Newspaper article International New York Times

In China, a Building Frenzy's Fault Lines ; Many Foreign Investors, Lured by Real Estate Boom, Overlooked Risks

Newspaper article International New York Times

In China, a Building Frenzy's Fault Lines ; Many Foreign Investors, Lured by Real Estate Boom, Overlooked Risks

Article excerpt

As foreign investors clamored for a piece of China's real estate boom, it was easy to overlook the type of risk that brought down the property developer Kaisa.

As the real estate market in the United States was collapsing in the mid-2000s, Wall Street went in search of new terrain, and found it in China. All across the country, from Beijing to Shenzhen, sprawling housing developments and business districts were popping up, seemingly overnight. Real estate prices were soaring. Western banks, hedge funds, private equity firms and other investors wanted a piece of the action.

Billions poured into Chinese real estate, and big foreign financial firms hunted for the next hit -- the small bet that investors could ride to great heights. One of those firms, Credit Suisse, scoured the landscape and in 2007 discovered Kaisa, a relatively small property developer in Shenzhen that mostly bought and rehabilitated distressed properties. Credit Suisse brokered a $300 million investment deal for Kaisa, and two years later, it went public. Its chairman, Guo Yingcheng, posed for photographs on the floor of the Hong Kong Stock Exchange holding a statue of a bull, which seemed to signify hopes for his company's coming bull run. His colleagues poured Champagne into an ice sculpture of the company's stock code: 1638.

With the $450 million raised in the initial public offering, Kaisa embarked on an aggressive expansion into 20 more cities. It formed a partnership with Marriott hotels and announced plans to build one of the world's tallest buildings. Kaisa shares skyrocketed, helping lift the fortunes of its Western patrons, including the Carlyle Group, an American private equity firm.

Then came the fall.

The real estate market slumped, dragging down the rest of the Chinese economy.

Developers, in particular, were under pressure, as foreign investment dried up.

And in this market tumult, reports surfaced late last year that Kaisa's chairman was being questioned in a corruption case. With little explanation, in December, the Shenzhen authorities blocked Kaisa from selling homes at several major residential developments.

Soon after, Mr. Guo, the chairman, resigned "due to health reasons." A string of resignations followed that wiped out virtually the entire senior management team, including the chief executive, chief financial officer and the head of investor relations.

The chairman's family bailed out of the company in February, agreeing to sell its 49 percent stake to a Chinese developer for $580 million, a small fraction of its value just months earlier.

Stock investors got burned as Kaisa's share price fell 55 percent in just a few months. The developer had also tapped the debt markets, selling $2.5 billion worth of bonds overseas to big fund management companies like BlackRock and Fidelity Investments.

Kaisa is now pushing such bondholders to accept roughly 50 percent of the value of their holdings, or risk getting pennies on the dollar if the company goes bankrupt.

"We've seen problems with other developers, but nothing like this," said Peter Churchouse, a property consultant in Hong Kong and a former executive with Morgan Stanley. "There's a deep mystery here."

The Kaisa story offers an unusual window into what can go wrong when investors rush headlong into China. In a country where the profits have been so tempting, the red flags -- the complex corporate structures, the opaque deals, the political influence -- often go unheeded. Investors, even sophisticated investors, either miss them or ignore them.

The Chinese authorities have offered no reason for their decision to freeze sales at Kaisa properties. And the company's executives are not talking. But there were warning signs. Reports of bribery. Insider deals involving more than a dozen of the chairman's relatives. An increasingly complex network of affiliated companies. And a land development project tied to a former Chinese security chief and Politburo member, Zhou Yongkang, who was arrested and expelled from the Communist Party last year in one of the biggest graft cases in decades. …

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