A hot year for real estate

On April 13 2010, the Ministry of Housing and Urban-Rural Development (Mohurd) issued the Circular on the Issues Relevant to Further Strengthening the Regulation of the Real Property Market and Improving the System for Pre-sale of Commodity Residential Premises (住房和城乡建设部关于进一步加强房地产市场监管完善商品住房预售制度有关问题的通知) (Pre-sale Circular). The Pre-sale Circular regulates developers' pre-sale activities and (i) prohibits developers from charging a deposit, prepayment, subscription, reservation or other similar fees to circumvent pre-sale requirements, and (ii) requires such developers to publish a list of all residences available for pre-sale together with their sales prices within 10 days of the pre-sale permit receipt. The Pre-sale Circular also empowers and urges local governments to adopt implementing rules to establish a system for the administration of pre-sale proceeds.

After the adoption of the Pre-sale Circular, numerous provinces and municipalities (including Beijing, Guangzhou, Zhejiang Province, Nanjing, Whuhan, Qingdao, Zhengzhou, and Shijiazhuan) have promulgated local implementing rules. These rules typically require the applicable real estate administration authorities to work with designated escrow banks to limit the developer's use of pre-sale proceeds solely for the payment of construction costs until construction completion.

The Pre-sale Circular establishes a more transparent pre-sale system and, together with local implementing rules, prevents developers from using pre-sale proceeds for non project-related costs (including the increase of their land banks). As developers are constrained by both more restrictive monetary policies and by the way they use cash generated by development projects, foreign investors may find these developers more receptive to foreign investment both at the project and platform levels.

National Ten Guidelines and New Five Measures

On April 17 2010, the State Council issued the Circular on Determined Suppression of the Exceedingly Rapid Rise of Certain Urban Housing Prices (国务院关于坚决遏制部分城市房价过快上涨的通知) (No. 10 [2010] of the State Council) (National Ten Guidelines). On September 29 2010 (i) Mohurd, the State Administration of Tax (SAT) and the Ministry of Finance (Mof) jointly issued Circular 94, (ii) the People's Bank of China (PBOC) and the China Banking Regulatory Commission (CBRC) jointly promulgated Circular Yinfa (2010) No.275, and (iii) Mohurd, the Ministry of Land and Resources, and the Ministry of Construction jointly issued Circular Jianfang (2010) No.55 (collectively, the New Five Measures).

The State Council has empowered each jurisdiction, typically on a city-by-city basis, to decide whether the economics of their particular market make it advisable to adopt the National Ten Guidelines and the New Five Measures, which are intended to curb the rise of housing prices and provide the following further restrictions on mortgage lending policies: (a) for the purchase of first homes over 90 square metres, down payments are required to be at least 30%, (b) for the purchase of second homes, down payments are required to be at least 50% with interest rates at least 10% in excess of the PBOC base rate, and (c) loans for the purchase of third (or subsequent) homes are suspended.

The National Ten Guidelines also reinforce regulations on developers' land purchases, and financing, pre-sale and leasing practices. Relevant local authorities are required to penalise developers who withhold pre-sale properties from the market to increase prices. These penalties may include disqualifying developers from engaging in property development. The New Five Measures further provides that for developers who intentionally and wrongfully delay development, change land use, or delay construction commencement or completion, the relevant authorities are to suspend or disapprove that developer's public listing plan, corporate bond issuance, and/or prohibit their acquisition of new land. Additionally, commercial banks are prohibited from granting new loans or extending existing loans to these developers.

To date, 11 municipalities (including Beijing, Shanghai, Shenzhen, Xiamen, Ningbo, Fuzhou and Hangzhou) have adopted local regulations to implement the National Ten Guidelines and New Five Measures. Market rumours currently anticipate that some or all of these restrictions are temporary and may be rescinded as market dynamics change.

Reiteration of foreign investor restrictions

On November 4 2010, Mohurd and the State Administration of Foreign Exchange (Safe) jointly issued the Circular on Further Regulating the Administration of Premises Purchases by Overseas Organisations and Individuals(关于进一步规范境外机构和个人购房管理的通知) (Jianfa (2010) No. 186) (Circular 186), which reiterates several existing restrictions applicable to the foreign investment in real estate and adopts practical enforcement policies for certain restrictions.

Circular 186 reinforces existing Circular 171 restrictions, including that (i) each foreign individual may only purchase one residential property for self-use, and (ii) each foreign branch office or representative office may only purchase non-residential property in the city where it is registered for its own office use. Circular 186 also includes new verification procedures which require foreign purchasers subject to these restrictions to provide a written undertaking regarding their compliance with these restrictions together with certain supporting documents prior to approval of a title transfer, and reiterates the requirement for strict compliance with the foreign exchange settlement procedures of 2006's Safe Circular 47. Circular 186 clarifies that the “non-residential property for office use” policy applies to all foreign branch offices and representative offices.

There has been confusion regarding whether Circular 186's restriction on foreign branch offices and representative offices overrides existing rules with respect to foreign-invested enterprises which receive specific approval to purchase, develop and/or own Chinese real estate. These restrictions do not appear to govern such foreign-invested enterprises but, rather, govern certain entities that were not specifically approved to purchase or own Chinese real estate. Since the issuance of Circular 171, foreign investors engaging in real estate development and/or investment have been required to receive approval from the Ministry of Commerce (Mofcom), or its relevant local counterpart, to operate in China either as a wholly foreign-owned enterprise or as a joint venture company. Circular 186 does not appear to change the rules applicable to these companies, or to have changed the relevant required approvals.

Considering the series of recent measures taken by the Chinese government to control the domestic real estate market and the flow of “hot money” into China, Circular 186 is another indicator that the Chinese government is seeking to cool down the market. If the existing measures do not have their desired effect, it is expected that the government will seek to impose additional measures.

Circular 698 on offshore transactions

On December 10 2009, SAT issued the Circular on Strengthening the Administration of Enterprise Income Tax on Income Derived from the Transfer of Equity of Non-tax-resident Enterprises (关于加强非居民企业股权转让所得企业所得税管理的通知) (Circular 698). Circular 698 regulates offshore share/equity transactions, and applies retroactively to all transactions occurring on or after 2007. Circular 698 is particularly notable because it represents the first time that China has adopted specific measure aimed at taxing offshore transactions. Circular 698 applies to both (i) the direct sale of a Chinese company and (ii) the indirect sale of such a company through the sale of offshore equity. The regulation of the sale of direct or indirect offshore equity interests in a Chinese company is particularly noteworthy because it marks a profound change from the assumption of only a few years ago that no China tax was due with respect to offshore transactions.

Foreign investors who use or have used offshore holding companies to make investments in Chinese real estate should pay particular attention to the retroactive effect Circular 698. To date, it is not clear what impact Circular 698 will have on transactions where no Circular 698 filing was made with respect to transactions occurring prior to its adoption. At a minimum, foreign investors should review their current ownership positions to assess the implications of the prospective assessment of retroactive tax.

Foreign-invested partnerships for investment funds

On March 1 2010, the Measures for the Administration of the Establishment of Partnerships in China by Foreign Enterprises or Individuals (外国企业或者个人在中国境内设立合伙企业管理办法)( FIP Measures) became effective. Under the FIP Measures, formation of a foreign-invested partnership (FIPs) would not require approval by Mofcom, but merely require registration with the local counterpart of the State Administration of Industry and Commerce (SAIC). FIPs are still subject to foreign investment restrictions applicable to the specific industry in which an investment is made.

The FIP Measures reflect the Chinese government's encouragement of the use of the partnership structure by foreign investors. The FIP Measures do not contain a minimum partnership capital requirement or contribution timeline, implying regulatory flexibility. The measures do not, however, clarify how a foreign-invested partnership's foreign currency capital contributions will be permitted to be converted into renminbi (Rmb) in conformance with Safe Circular No.142 (governing the conversion of a foreign-invested enterprise's registered capital), and how repatriation will be administered when foreign partners receive foreign-invested partnership Rmb distributions and/or a return of capital. Since the issuance of the measures, the Carlyle Group and Fosun International have jointly formed a private equity FIP in Shanghai.

Investment rules of insurance funds

On September 5 2010, the long-awaited Tentative Measures for Investment in Immovables with Insurance Proceeds (保险资金投资不动产暂行办法) (Bao Jian Fa [2010] No. 80) (Real Estate Investment Measures) and the Tentative Measures for Equity Investment with Insurance Capital (保险资金投资股权暂行办法) (Bao Jian Fa [2010] No. 79) (Equity Investment Measures) were issued by the China Insurance Regulatory Commission (CIRC). These two new measures were promulgated in furtherance of the Tentative Measures for the Administration of the Application of Insurance Capital (保险资金运用管理暂行办法) (CIRC Order [2010] No. 9) (Insurance Funds Utilisation Measures), which were issued by the CIRC on July 30 2010.

After a year-long debate and discussion among many industry participants and interested parties after the adoption of the amended PRC Insurance Law (中华人民共和国保险法) almost a year ago, opening the door to Chinese insurance companies' investment in real estate and non-public equity, these new measures represent the first official attempt by the CIRC to provide detailed guidance as to the procedures and requirements for Chinese insurance companies to expand their investment channels into the real estate and private equity sectors. Under these measures, up to 10% of an insurance company's total insurance assets are permitted to be invested in the real estate sector. Insurance funds are not only allowed to be invested in real property, but are also allowed to be invested in real estate-related financial products (for example, real estate investment funds or Reits). The pool of capital available to insurance companies for real estate investment is exceedingly large (estimates of approximately Rmb 450 billion are common) and the entry into the real estate market of insurance companies will, over time, have a profound effect on Chinese real estate including, potentially, further advancing the institutionalisation of the real estate asset class.

David Blumenfeld, Alex Wang and Cindy Pan, Paul Hastings Janofsky & Walker, Shanghai