Every Cloud Has A Silver Lining: Outlook of Real Estate Industry and Its Legal Services in 2023

Author: DU Yusong, LIAO Lilin Grandall Law Firm

Over the past few years, governments' tightened administration on the real estate sector combining with the impact of pandemic controls, and the global-wide restructure of industrial chains together have caused a widespread impact on the traditional real estate realms including residential, office, and commercial properties. At the end of 2022, the People's Bank of China and the China Banking and Insurance Regulatory Commission jointly issued the Notice on Maintaining Current Financial Support for the Stable and Healthy Development of the Real Estate Market (the "Notice"), listing 16 measures to coordinate and encourage local governments, financial institutions and other entities to promote the stable and healthy development of the real estate market, and reiterating the critical importance of the real estate sector as a major economy stabilizer and development booster. With this macro perspective, real estate developers are forging a stronger bond with legal professionals to handle the crises, enhance compliance, and grasp the opportunities in policies. Law firms can serve the real estate business to better manage the challenges of the new era. 

Firstly, the latest real estate administration policies have guided the real estate industry to gradually enter a new stage of development, and the grasp of the industry trends shall be based on the study and understanding of the policies.

I. The Switch of Real Estate Administration Policies

Compared with the previous tightened regulation, the real estate finance regulatory policies in 2022 generally focus on "rectification of deviation" and "bailout". Since March 2022, various ministries have started to actively introduce market-friendly policies to promote the transformation of the real estate industry, to encourage financial institutions to grant M&A loans in a steady and orderly manner, to focus on supporting high-quality real estate developers to merge and acquire high-quality projects of troubled real estate developers, and to promote the virtuous cycle and healthy development of the real estate industry. At the same time, real estate financing policies have been progressively loosened, with the introduction of policies such as M&A loans no longer being counted into the "three red lines" and affordable rental housing loans not being included in the administration of real estate loan concentrations.

Since November 2022, the regulatory attitude towards the financing of real estate developers has further changed. The introduction of the Notice rectified the over-tight housing-related credit and financial administration policies, elaborated in detail how the finance sector shall help real estate achieve a "soft landing" through  six aspects including maintaining the stable and orderly real estate financing, assisting in the risk disposal of distressed real estate developers, phased adjusting of partial financial administration policies and strengthening financial support for housing rental industry. On 15 December 2022, the Vice Premier of the PRC Liu He delivered a written message in public, pointing out that real estate industry is a pillar industry of the national economy of China, and that in response to the downside risks that have emerged, several policies have been introduced and new initiatives are being considered to improve the balance sheet of the industry and to guide market expectations and confidence to rebound.

With the gradual easing of policies, we believe that market performance will pick up compared to the past year. However, the development model of "high debt, high leverage and high turnover" in real estate industry is no longer sustainable, and it is urgent to shift to new development models such as leasing, asset-light development, inventory revitalization and industrial real estate. In the future, these sectors may receive more policy support, and real estate developers should seek new opportunities in these realms to achieve high-quality development.

In an economic adjustment cycle of the real estate sector, the traditional sectors witness an insufficient quantity of new builds, while the revitalization, renewal, and dispute resolution around the existing inventory properties are brought into the limelight, all of which demand from legal professionals a defter hand to carry out in-depth professional research and a far superior mind with rich sector-specific experience and insight. To be more specific:

II. Bailout of Distressed Real Estate Developers

Macroeconomic policies, COVID-19 pandemic, and industrial chain transfer have joined forces to transform the commercial atmosphere surrounding real estate developers, with a number of developers being sucked into operational hardship. Even top large real estate developers, including Evergrande and Sunac China, have frequently defaulted on their debts, while the small and medium-sized developers find themselves in more dire straits. Though with the recent policies turnaround, many of them would still require debt restructuring or even bankruptcy reorganization. In response to market changes, legal services have shifted from providing support for real estate investments, land transactions, and acquisition deals to assisting real estate developers in obtaining financing through multifarious channels, disposing of non-performing assets, undergoing bankruptcy, and restructuring as well as in providing services to robust developers in their purchase of troubled developers and select properties. The ability to combat complicated problems is needed more than ever to revitalize distressed companies and assets so as to help unlock values that benefit more than one party. Unlike the new builds market, where business practice is relatively standardized, distressed investment opportunity is peculiar and one of a kind, setting a higher bar for realty operators and legal professionals to identify and respond to risks based on their accumulated expertise.

III. Urban Renewal Opportunities

China in the 14th Five-Year Plan has made plain its aim to "accelerate urban renewal by redeveloping and upgrading the functions of old residential areas, old factory areas, old neighborhoods, and urban villages, among other idle zones, and by promoting the renovation of old buildings". Beijing, Shanghai, Chongqing, and other cities have since lined up to introduce implementing policies. Figures released by the National Bureau of Statistics of the PRC indicate that the urbanization rate of China has stood at 65.22% at the end of 2022. According to the experts from the Ministry of Housing and Urban-Rural Development, the urbanization rate is projected to climb to the range of 65% to 70% during the 14th Five-Year Plan period but at a gradually reducing pace. As such, urban renewal in the new era, in contrast to the "Three-old Renovation" in the past, will be veering from large-scale demolition, construction, and relocation to "high-quality growth" focusing on the existing inventories with a human-oriented emphasis. In the years to come, smart cities, eco-cities, and the like will be a key destination for investments worth up to tens of trillions Renminbi, to be accompanied by an influx of legal services that support those investments. 

IV. Real Estate-Related Dispute Resolution

In a downcycle of the sector, real estate-related disputes continue to spring up one after another. Combining our practical experiences and referring to the observations of the Beijing Arbitration Commission, the main features of real estate-related disputes in recent years are as follows. Firstly, as a result of the falling house price, there has been an increase in the number of default cases where buyers' mortgage payments are cut off or overdue, and the number of foreclosures has also surged. Secondly, the quality issues and illegal renovation issues of properties has deteriorated due to the cost reduction of real estate developers. Thirdly, the market downturn has exacerbated the disputes between real estate developers over their cooperation in project development. Fourthly, due to the economic downturn overlaid with the previous pandemic prevention, the default cases in the commercial real estate sector have been more than ever. Fifthly, the number of real estate developers suffering from liquidity crises has been increasing, aggravating the disputes between real estate developers and construction companies, material suppliers and financial institutions. In an effort to better tackle escalating litigation risks, real estate developers ought to work out preventative measures beforehand, heeding the potential risks once the business is started, and establishing compliance and risk management programs in a more proactive manner to effectively mitigate the costs and expenses arising out of future lawsuits. 

Additionally, new areas of economic growth and new trends in government regulation are cultivating the formation and evolution of new businesses, exemplified by new infrastructure including internet data centers (IDC) and legal compliance following tighter antitrust enforcement. 

V. IDC Continually as a Windfall for Investment in the Context of Digital Transformation

The pandemic in the past three years has led the smartphone and internet penetration rate to experience a meteoric rise, which fueled the galloping growth of the digital economy. China is set to become one of the world's largest data hubs, further firming up the foundations for the high-speed buildout of IDC across the country. In February 2022, the National Development and Reform Commission of the PRC (NDRC), as a step toward the goal of reinforcing digital transformation, unveiled the "Eastern Data and Western Computing" project, another national endeavor to optimize resource allocation in addition to "South-to-North Water Diversion", "West-to-East Power Transmission", and "West-to-East Gas Transmission". The NDRC forecasted in a press release that, during the 14th Five-Year Plan period, there would be a surge in big data center investment at an annual rate exceeding 20%, which would stimulate investments across various industries and sectors beyond three trillion Renminbi in worth. Riding the tailwinds created by market developments, national needs, and encouraging policies, IDC will continue to be a windfall for investment. Sitting at the intersection of asset-heavy businesses and high-tech industries, IDC forms a relatively specialized sector which imposes stricter requirements for both capabilities in the traditional areas such as real estate, investment and financing, and telecom, as well as expertise in the emerging realms of data security, energy conservation and carbon reduction, ESG etc. Those requirements set the bar for the depth and breadth of expertise of IDC's legal services teams. 

VI. Increasing Demand for Industrial Parks

As the world changes, many old factory buildings and traditional industrial parks are in urgent need of revitalization due to their inability to achieve their output targets and meet the demands of the new industries. Meanwhile, for the purpose of optimizing the urban spatial layout, promoting the concentrated development and transformation and upgrading of industries, the industrial enterprises will gradually relocate from urban areas to suburban industrial parks. Hence, there is an increase in the renovation of old industrial parks and construction of new type industrial parks, especially in the eastern region and the Yangtze River Economic Zone, where in the cause of cultivating advanced manufacturing clusters, the demand for new type industrial parks is increasing in both quantity and quality. The renovation of old industrial parks depends on the proper handling of the original projects, the evaluation of the land use conditions and the management of the whole life cycle of the new industries. Legal professionals should also closely adapt to the new demands and act in response to such changes with the upgraded legal services.

VII. Impact of the Amendment to the Anti-Monopoly Law on Legal Practice in Real Estate Investment

The real estate sector is generally deemed as an industry with relatively adequate competition and distributed market shares, and therefore not considered as the focus of anti-monopoly supervision for long. Among the numerous M&A transactions in the real estate sector in the past, only a few were declared to the Anti-monopoly Bureau for concentration of undertakings review, while cases where parties were penalized for unfulfillment of the duty to declare were rare. However, with the implementation of the Amendment to the Anti-Monopoly Law on August 1, 2022, the legal liability for violation of laws or regulation of unfair competition is aggravated significantly, greatly strengthening the deterrence of the Anti-Monopoly Law. The newly promulgated law has raised the importance of competition policy to a new level for the construction of the market economy. For a proposed M&A transaction in the real estate sector that falls into the scope of declaration under the new law, if the parties habitually fail to declare, such proposed transaction will be possibly exposed to greater risk of investigation than before and subject to a heftier fine. On the other hand, if the parties file a declaration in accordance with the law, it is more likely to eliminate the hidden risks of regulatory punishment in the transaction through a speedy investigation process with relatively lower costs meanwhile increasing the certainty of the transaction, given the small possibility of a real estate transaction being identified as monopolistic practice. Therefore, the legal services in assisting real estate enterprises in antitrust filings are expected to increase significantly.

Lastly, in order to expand channels for private investors in the market, infrastructure REITs will accelerate the expansion of fundraising. The market also calls for easing the policies on foreign investors. With abundant funds, the real estate market will bottom out and gradually embark on the track of stable and sound development.

VIII. Expanded Offering in REITs

The rules for expanded offering in infrastructure-backed real estate investment trusts (REITs) have been issued in 2022, which make clear that the efficiency of project recommendation and review will be improved to encourage more qualified infrastructure REITs projects to be listed in the market. The rules further specify affordable rental housing, ecological and environmental protection, industrial parks, warehousing and logistics, new infrastructure project, and other assets as the key areas for development of the infrastructure REITs. In December 2022, the Central Committee of the Chinese Communist Party and the State Council issued the Outline of the Strategic Planning for Expanding Domestic Demand (2022-2035), further requiring the orderly promotion of the healthy development of infrastructure REITs. It is foreseeable that driven by the policy and market demand, the accelerated development of infrastructure REITs will effectively revitalize the existing assets and promote the virtuous cycle of existing assets and new investments. Throughout this process, legal professionals will shepherd the development of infrastructure REITs.

IX. New Opportunities for Foreign Investors in Real Estate Investment

The previous strict policies applicable to foreign investors in real estate have been gradually eased. The real estate sector is not named on China's Negative List for Foreign Investment Access and foreign real estate investors are entitled to national treatment. The updated criteria of the application for developer qualification are very friendly to foreign investors, which allows the investors with no project in process to file the application. Although there are still restrictions on real estate enterprises in foreign debts borrowing, the voices calling for opening-up are getting stronger with the hope of bringing more benefits to foreign real estate investors. At the same time, in the new economic climate, in line with the idea of human-oriented development and the need to enhance the level of urbanization, foreign real estate investors can adopt a more flexible, asset-light investment strategy by providing high-caliber operation management services and brand value, etc., to increase the flexibility in and to improve the return on their investments. In the process of such transition, legal professionals can assist foreign real estate investors to effectively grasp the key compliance issues of the new businesses and formulate more sophisticated investment strategies.