read literature 08 March 2011
2.Complete proposal 08 April 2011
3. Devise research approach and strategy 03 May 2011
4. Draft questionnaire 15 May 2011
5. Administer questionnaire 20 May 2011
6. Analyze data and conclusion 01 June 2011
7. Complete remaining chapters 20 June 2011
8. Submit to tutor and await feedback 15 July 2011
9. Revise draft, format for submission 10 August 2011
10. Submit 26 August 2011
Chapter 3
Literature Review
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The literature review will include two areas: 1) the literature relating enterprise wide risk
management in industries; 2) The risk in Chinese real estate industry;
The Development of Risk Management Theory
In 1921, Marshall (Marshall, 1922) put forward the idea of Administration of Risk-Bearing, at
the same time he addressed two managing risks ways as Risk elimination and Risk Deviation.
During 1929-1933, The American entrepreneurs spread the enterprise management movement.
American Marketing Association (AMA) realized the importance of the risk analysis of
enterprise and established particular research and consultant departments. Risk Manager
established Insurance Buyers of New York in 1932. From that time, enterprises insurance
management began to be popular, and come up some managing risks ways.
In the 1950s, Risk Management gradually developed into a special academic course. In the 1950,
Mowbray and Blanchard (Song Mingzhe, 2003) first defined the concept- Risk management in
their book Insurance. Gallagher (1956) addressed the Risk management- new phase of cost
control. From then on, Risk management started to step into the historical stage.
In the1960s, Mehr and Hedgs (Liu XinLi, 2006) and Williams and Heins (Willams and Heins,
1990) led the study of risk management into a systematic way. Their masterpieces as Risk
Management in the Business Enterprise and Risk Management and Insurance made the idea --
Risk Management deeply into the popular life.
The term risk management was introduced by the risk managers around 1970s, at first, risk
management primarily focus on manage selected financial and hazard exposures and internal
controls. People always transfer the risk by purchasing insurance. However, due to the economic
disaster in 1990s, there were several companies failed, such as Piper Alpha and Baring Bank.
Risk manager introduced a new term, which is business risk management and it only focusing on
the business risk in the organization. Risk manager aim to deal with the business risk and turn the
competitive threat into business opportunities. But, under the rapidly changing business
environment, the traditional risk management is no longer adapting the current business
situation. Recent year, risk manager applied a new risk management approach to manage risk,
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which was called enterprise-wide risk management. It is a broadly focused way to deal with the
risk, for example, ERM see various risks as an integrated risk and deal with the integrated risk to
improve the organization as a whole, not only one particular part.
During the 1970s, most American universities opened the risk management courses. In 1983,
Risk and Insurance Management Society adopted Risk Management 101 in their annual
conference. The rules of 101 risk management have been the guides for managing risks, and used
up till now. In 1987, Professor Cooper and Chapman (1987) put forward the conceptRisk
Engineering. They considered that risk engineering as the integration of different kinds of risk
analysis technologies. Risk engineering is far-ranging and more flexible, and can compensate the
limitations of single model.
When time moved into 1990s, researches on the risk management have made a big progress,
establishing an integral system and an independent research field. Risk management has been
taken into consideration when making business strategies. Around 70 percent enterprises have
their particular risk manager and 90 percent enterprises have the risk management training.
Zhao Xuehong, 2006).
Marsh (2010) acted that ERM is a kind of approach which can supply a explicit and confidence
investment direction for the organization and can create values under the uncertain environment.
Many organizations are implementing ERM to increase the effectiveness and efficiency of their
activities in the developed countries. However, only the financial institutions are implementing
the ERM processes in China. (Basel II, 2004) Banks have been leaders in ERM adoption due to
the emphasis on risk management in the global regulation as a way to reduce minimum capital
requirements. (Bies, 2004) The US Federal Reserve Board has recently announced
expectations for expanded ERM processes in US financial institutions. (Whitfield, 2004)
Educational institutions also face significant regulation and have been strongly encouraged to
adopt ERM. and, Insurers have come to recognize enterprise risk management as fundamental
in creating and improving shareholder value through better risk-based decision making and
capital allocation (Tillinghast-Towers Perrin, 2004).
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The risk in Chinese real estate industry
The massive growth in the sector is supported by the required investment which makes the sector
very attractive for all industries. AbouRiz & Er (2004) have analysed the risk in the real estate
sector in China into different areas under two major categories which he calls the
macroeconomic risks and industry risk. In terms of the former, it includes risk which relates to
social environment risk ,political environment risk, , land policy risk, housing policy risk,
financial policy risk tax policy risk, urban planning risk, environmental protection policy risk,
GDP growth risk, inflation risk, urbanization risk, legal environment risk (Almgren & Berg,
2002).
The industry risks in Chinese real estate companies included the supply and demand risk, human
resource risk, the project risks in Chinese real estate corporations, land price risk, marketing risk,
financing risk, resettlement risk and new technology risk. To be able to exhaust all of these, it
will require extensive study which cannot be covered in this research. To this end the research
and study is going to be restricted to analyzing the demand risk in the sector. The reason for this
choice is the fact that economic growth which is expected to bring with it enhance standard of
living seems to be far ahead of the ordinary livings of the Chinese. Many are unable to afford
accommodation provided unless under very tight mortgage conditions which is increasingly
becoming unattractive (Brealey and Allen, 2005).
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A city by city look of Chinese Real Estate Industry
Beijing
The residential property price did not take off until 2003. It had since risen at an averaged 7.6%
until 2007. The property prices have started to cool down since the beginning of 2008, after a
sharp 11% increase in 2007 (Chart 4a). The peak of Beijings housing price is also coincided
with the peak of its real estate investment cycle.
Shanghai
Its housing prices started to rise in 2001 and peaked in 2003 after registering a yoy growth of
over 20%. Growth in the property prices on average soon dropped sharply and even declined by
2 to 3% in 2006. The price rebounded somewhat in 2007 and 2008 before declining again in
early 2009 (Chart 4b).
Shenzhen
Affected by the Asian financial crisis in 1997-98, Shenzhens housing prices stagnated for the
period of 1998 to 2002. After 2003, the housing prices rose sharply and peaked in 2006 and 2007
with a yoy growth at over 17%. The residential housing prices have since dropped sharply. The
price falls in Shenzhen have been the largest so far among the key cities in China with a large
negative yoy growth of 15.7% in February 2009 (Chart 4c).
Guangzhou
Affected seriously by the Asian financial crisis, Guangzhous property prices fell over the period
from 1998 to 2003. The decline in the residential property prices was the largest in 1999 with anegative 5%. The city saw a moderate recovery of housing prices between 2004 and 2007.
However, the rebound over the period was not very large. For example, the largest increase was
close to 7% in 2007. The prices then declined again in 2009 by as much as 5% in early 2009.
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Tianjin
The housing prices in Tianjin stood still for the period of 1998 to 2002. It took off sharply in
2003 and peaked in 2004 with a yoy growth rate of over 13% driven by central government
intentions to enhance Tianjins status as a high-tech and financial center for Northeast China.
Rapid growth in housing prices halted in 2005 and it had since been maintained at a yoy rate of
less than 6 until a large drop to a negative 2% in 2009. Despite price moderations, real estate
investment continued to rise at a fast rate. Indeed, the supply factor especially after the set up of
a new special economic zone in Tianjin in 2005 will continue to affect Tianjins property prices.
Chongqing
It appears that Chongqings residential housing prices had already experienced a cycle after its
naming as the fourth Municipality--a status similar to a province--in China in 1997. This cycle
bottomed in 2001; another cycle soon began and it was peaked in 2004 at a yoy growth rate of
14%. Although growth in property prices rebounded after 2006, it has dropped sharply after 2008
to an averaged negative 2% in early 2009. Chongqing is another city where real estate
investment has seen rapid increase after 2005.
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Sources: CEIC and BBVA estimates
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Chapter 5
Mortgage finance and interest rates
Mortgage finance also has a short history in China. Chinas mortgage
outstanding, though growing fast remains a small portion of bank loans at around 10% at the end
of 2008. Mortgage rates showed a negative relationship with property prices unptil 2003. This
relationship seemed to have changed for the period of 2004 to 2008, where there is a coordinated
movement between real interest rate and property prices. This suggests that some other factors
such as expectation of fast appreciation in residential properties and favorable credit conditions
were also driving the rapid rise in housing prices during this period. The negative relationship
returned after 2008.
For the time being, most mortgage loans are mostly on banks balance sheet and there is little
securitization of bank mortgages. Although the current mode of development appears to be
adequate to meet demand for mortgage finances, it also runs the risk of potential maturity
mismatch for the banking system, as the term structure of bank deposits is usually shorter than
that of mortgage loans.
Alternative mortgage finance methods such as covered bonds and mortgage backed securities
should also be developed. The on-going global financial crisis that originated from the subprime
mortgage crisis in the US shows the covered bonds approach may be more appropriate for China,
largely because the structure of the covered bonds is simple and the identification of the ultimate
risk bearer straightforward. The latest developments also show that the covered bonds do not
seem to be highly sensitive to changes in the underlying asset price.
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Source: Wind
Sources: CEIC and BBVA estimates
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Chapter 6
Housing Provident Fund
The housing provident fund is a unique form of housing finance institution in China: It is a fund
contributed by both employees and employers. Employees usually contribute 5% to 20% of their
salary to the fund with the equal amount matched by their employers. Participating in such a
fund allows one to enjoy lower mortgage interest rates than the market rates. In addition, through
monthly contribution, one can accumulate savings for a housing purchase that can be drawn as
down payment or use the savings accumulated to lower the loan amount.
Origins of Housing Provident Fund (HPF)
Before Chinas economic reform in 1978, there was little private housing ownership in China.
Housing had used to be provided by an individuals work unit in the urban area, known as state-
distributed housing system. Private housing ownership was allowed as early as in the beginning
of the 1980s.
However, the majority of households could not afford the high costs of privately-owned housing
in the early days of private housing ownership, largely because the wages were controlled at a
subsistence level at the early stage of Chinas economic transition.
In 1991, the housing provident fund was introduced as a pilot program in Shanghai. It was a part
of a large housing reform package adopted by the Shanghai municipal government. Similar type
of HPF schemes was established in Beijing, Guangzhou, and Tianjin in 1992. This scheme was
formally extended nationwide in the urban area in 1995. Through contributions made by both
employers and employees, the fund intends to make private housing affordable so that the state
can gradually phase out the state-distributed housing system. In 1998, the State Council decided
to completely end the old housing allocation system and elevated
HPFs role in financing private housing purchase. The State Council then issued the Housing
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Provident Fund Management Regulations in March 1999 as a legal framework to standardize
HPF contribution and fund management. All prefecture cities were required to set up HPF
schemes. In March 2002, the Housing Provident Fund Management Regulations were amended
by Decree 350 of the State Council. The amended regulations stipulated that all enterprises
(including state, private, and township and joint ventures enterprises), government agencies,
public institutions, and social organizations are required to take part in the HPF system.
Furthermore, the amended regulation has also standardized the fund usage, financial auditing and
supervision, and penalties on violations.
Typically, employees who join the program need to deposit a certain portion of their salary in the
range of 5 to 20% in the HPF account. The contributions are then matched one-for-one by their
employers. In Beijngs case, an employee usually contributes 12% of his/her salary monthly, at
the same time, the employer also needs to pay the same amount to the employees HPF account,
but the total contribution is capped at RMB 2392 no matter how high the employees salary
is.The contribution rate varies across the cities in China, for example, it is only 7% in Shanghai.
Once in the program, the employees need to pay for the monthly contributions to the HPF
account until they retire. In return, the participants of the HPF will be able to get housing
financing loans that enjoy below market mortgage rates from banks. If the employee doesnt buy
any housing, the fund can be drawn in a lump sum at retirement.
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Chapter 7
Comparison between commercial mortgage loans and HPF loans
After the Chinese government ended the housing allocation in 1998, HPF has been a major
policy tool to enhance housing affordability for urban residents, which provides a lower interest
rate (usually 200 basis points lower) than market-based commercial mortgage loans by banks
(Chart 1). For example, the current HPF loan interest rate for 6 to 30 years is 3.87%, while
commercial loan interest rate for the same maturity is 5.94%. Even the commercial loans interest
rate can be discounted 30% the most qualified customers, namely at 4.158%, they are still higher
than the HPF interest rate.
Therefore, if households want to apply for mortgage loans, the first choice could be to seek loan
applications from an HPF management center. If the loan amount is not enough to cover the
housing purchase, they can then go to banks for a second commercial loan to make up the
difference.
As shown in Table, the households that can obtain HPF loans only account for a small portion in
the population. As of 2007, total loan amount issued by HPF management centers is RMB 856.6
billion, while the mortgage loans from banks amount to RMB 2962.5 billion, or less than one
third of commercial mortgage loans. In term of amount, the commercial loan is much larger than
the HPF, and it plays a bigger role in financing the housing purchase.
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Source: Wind Economic Data
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