The main sources of real estate law in the People’s Republic of China (PRC) include the laws, administrative regulations, ministerial rules, local regulations and other normative documents promulgated by the national and local governments. Among these, the laws promulgated at the national level include the Civil Code, the Land Administration Law of the PRC, the Urban and Rural Planning Law of the PRC, the Construction Law of the PRC and the Urban Real Estate Administration Law of the PRC.
During 2022, office space remained the most sought-after asset class in terms of transaction value in the real estate market of the PRC. However, an upward trend in the acquisitions of other asset types, such as business parks, logistics and industrial properties, apartments and hotels, has been observed (Source: Colliers International Group Inc, Annual Analysis for Real Estate Transactions in China, 13 January 2023). Specifically, business parks, and logistics and industrial properties accounted for 26.8% of the total transaction value, representing a significant increase of approximately 9.8% compared to the previous year. In contrast, the transaction value of apartments and hotels accounted for 10.1%, with a moderate increase of about 3.1%.
In 2022, factors such as pandemic uncertainty, geopolitical tensions, sluggish economic performance and weak leasing fundamentals, contributed to a decline in the total transaction value of bulk properties. The majority of transactions continue to be driven by domestic demand, accounting for a staggering 80% of all transactions.
Notable transactions in 2022 include China Resources Land (CR Land) acquiring a portfolio of office, commercial and residential assets in Wuhan and Nanjing from China Fortune Land for a discounted price of RMB12.4 billion. This acquisition sought to alleviate liquidity stress following China Fortune Land’s default last year. Additionally, ESR Cayman Limited (ESR) purchased a portfolio of logistics and industrial assets in the Greater Shanghai area, comprising 11 completed logistics and industrial properties with a gross floor area exceeding 550,000 square metres. This acquisition represents the largest logistics and industrial portfolio ever sold in the area.
The real estate industry in China is gradually recovering, thanks to adjustments in epidemic prevention policies and the introduction of favourable policies for the sector at the end of 2022. In 2022, China’s inflation rate remained relatively low compared to other countries. Further contributing to this recovery are decreases in interest rates throughout 2022 and cuts in the reserve requirement ratio until March 2023.
No significant changes have been seen.
On 26 January 2022, the Ministry of Finance and the State Taxation Administration jointly issued Bulletin (2022) No 3, which introduced pilot tax policies for real estate investment trusts (REITs) in the infrastructure sector. The pilot tax policies include both corporate income tax exemption prior to the establishment of infrastructure REITs and deferral of corporate income tax during the establishment stage of these REITs. It is anticipated that implementing tax rules will be introduced, which will effectively boost asset supply and growth of the REITs market.
There are two main categories of property rights under PRC laws.
National laws and regulations governing the transfer of title to real estate mainly include the Civil Code, Urban Real Estate Administration Law, the Interim Regulations of the PRC Concerning the Assignment and Transfer of the Right to the Use of State-Owned Land in Urban Areas, and the Interim Regulation on Real Estate Registration.
The effectiveness of the transfer of real estate is subject to registration with competent real estate authorities, and no transfer is valid unless it is duly registered or otherwise provided by law. For example, a court judgment, arbitration award or, in the event of government taking or expropriation, an administrative decision of government, may serve to effect a title transfer if the same is effectively issued.
Title insurance is not common in the PRC.
The COVID-19 pandemic has, to some extent, propelled the government’s ongoing digitalisation reform of the real estate registration system relying on the internet and blockchain technology. In certain localities (such as Guangzhou and Shenzhen), the process of second-hand non-residential properties transfers between enterprises can be completed online.
A buyer typically performs due diligence investigations on various aspects, such as legal, tax, financial, environmental and technical.
In terms of legal due diligence, the scope for an asset deal focuses more on the property, such as title, existing encumbrances, zoning and licence requirements, environmental compliance, leasing, operation and management status, but also covers verification of key aspects of the seller, which may prevent or materially affect the sale of the property, such as the corporate governance structure and legal capacity of the seller, restrictions under financing obligations, and ongoing or pending material litigation, arbitration and administrative penalties involving the property.
The scope for an equity deal is generally a comprehensive investigation, subject to the client’s specific instruction, of the target company and the target property. The investigation of the target company generally covers the corporate history, corporate governance structure, business operation, material contracts (including financing contracts), environmental compliance, material litigation, arbitration and administrative penalty, intellectual property, labour and employment, taxes, subsidiaries and investment into other entities. The investigation of the target property is similar to that of an asset deal if not already covered in the part on the target company in the due diligence report.
Impact of the COVID-19 Pandemic
Due diligence investigations have been affected by the COVID-19 pandemic. On-site due diligence investigations and verifications are more difficult, if not completely impossible, and conference calls, database verification and virtual interviews have been used more often in due diligence practices.
A buyer generally requests the seller to make representations and warranties on itself and on the target (ie, the target property in an asset deal, and the target property, the target company and the target equity/shares in the target company in the event of an equity deal). Typical representations and warranties on the seller include capacity, power, authority, solvency of the seller, all authorisations, consents and approvals obtained, the binding effect of the contract and the sale of the target without contravention or claim by third parties or other contracts.
In spite of the COVID-19 pandemic, specific coronavirus-related representations and warranties are uncommon in practice.
Typical representation and warranties on the target property in an asset deal include clean title to the target property (free from encumbrances or, as the case might be, with disclosed existing encumbrances), the state of the target property, leasing status, no pending fees and no knowledge of taking, seizure or expropriation.
In an equity deal, sellers are often requested to make additional representations and warranties on the clean title to the target equity/shares (free from encumbrances or, as the case might be, with disclosed existing encumbrances), legal capacity and status, financial condition, tax matters, compliance with laws, environmental matters, indebtedness and loans, leases and other material contracts, employees, intellectual property and no pending litigation in respect of the target company.
Coverage of Representation and Warranties
The coverage of representation and warranties is subject to business negotiations between the parties to a transaction. In general, parties to cross-border transactions are more comfortable with standard broad representation and warranties provisions, while domestic players tend to welcome a shorter version of an asset or equity transfer agreement; ie, a more condensed coverage of representation and warranties.
Breach of Representations and Warranties
If the seller is in breach of the relevant representations and warranties, the buyer is generally entitled, in accordance with the contract or relevant PRC laws, to claim for damages, refuse to proceed with the closing or even terminate the contract.
A sophisticated seller may insist that the buyer may only refuse to proceed with the closing or terminate the contract when the seller is in breach of fundamental representations and warranties, and otherwise only claim for damages in the event of breach of general representations and warranties.
Breach of certain representations and warranties is articulately regulated by the relevant PRC laws to protect the interests of buyers when purchasing property from real estate developers. For instance, the failure of a seller, being a developer, to have a pre-sale permit for a building under construction might lead to the invalidity of a strata title property sales contract.
Seller’s representations and warranties apply primarily to the facts and circumstances existing at the time of contract execution and are deemed to have been remade on and as of the closing date. A sophisticated seller may insist on adding a time limit for bringing claims for breach of such representations or warranties and capping the seller’s liability for breach of the same. A typical cap for the aggregate of all the claims is 100% of the total contract price, while a sophisticated seller generally sets different sub-caps for different categories of claims.
Representation and warranty insurance is more often seen in cross-border transactions involving international players, mostly taken out by purchasers in cross-border transactions. Although pure domestic transactions involving local parties taking out representation and warranty insurance are still uncommon, local parties, particularly state-owned enterprises, are becoming increasingly aware of and interested in such insurance.
See 1.1 Main Sources of Law, 2.2 Laws Applicable to Transfer of Title, 2.11 Legal Restrictions on Foreign Investors and 5.4 Applicable Governance Requirements.
The Environmental Protection Law of the PRC and Soil Pollution Prevention and Control Law of the PRC provide that the person causing the soil pollution (the “causing person”) is responsible for managing the soil pollution risks and the remediation of the soil pollution it caused. However, if the causing person cannot be identified, the land use right owner (eventually the buyer, unfortunately) is responsible for managing the soil pollution risks and remediation of the same, even if the land use right owner did not cause the pollution or contamination.
A buyer can ascertain the permitted use of a parcel of real estate by viewing the construction land planning permit (建设用地规划许可证 in Chinese), land grant contract (土地出让合同 in Chinese), the construction works planning permit (建设工程规划许可证 in Chinese), other relevant zoning documents and the title certificate. In addition, a buyer may make further verification by accessing, with the authorisation of the seller, the relevant files of the real estate at the competent planning and natural resources authority (the Planning and Natural Resources Commission or PNRC) or the competent local urban construction archives.
The state may, in the public interest:
The power of expropriation and temporary requisition must be exercised with due authority and legitimate process.
The compensation must be fair and reasonable in case of expropriation and temporary requisition. Where the land to be expropriated is collectively owned by farmers, they shall be compensated according to the principle that their living standard is not negatively affected; while the land user, in respect of land under a land grant contract to be taken back by the government for public interest, shall be compensated, considering the actual elapsed term of the land use and the status and condition of the developments made on the land. In the case of requisition, compensation shall be made for any damage to or destruction of the requisitioned real estate.
In respect of the purchase and sale of real estate, taxes payable may differ depending on the different transaction structures.
In an asset deal, taxes payable include:
In an equity deal (regardless of whether to purchase all or a portion of the equity/shares), taxes payable include:
In addition, see 7.2 Assigning Responsibility for the Design and Construction of a Project for the potential exposure to land appreciation tax in an equity deal.
Enterprise income tax
The rate ranges from 10% to 25%. The individual income tax rate is generally 20%, but an individual who transfers their sole residential housing after holding it for more than five years is exempt from individual income tax payment.
The rate ranges from 5% to 9%. Surcharges imposed on the VAT payable include tax for maintenance and construction of cities at an applicable rate ranging from 1% to 7%; education surtax at an applicable rate of 3%; and local education surtax, the rate of which varies in different localities. See 7.1 Common Structures Used to Price Construction Projects for more detailed analysis.
Land appreciation tax
The rate for this is progressive, ranging from 30% to 60%, but an individual who transfers their residential housing is exempt from paying this tax.
This generally ranges from 3% to 5%, but an individual who purchases a sole residence for their family (including their spouse and underage children) with a gross floor area of more than 90 square metres is eligible for a reduced rate of 1.5% and with a gross floor area of less than 90 square metres, of 1%.
The rate is generally 0.05% for the seller and the buyer. Currently, an individual who purchases or transfers residential housing is exempt from paying this tax.
A major restriction on foreign investors acquiring real estate in the PRC is the “commercial presence” requirement; ie, offshore entities or individuals cannot acquire real estate in the PRC for non-personal use unless a foreign-invested enterprise is established or has been established in the PRC to own and operate the real property. The following restrictions also apply to foreign investors:
In addition, no real estate companies are currently allowed to acquire offshore loans except for foreign-invested real estate companies incorporated prior to 1 June 2007.
If commercial real estate is acquired by an onshore entity (including a foreign-invested enterprise), generally the onshore entity may seek financing from banks within the PRC, subject to certain restrictions required by the China Banking Regulatory Commission. For instance, the facility amount shall not exceed 60% of the total acquisition price, and the term of the loan shall not exceed seven years. If the onshore entity intends to arrange loans from offshore bank(s) or offshore entities, including shareholder(s), to acquire a commercial real estate, it must meet the requirements and restraints in relation to foreign debt under the PRC laws. Currently, no real estate companies are allowed to arrange loans from offshore, except for foreign-invested real estate companies incorporated prior to 1 June 2007. In cases where the onshore entity acquires equity in a target company engaged in real estate, obtaining loans from offshore banks or entities may still be practically unattainable.
Offshore Acquisition and Onshore Fixed-Asset Loans
Where a foreign investor acquires commercial real estate through an equity deal (by acquiring equity interest in the onshore company holding the real estate), the most common financing structure is an offshore acquisition loan accompanied by an onshore fixed-asset loan in renminbi. The offshore acquisition loan is extended by an offshore bank to the offshore buyer to pay for the equity/share purchase price in the same currency as that of the equity/share purchase price, secured by a pledge over the equity interest in the onshore target company acquired by the buyer. The onshore fixed-asset loan is generally extended to the onshore target company by an onshore subsidiary of the offshore bank, secured by a mortgage over the real estate owned by the onshore target company. Nowadays, we are seeing more onshore domestic banks directly extending foreign-currency acquisition loans to offshore buyers to finance the purchase price payment.
Where a commercial real estate investor that intends to acquire or develop real estate, acquires a loan from a lender, it will usually be required to provide the following forms of security:
Although the PRC laws do not prohibit an offshore lender from being the mortgagee of real estate collateral, in practice, certain local real estate registration centres, which serve as the competent authority in charge of real estate mortgage registration, such as in Xiamen, refuse to register an offshore entity (including offshore banks) as the mortgagee. Therefore, in terms of practicality, it may not be possible to register a mortgage in favour of offshore lenders in certain localities, resulting in a failure to create an effective mortgage.
A borrower is generally able to make repayments to its offshore lender without further restrictions, provided that they have completed the relevant foreign exchange regulatory formalities for the cross-border loan (including, but not limited to, the registration of such cross-border loan) in accordance with the PRC laws.
If a mortgage is created over real estate, both the mortgagor and the mortgagee are obliged to pay stamp duty for the mortgage contract at a tax rate of 0.05% each of the secured debt. A minimal registration fee for a real estate mortgage (CNY80 for residential property and CNY550 for non-residential property, per registration) is charged by the registration authority and often borne by the mortgagee.
Furthermore, if the mortgagor and mortgagee agree in the mortgage contract to an enforcement notarisation, a fee for enforcement notarisation may be incurred, which is usually borne by the mortgagor. Such fee is charged by the notary public office at a rate equal to an agreed percentage of the amount of the secured debt, which may vary at different localities.
Under PRC laws, certain real estate may not be used as collateral to secure a debt, such as:
When a lender enforces its security over real estate against a defaulting borrower, if the lender and the mortgagor have explicitly agreed in the mortgage contract to apply the enforcement notarisation approach, the lender may directly apply to the competent court for enforcement by presenting the duly notarised mortgage contract and the enforcement certificate issued by the notary public’s office. If the lender and the mortgagor have not explicitly agreed in the mortgage contract to apply the enforcement notarisation approach, the lender may, by agreement with the mortgagor, dispose of the collateral by negotiating a purchase price, by auction or sale of the collateral, and the lender may claim its senior debt against the proceeds from such a negotiated purchase price for auction or sale of the collateral. Failing an agreement between the mortgagor and the mortgagee on the means of disposal of the collateral, the lender may apply to the local court to auction or sell the collateral. In either case, the sale or negotiated purchase price of the collateral shall be based upon market price.
The time frame required for the aforesaid enforcement varies, and typically ranges from 6 to 12 months.
There is no restriction on the lender’s ability to foreclose or realise on collateral in real estate lending implemented by governmental entities in response to the COVID-19 pandemic.
An existing mortgage debt may become subordinated to a newly created mortgage debt, the mortgage interest of which has been duly registered, only if the mortgage over such existing debt has not been duly registered. But if the mortgage over the newly created debt has also not been duly registered, the existing debt will rank pari passu with the newly created debt.
Given the principle that whoever causes the pollution shall be responsible for remediation, the party causing the pollution shall be held liable. Therefore, the lender, being the mortgagee of the real estate, will not generally be held liable. However, if the lender becomes the land use right owner in respect of such real estate as a result of foreclosure (or enforcement) of the mortgage, the lender may be held liable for such non-compliance if the party that caused the pollution cannot be identified.
The security interests created by a borrower in favour of a lender will not be made void if the borrower becomes insolvent, and the lender may continue to claim its senior debt against the collateral, although this will be subordinated to the contractor’s lien. In the event of restructuring during the bankruptcy proceedings, the lender will have to temporarily suspend its enforcement of the mortgage (unless damage to the collateral or a situation is likely to decrease the value of the collateral and might endanger the mortgagee’s interests). If the borrower enters into reconciliation or a liquidation procedure, the lender may continue to enforce the mortgage.
In response to the discontinuation of LIBOR at the end of 2021, lenders and borrowers frequently agree, mostly in cross-border facility agreements, to use an alternative interest rate (such as the interest rate published by the relevant reference banks) where there is no applicable LIBOR.
The PRC laws applicable to strategic planning and zoning at state level mainly include the Land Administration Law, and the Urban and Rural Planning Law.
Local governments shall, in accordance with these laws, prepare the urban planning and zoning, and reasonably determine the development scale, steps and construction standards of the urban locality.
In addition to the relevant laws and regulations, such as the Construction Law of the PRC and Regulation on the Quality Management of Construction Projects, the design, appearance and method of construction are governed by the national standards promulgated by the relevant authorities of the state council, such as the:
Generally, these regulations and rules apply to both the construction of a new building and the refurbishment of an existing building. Local governments may promulgate detailed implementing rules according to the relevant national regulations and policies.
The development and designated use of real estate are generally governed by the competent authorities of the state and local governments, such as:
The approval process for development of a new building and/or infrastructure project can be divided into four phases:
Refurbishment and expansion of an existing building also require the relevant approval and permits, which generally include the construction works planning permit (建设工程规划许可证), the construction works construction permit (建筑工程施工许可证), and the completion acceptance filing. Local authorities may also issue detailed implementation orders.
In addition, for any modification to urban and rural zoning, the relevant authorities that prepared such urban and rural zoning shall solicit public opinion by holding hearings or using other methods. In the event of any modification to the approved detailed construction plan or master plan of a project design, the relevant zoning authorities shall solicit the interested parties’ opinions by holding hearings or using other methods. Also, any entity or individual is entitled to report any zoning non-compliance to the competent zoning or other relevant authorities.
If a real estate developer objects to the approval decision of the competent authority, generally such developer may submit applications for administrative review to the local government or the administrative department at the higher level. If such developer further objects to the administrative review decision, it may file an administrative lawsuit to the court, unless such administrative review decision is, as provided by law, a final decision.
A developer or investor may enter into an investment or joint development agreement with the competent subdivision of the local government, specifying, among other things, local regulatory requirements upon construction, progress and the investment intensity, and the fiscal preferential treatment offered by the local government. The specific contents of such agreement vary from project to project and are subject to local policies and negotiations.
The regulatory authorities may enforce restrictions on the development and designated use of a piece of land in various ways.
Investors generally set up companies to hold real estate assets, unless an individual prefers to own a real estate asset directly. Under the Company Law, the types of companies include limited liability companies (有限责任公司) and limited companies by shares (股份有限公司). The liability of each shareholder of either a limited liability company or a limited company by shares is limited to its respective subscribed capital contribution to the company. Limited liability companies are the most common choice for acquiring real estate assets among both domestic and offshore investors.
Both limited liability companies and limited companies by shares are formed and governed by their articles of association (章程), which also govern their shareholders, directors, supervisors and officers, in addition to the companies themselves. These provide for, among other things, capital contributions, shareholding percentage, governance rights, distribution rights, dissolution and liquidation matters.
The minimum capital for companies engaging in real estate development may not be less than CNY1 million.
A Limited Liability Company
Pursuant to the Company Law, a limited liability company shall have:
Board directors are appointed by the shareholders’ assembly (or shareholder). A limited liability company may have a general manager, who reports to the board, to be appointed or dismissed by decision of the board.
A Limited Company by Shares
A limited company by shares is incorporated by two to 200 sponsors, with at least half of them having residence in the PRC, and has:
As in the limited liability company, board directors are appointed by the general assembly of shareholders, and the general manager is appointed or dismissed by decision of the board of directors.
Upon incorporation, a company must submit the annual report for the preceding year to the administration for market regulation through the corporate credit information disclosure system between 1 January and 30 June each year. No fees are required for the submission of such report.
Companies are also required to prepare financial accounting reports at the end of each fiscal year, which are audited by an accounting firm. In addition to such accounting expenses, additional fees may be incurred for other financial matters as agreed in a company’s articles of association. Such fees vary depending on the location of the accounting firm and the company’s assets and financial condition.
Leasing is the most common method to obtain the right to occupy and use any or all of a building for a limited period of time. In addition, the habitation right, if duly registered, is another method to occupy and use another person’s dwellings, generally free of charge unless otherwise agreed. The habitation right is a newly created right under the Civil Code.
Methods to obtain the use right to a piece of land vary depending on the type of land. According to the Land Administration Law, land is classified into farmland, construction land and unused land:
The use right to farmland may be obtained through a contracting arrangement, whereby contractors may enter into an agreement with a landowner or other entities with delegated authority to engage in agricultural production such as planting, forestry, animal husbandry, and fishery on the land, and benefit from such production.
The use right to construction land may be obtained by entering into a land grant contract (with land premiums to be paid) or a land allocation contract (no land premiums to be paid) with the competent local land authorities if it is stated-owned or the relevant collective if it is collectively owned.
In addition, real estate owners are entitled, under the PRC laws, to use the land or buildings adjacent to their own real estate for the purpose of obtaining and draining water, passage, ventilation and lighting, etc that are necessary for their life or production. Such neighbouring right is mandatory and no agreement between the parties is required. Parties may also create easement through execution of agreements to obtain the right to use another party’s real estate.
In practice, commercial leases may be divided into the following categories depending on the different rent payment methods:
PRC laws stipulate that the term in a lease agreement cannot exceed 20 years. If the term exceeds 20 years, the excess period will be invalid. When the lease term expires, the parties may renew the lease agreement for up to 20 years from the date of renewal of the lease agreement. Lease agreements with a term longer than the remaining term of the land use right to the land located beneath the property may be at risk because it is uncertain whether the landlord will still have the right to use the land after the land use term expires.
The rent for a commercial lease is generally negotiable and subject to agreement between tenant and landlord. However, rent for affordable housing such as public rental housing (公共租赁住房) and low-rent housing (廉租房) may not exceed the guiding rental rate promulgated by the local government.
In the wake of the COVID-19 pandemic, the Supreme People’s Court issued a special guiding opinion on 15 May 2020 and later, ministries and local governments issued various administrative orders to address leases affected by the pandemic. Termination of lease and claims for damages made by a landlord on the basis of a tenant’s failure to pay the rent of a commercial lease, where the tenant’s business proceeds have significantly declined, or the tenant has encountered working capital difficulties as a result of the pandemic or its control measures, will not be supported by the court. Macro and small businesses, which are tenants of state-owned landlords, are entitled to a rent reduction or exemption for up to three months in most cases. Other tenants of commercial leases may apply to the court to adjust the terms of the lease if the continued performance of the lease becomes inequitable or unfair under the circumstances of the pandemic. The aforesaid rules have since been consistently applied by the courts.
Generally, the length of a lease term is subject to the agreement between the landlord and the tenant but shall not exceed 20 years (see 6.3 Regulation of Rents or Lease Terms). The landlord and tenant may agree in the lease whether the term may be renewed and if so, how the lease may be renewed.
PRC law provides that the landlord shall be responsible for the maintenance and repair of the leased premises, unless otherwise agreed by the parties. The tenant has the right to require the landlord to maintain and repair the leased premises within a reasonable time limit when necessary. Where maintenance and repair affect the use of the leased premises, the rent may be reduced, or the lease term extended accordingly.
The frequency of rent payment is, subject to the agreement between the landlord and the tenant, generally on a monthly, quarterly or yearly basis.
The tenant shall pay rent in the amount and manner as agreed in the lease agreement. If agreed in the lease, the rental rate may be adjusted based on the agreed adjustment mechanism. For example, the rental rate may be adjusted annually based on the increase or decrease in the consumer price index in the preceding year. Parties are not allowed to unilaterally change rent payments, unless otherwise agreed by the parties or provided for by PRC laws, such as the occurrence of a force majeure, or an unforeseeable material change (other than commercial risks and force majeure) of circumstance.
When deciding the price adjustment mechanism, a fixed yearly increase rate, the consumer price index or fair market prices are often taken into consideration.
The landlord is responsible for the payment of VAT on the rent income generated from leasing real estate.
Generally, in addition to rent, a refundable security deposit, equal to rent plus a management fee of three to six months in most cases for commercial leases (or one to three months for residential leases), is required to be paid to the landlord at the start of a lease. If the tenant wishes to improve or fit out the property, the tenant may be required to pay a security deposit for the fitting-out or improvements, refundable after the completion of the work. Improvements or fitting-out work undertaken by the tenant is usually borne by the tenant, unless otherwise agreed.
Under the PRC laws, unless otherwise agreed by the parties, the landlord is responsible for the maintenance and repair of the leased premises. In practice, small maintenance and repairs of common areas and shared equipment, machinery and facilities are generally conducted by the property manager engaged by the landlord, and covered by the management fees, which are payable to the property manager by either the landlord or the tenant, subject to the lease agreement.
In practice, the tenant pays their own utilities and telecommunications fees incurred in respect of, or consumed at, the leased premises. Utilities and telecommunications fees incurred in respect of common areas, and public equipment, machinery and facilities are often shared and charged to the end user (ie, the tenant in most cases, or the landlord if otherwise agreed in the lease, or if the premises are vacant) in proportion to the floor area of the leased premises.
The landlord will usually take out and maintain, at their own cost, property all risks insurance for the leased premises, which covers physical loss of or damage to the insured property arising from any natural hazards or accident. Damages caused or expenses incurred by intentional acts or gross negligence, confiscation, requisition, destruction or damage by any action or order of any government or public authority, war, coup d'état, or strike are generally excluded. On the other hand, the tenant is usually requested by the landlord to take out and maintain through the lease term construction/installation works all risks insurance for the tenant’s fitting-out or improvement works, and public liability insurance for the tenant’s business operations in the leased premises.
Business interruption insurance, an insurance ancillary to the property all risks insurance, generally only covers losses incurred by business interruption resulting from property damage. In response to the COVID-19 pandemic, certain insurers have developed insurance products that include “Business Interruption Plus Infectious Disease Clause” to cover business losses (eg, gross profits and expenses) resulting from government epidemic prevention measures. Due to the recurrent and sudden outbreaks of coronavirus, insurers in China are becoming less interested in promoting such insurance products.
In practice, the landlord commonly imposes various restrictions in the lease agreement on how a tenant shall use the leased property, including but not limited to restrictions on the permitted use, subleasing, assignment, and fitting-out of the leased premises. Applicable PRC laws also require that use of the leased premises shall be in accordance with the zoned usage, and the tenant shall not change the load-bearing structure or demolish indoor facilities without the landlord’s approval.
Typically, the tenant must obtain the landlord’s prior consent if the tenant intends to improve or fit out the leased premises. A fitting-out plan is typically required in order to obtain the landlord’s written consent. To ensure the safety of the leased premises, the landlord usually requires that the tenant takes out insurance for such improvement or fitting-out works and engages qualified contractors. As discussed in 6.12 Restrictions on the Use of Real Estate, the tenant may not change the load-bearing structure or other main structure of the leased premises without approval. Furthermore, it is common practice for the landlord to require the tenant to complete all the approval, filing and recording procedures required by the competent authorities (including but not limited to the planning, construction and fire-protection approvals and completion acceptance) for such improvement or fitting-out at the tenant’s own cost.
Leasing of various types of real estate are mainly governed by the:
It is common practice to specify in the lease that the landlord is entitled to terminate the lease should the tenant become insolvent. Failing explicit agreement, the Enterprise Bankruptcy Law of the PRC shall govern. If the court accepts the tenant’s application for bankruptcy, the tenant’s bankruptcy administrator decides whether to rescind or continue to perform the lease agreement. Failure by the bankruptcy administrator to notify the landlord of its decision within two months from the date when the bankruptcy application was accepted, or to reply to the landlord within 30 days after receiving the landlord’s exhortation, will result in the rescindment of the lease agreement.
Rescindment of the Lease Agreement
Where the lease agreement is so rescinded, the tenant shall reinstate and return the leased premises, and the landlord is entitled to declare its claims to the court, in accordance with the bankruptcy proceedings, for the damages incurred thereunder. Where the administrator decides to continue the performance of the lease agreement, the landlord must comply. However, the landlord has the right to request the administrator to provide security. The lease agreement will then be deemed rescinded if the administrator fails to provide security.
It is common practice to specify in the lease that the tenant shall pay a refundable security deposit to secure the performance of its obligations under the lease agreement, and the security deposit may be utilised by the landlord, in whole or in part, to rectify the tenant’s default. The security deposit is, in most cases, equal to rent plus a management fee of three to six months for commercial leases, or one to three months for residential leases.
After the expiry or termination of a lease, the tenant generally has no right to continue occupying the leased premises. However, if the tenant continues to use the premises after the expiry of the lease without any objection from the landlord, the original lease shall be deemed as remaining in force but without a fixed term. Under such circumstances, either party can terminate the lease at any time, provided that the landlord gives the tenant reasonable prior notice of such termination. In addition, if the landlord intends to lease the premises after the expiry of the lease, the tenant shall have a right of first refusal under the same terms and conditions.
According to the PRC laws, the tenant may sublease part or all of the leased premises to a third party with the prior consent of the landlord. The sublease term should not be longer than the residual lease term of the original lease agreement. In addition, the tenant is liable for any damages caused by such third parties to the leased premises.
The following circumstances are often seen in a lease as causes for termination by the tenant:
The PRC laws also give the tenant the right to terminate the lease in the event of:
The following circumstances are often seen in a lease as causes for termination by the landlord:
The PRC laws also give the landlord the right to terminate the lease should the tenant sublease the leased premises without the landlord’s consent.
The PRC laws provide that a lease agreement shall, within 30 days of its execution, be filed with the competent real estate authority of the city where the real estate is located, otherwise the parties to the lease will be ordered to comply. Should the parties fail to comply within the prescribed time period, the parties shall be subject to a fine of CNY1,000 (in the case of an individual) or CNY1,000 to CNY10,000 (in the case of a legal entity).
The lease of real estate is not usually reflected in the Land Record.
If the lease is terminated as a result of the tenant’s default, the tenant must reinstate and return the leased premises in a timely manner. Should the tenant fail to do so, after the lease has been duly terminated, the landlord may cut off the water or electricity supply to force the eviction of the tenant.
The landlord may file a lawsuit to the court with competent jurisdiction for its confirmation that the lease is duly terminated. If the tenant still occupies the leased premises after the court has found that the lease has been terminated, the landlord may apply for an enforced eviction based on a valid judgment. In practice, the period required for a court to make a judgment and complete the enforcement procedure varies in different localities but is usually longer than a year.
A third party who is not a party to the lease cannot generally terminate the lease because it is not a party to the lease. However, under certain circumstances, third parties may make it impossible for the lease to be performed or fulfilled, resulting in early termination of the lease.
The most common pricing structures for construction include:
These are not mutually exclusive and sometimes, multiple pricing structures might be included in the same contract.
Fixed Quota Pricing
Fixed quota pricing means that the construction price, in accordance with the bidding documents, is a total of:
Bill of Quantities Pricing
Bill of quantities pricing means that the aggregate of the price for each component of the construction work, which is calculated based on the integrated unit price and quantity of such component, is determined based on the construction drawing and construction management and engineering skills.
Fixed Lump-Sum Price
With a fixed lump-sum price, the total construction price is a fixed amount which is not adjustable within the agreed work scope and conditions.
Fixed Unit Price
This means that the unit price is a fixed amount, which is not adjustable in response to any change in conditions or quantities, and the total construction price is the product of the weighted summation of the fixed unit price multiplied by the quantity required.
Cost Plus Fee
Cost plus fee means that the contractor is paid a fee in the amount agreed between the parties, in addition to reimbursement of the actual construction cost.
With an adjustable price, the contract price is adjustable subject to agreed conditions, such as an increase in labour or material costs due to inflation or market change, a change in the order, a change of quantities or other geotechnical conditions.
An owner may either enter into an EPC Contract with a general contractor, or separately enter into a design contract and a construction contract with a local design institute and construction contractor, respectively.
EPC Contracts include the following according to market practices:
Construction risks may be allocated between the parties to a contract, considering factors such as bargaining power, fairness and justice. For instance, the owner may transfer the risk of price increase to the contractor by adopting the fixed lump-sum price contract, or the contractor may agree to indemnify the owner only to the extent of the total contract price. Generally, risk allocation arrangements are valid and recognised by the courts, provided they are not in violation of the mandatory provisions of PRC laws and administrative regulations.
Furthermore, a project owner may require a contractor to take out and maintain project-related insurance (such as contractor’s all risks and third-party liability insurance) in favour of the owner.
The owner and contractor generally specify a duration for work, including milestone and completion dates in the contract, and manage the work progress through the following contractual arrangements:
Monetary compensation may be claimed by an owner in accordance with the contract or by law, if certain milestone and completion dates are not achieved.
In practice, the following forms of security are generally requested by the owner:
The contractor for construction work has the right of contractor’s lien over the construction in the event of non-payment by the owner, which is senior to a mortgage or other debts. Such contractor’s lien is valid for up to 18 months, commencing from the date the construction payment becomes due. The contractor’s lien may be removed if the overdue payments are made in full by the owner by voluntary payment or offset against the negotiated sale price (between owner and contractor) of the construction, or the proceeds from the auction of the construction, ordered by a competent court.
The PRC laws explicitly stipulate that no construction shall be delivered for use unless it passes completion acceptance. The owner must organise the geological survey contractor (勘察), designer, contractor and jianli (监理) (professional supervision engineer mainly responsible for the supervision and management of the construction quality and schedule) to attend the completion acceptance inspection; and, after completion acceptance is passed, the owner must go through specific completion acceptance filing formalities at the relevant government authorities, and obtain the Completion Verification and Acceptance Filing Certificate for the Construction Project (建设工程竣工验收备案证书), which may be replaced by an electronic notice from HUDA declaring that the completion acceptance has been passed, for certain small-scale non-residential construction works in some localities.
In addition, in the case of a residential housing project, the PRC laws also require the Residential Housing Quality Warranty and Residential Housing Use Manual to be provided by the real estate developer when delivering such housing, and certain localities, such as Shanghai, Shandong province and Tianjin, further require a certificate of delivery and occupancy issued by the local HUDA, to be obtained by the real estate developer before occupation of the newly built residential housing.
PRC companies are subject to payment of VAT for the sale of real estate, and the seller is the obliged taxpayer. The taxes payable are equal to the sale price multiplied by the applicable tax rate. Two methods are applied to calculate the sale price:
For a general taxpayer, if the seller acquires the real estate before 30 April 2016, it may choose the simplified method (at an applicable rate of 5%) or the general method (at an applicable rate of 9%). If the real estate is acquired after 1 May 2016, only the general method may be applied (at an applicable rate of 9%).
For a small-scale taxpayer (ie, whose VAT-taxable sales are no more than CNY5 million per year), the simplified method at an applicable rate of 5% will be applied. If VAT-taxable sales are no more than CNY100,000 per month, such taxpayer is exempt from the payment of VAT.
An equity deal is often chosen by companies over an asset deal as a way to mitigate tax liabilities. However, the State Administration of Taxation has issued certain official replies on a case-by-case basis to collect land appreciation tax from the seller in equity transfer transactions where the main asset of the target company acquired was the real estate. As a result, there might be potential exposure to land appreciation tax liability in similar equity deals.
Property tax and urban land use tax are the main municipal taxes paid on the occupation and usage of real estate:
Preferential policies on property tax and urban land use tax in respect of commercial real estate are available to taxpayers in a less favourable financial situation or in certain specific industries.
In the case of an offshore entity holding an onshore project company, which, in turn, holds real estate in the PRC, such offshore entity is subject to:
In the case of an offshore entity directly holding real estate in the PRC, which existed before July 2006, such foreign investor, if it has no establishment in the PRC or the income generated in the PRC has no actual connection with such establishment, is subject to:
According to the PRC Enterprise Income Tax Law, real estate held by a company is typically treated as fixed assets, which may be depreciated, and the relevant depreciation amounts are allowed to be deducted from taxable income. The land use right held by companies is usually treated as a non-tangible asset, which may be amortised, and the relevant amortised amount may be deducted from taxable income.
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In 2022, a confluence of natural disasters, global inflation, the COVID-19 pandemic, and geopolitical tensions created a year fraught with uncertainty. This tumultuous environment led to a significant economic downturn, adversely affecting numerous businesses in China, including the real estate sector. In response to the resulting economic turbulence, both central and local governments introduced a series of city-specific stimulus measures and policies throughout the second half of 2022, with particular focus on the real estate sector – a critical component of China’s economy. These initiatives were instrumental in reversing the economic downturn and restoring investor confidence in the real estate market. As a result, it is expected that the real estate sector will contribute more to China’s economy in the coming year, despite previous market fluctuations. Many investors maintain a long-term perspective, considering real estate as a stable investment option with less volatility than other assets, making it an attractive safe haven during challenging times.
Supply and demand changes resulting from demographic shifts are intrinsic factors contributing to market volatility in developing countries. Official data from China’s Bureau of Statistics reveal a year-on-year decline in net population growth since 2016, resulting in an overall decrease in demand for residential properties. Concurrently, as urbanisation reaches its peak, domestic housing inventories continue to rise year after year, reversing the longstanding excessive demand-supply dynamic within the real estate industry. The contraction of demand can also be attributed to the fact that market participants, including sellers, investors, and banks, are pessimistic about the market. Additionally, factors such as broken capital chains for developers and the time required for policy implementation are contributing to the decline in demand.
In early 2022, transnational investors in China’s real estate market began the year with optimism, anticipating a performance akin to the peak year of 2021. However, as interest rates have continued to rise and GDP growth turned negative, fears of a recession have loomed over the real estate market. Property prices are now expected to decline following a period of uninterrupted growth, with real estate investment trusts (REITs) and listed developers are plunging in value as shareholders sell off holdings.
Although China’s real estate market is currently facing turbulence, it remains far from a crisis. While various aspects of the market indicate wavering investor confidence, newfound opportunities are also emerging.
Signs of Recovery in the Real Estate Market
Since the second half of 2022, the central government has repeatedly emphasised the importance of real estate as a pillar industry for the national economy. As a result, they have implemented supportive policies to ensure the timely delivery of presold homes, which has led to a gradual stabilisation of the market.
In May 2022, the Central Bank of China and the China Banking and Insurance Regulatory Commission announced a mortgage rate cut with the Notice on the Adjustment of Differential Housing Credit Policy.
In July 2022, the Central Political Bureau of the Central Committee of the Party outlined objectives to curb housing speculation, ensure timely deliveries of presold homes, stabilise people’s livelihoods, and fully utilise city-specific policy toolboxes.
In August 2022, China Development Bank and the Export-Import Bank of China provided special loans of RMB200 billion to support the timely delivery of presold homes.
In September 2022, the central bank mandated that the six major banks complete the investment of RMB600 billion in real estate loans within the year.
In November 2022, the Central Bank introduced a RMB200 billion interest-free refinancing support plan. In the same month, the Central Bank of China and the China Banking and Insurance Regulatory Commission jointly issued a Notice on the Current Financial Support for the Stable and Healthy Development of the Real Estate Market, introducing the “three arrows” policy, namely credit financing, bond financing and equity financing to safeguard the reasonable financing needs of real estate enterprises.
In February this year, the China Securities Regulatory Commission officially launched a pilot real estate private investment fund to support the stable and healthy development of the real estate market.
As central and local governments continue to introduce and implement favourable policies, the real estate market is showing signs of recovery, primarily in the following two aspects:
First, property price trends in large and medium-sized cities indicate positive momentum, with transaction volumes for new commercial properties and second-hand properties remaining substantial. According to data from China’s Bureau of Statistics on housing prices in 70 large and medium-sized cities, published in February 2023, prices in all tier cities have risen month-on-month, with a significant increase in the number of cities experiencing price growth. New commercial property prices in first-tier cities increased by 0.2% month-on-month, while second-hand property prices rose by 0.7%, expanding the rate of increase compared to the previous month. A total of 55 cities saw new commercial property prices increase, and 40 cities experienced second-hand property price growth, an increase of 19 and 27 cities compared to the previous month, respectively.
Second, the index of completed construction area is demonstrating a recovery trend, and investment in real estate development continues to expand. According to data from China’s Bureau of Statistics, from January to February this year, the completed construction area in real estate saw a growth of 8%, marking the first positive figure following an 11-month cumulative decline. China’s investment in real estate development reached RMB136.69 billion in 2022, a year-on-year decrease of 5.7%, but with a significantly narrower decline compared to 2021. Data from the China Index Academy reveals that the total land turnover in February was RMB175.399 billion, up 8.88% year-on-year and 29.91% month-on-month, showing a notable rebound in investment.
On 7 March 2023, during the second “ministerial channel” interview held at the first session of the 14th National People’s Congress, Ni Hong, the Minister of Housing and Urban-Rural Development, expressed confidence in the stabilisation and rebound of the real estate market. The central government anticipates that, with the diminishing impact of COVID-19 and significant improvements in the industrial PMI since January, the real estate market will maintain a gradual recovery throughout the year.
The Implementation and Impact of “Ensuring Delivery” Policies in Various Cities
Under the principle of “ensuring timely deliveries of presold homes and stabilising people’s livelihood” advocated by the CCP Central Political Bureau meeting in July 2022, local governments have established various special payments and supporting rules. According to statistics from the China Index Academy, since July 2022, nearly 40 provinces and cities across the country have introduced a series of policy initiatives to ensure this objective, with each level of government and its officials held responsible for the goal. Specific methods include acquisitions performed by regional state-owned enterprises and financial institutions, as well as the establishment of bailout funds.
In August 2022, Zhengzhou city pioneered the country’s first real estate bailout fund. According to the Zhengzhou Real Estate Bailout Fund Establishment and Operation Plan, the fund, led by the local government, amounted to RMB10 billion. Other cities have followed suit, setting up local bailout funds. Hubei Province served as a pilot for the RMB30 billion bailout fund established by China Construction Bank, which was used to acquire problematic projects and convert them into public rental housing. Nanning set up a “stabilisation” real estate fund with an initial amount of RMB3 billion, based on the principle of government-led and market-oriented operation.
In addition to establishing bailout funds, local governments are also employing various innovative methods to revitalise projects, such as introducing state-owned enterprises and trust intervention to reinvigorate local suspended projects. For example, China Evergrande Group’s project in Longgang, Shenzhen, under local government guidance, introduced the local state-owned enterprise Ancheng Investment Cooperation. China Cinda Asset Management Co., Ltd., which is engaged in non-performing asset disposal, is also actively exploring ways to resolve real estate risks and has cooperated with the government to implement several real estate risk resolution projects.
As the key entities responsible for “ensuring timely deliveries of presold properties”, real estate developers have actively marketed their assets and raised funds. Many real estate enterprises, including Shanghai Shimao, China Fortune Land Development, and Jinke Property Group, have released equity financing plans. Positive progress has been made, as all parties involved have taken on the task and collaborated closely to advance the goal of “ensuring timely delivery of presold homes”.
Significant progress has been made due to the collective efforts of all parties involved in the task, who are working in close collaboration towards the shared goal of “ensuring the timely delivery of presold homes”.
Debt Restructuring of Major Developers
Since 2021, numerous domestic real estate developers have been struggling with the debt crisis, prompting many to seek debt restructuring to avoid bankruptcy. These attempts gradually took effect from the second half of 2022. By now, Guangzhou R&F, Greenland, and Logan Estate have announced debt extensions, while the debt restructuring of China Fortune Land Development, SUNAC, and other developers has also made significant progress. Overall, the liquidity pressure on domestic real estate developers has eased.
In addition to these self-rescue attempts by market participants, China’s macro policies and specific measures on the real estate market have also played a crucial role in combating the crisis. In the first half of 2022, the central government issued clear requirements to study and implement countermeasures to defuse risks while supporting the reasonable financing needs of real estate developers. Subsequently, under the macro policy of “ensuring deliveries of presold homes”, China Bond Credit Promotion Investment Co., Ltd., funded by several state-owned enterprises, strengthened its support for private developers’ bond issuance projects and successively provided credit enhancement guarantees for more than ten developers. Moreover, at the end of 2022, the China Securities Regulatory Commission (CSRC) decided to resume refinancing for listed real estate enterprises and related companies. These measures have expanded financing channels for developers, especially private ones.
Theoretically, various debt restructuring modes are available, including debt extension, adjustment of principal and interest, debt repayment through selling quality assets and debt-equity swaps. According to announced debt restructuring cases so far, most developers primarily opt for debt extension. For instance, R&F completed the rollover of domestic and foreign bonds in the second half of 2022, after selling assets like the Wanda Realm Hotel Beijing to recoup funds. CIFI, China Fortune Land Development and other developers have adopted similar plans. Additionally, some developers are assessing the “debt-equity swap” mode, but retaining control of the company remains a common concern for developers.
It seems that the combined strength of the policy and markets has temporarily stabilised developers’ situations. Nevertheless, the real estate developers have only gained a brief respite through debt extension, and solving the debt crisis completely is still a long way off. In the post-pandemic era, confidence in both the economy and the consumer market will need time to recover.
Blossoming of the Agent Construction Model
With the implementation of the “dual centralisation” policy (centralised land supply combined with centralised property opening sale, intended to have more governmental control over market fluctuation) launched in 2021, the real estate and infrastructure industry is undergoing corresponding adjustments and transformations. As competition intensifies for obtaining undeveloped land and with fewer options in sales strategy, many developers opt not to hold the land but rather cooperate with landowners (often local governments or their platform entities) to offer their development management services, known as “agent construction service”. This approach has become a safe and lucrative option for traditional developers, with increasingly broader applications in recent projects. As a result, the agent construction mechanism is emerging as a potential breakthrough for real estate enterprises to shift their business focus from front-end development to back-end services.
The agent construction service is not technically new in China, as it can be traced back to the 2000s when government-led investment projects began implementing the agent construction mechanism. In the decree “Decision on Reforming the Investment System” promulgated in 2004 by the State Council, the concept was explicitly proposed to encourage the government to employ real estate developers to manage the construction of infrastructure projects. However, in 2022 the agent construction business boomed in the private sector, and the current agent model is relatively more complex and multi-dimensional compared to its governmental counterpart, with diversified models, including pure service fee-based, fund-based and equity-based models. The concurrency of various models effectively meets the construction management requirements of professionalism and standardisation, providing a broad outlook and positive prospects.
In recent years, China’s agent construction business has surged rapidly, becoming an unstoppable trend. It is expected that, in 2022, agent construction projects will have newly signed contracts covering construction areas of 110.73 million square metres, reaching a historical peak with growth of 11.3% compared to the previous year.
In the years ahead, there will be an abundance of opportunities in the agent construction market, which will be most evident in areas such as local urban investment companies, government-supported housing, resettlement housing, non-performing assets, and the revitalisation of existing real estate assets of financial institutions. From this perspective, the agent construction system is beneficial for project owners to leverage the advantages of its business models and exert its core competitiveness to the fullest.
Against the backdrop of the “carbon neutrality” policy and the globally rising trend of ESG, green building construction will emerge as a vital economic growth point. The agent construction mechanism also contributes to the green economy due to its characteristics of “light assets”, “professionalised management”, and suitability for renovation projects.
Despite its enormous potential and significant industry empowerment, the agent construction system also faces challenges, such as insufficient qualifications of contractors and the imbalance between macro-level control and micro-level specialisation. The Chinese government is studying the regulatory framework of the agent construction mechanism for comprehensive supervision, particularly in private sectors, to establish a robust risk management system and align with the primary purpose of industry development.
A Boom in REITs can be Anticipated
Globally, REITs play a crucial role in the real estate financial market. China is catching up in developing a large REITs market to provide an exit solution for various investors, including the government, in the infrastructure sector. China’s REITs development began in 2016 when the Ministry of Commerce first proposed the “Suggestion on Opening the Financing Channels of Domestic REITs”. The underlying assets of the first REITs include infrastructure such as ports, logistics warehouses and industrial parks, distributed in first-tier cities like Beijing, Shanghai and Shenzhen. In 2021, a joint notice published by China’s National Development and Reform Commission and China Securities Regulatory Commission expanded the eligible classes of “infrastructure assets” to “new infrastructure”, including data centres, cable TV network projects, smart energy and subsidised rental housing.
Although fewer than twenty REITs are currently issued and traded in the Shanghai and Shenzhen stock exchanges, a boom in REITs can be anticipated, as a large number of potentially qualified projects are being submitted to authorities for further approval or being reorganised by investors or banks to get prepared. Most importantly, the financial market sees REITs as an attractive exit option that boosts investment confidence.
Real Estate Private Fund is Launched
To explore new development models to support real estate enterprises’ equity financing, the China Securities Regulatory Commission proposed on 28 November 2022 to allow qualified PE fund managers to set up real estate private equity investment funds to invest in existing residential real estate, commercial real estate and infrastructure in the future. On 20 February 2023, to encourage real estate funds to invest in specific real estate projects, the Asset Management Association of China (AMAC) officially issued the Guidelines for the Filing of a Pilot Scheme on Real Estate Private Equity Funds (for Trial Implementation). This document clarifies that PE fund managers can apply for pilot issuance of real estate private equity funds within a certain investment scope, investment equity-debt ratio, and expansion restrictions, etc. This measure confirms the role of real estate private equity funds and their development prospects, which will effectively promote real estate enterprises’ revitalisation of operational real estate and is expected to impact the pattern of funds and the real estate industry.
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