Abaci's Common Sense Investing

I recall K.S. Li once said in the press that in the good old days before 1997, a land developer could easily earn profit from three sources for every dollar it puts in a project.

1. Increasing demand for housing as people become more affluent
2. Inflation created by negative interest rate environment
3. Profit on construction and finance costs

And profits from 1 and 2 was often multiples of 3. Of course we all know what happened after the good old days when profits from 1 and 2 disappeared.

China property market is in a similar environment. But China doesn't have an inflation problem, quite the contrary its problem is too many people are producing too many stuff too quickly. This factor is nevertheless replaced by the speculation on RMB appreciation, which has created an even greater impact. So we can understand why HK developers, big and small, are all rushing into China to rekindle the long lost romance.

Land VAT was said to be in place since 1993 but has never strictly been enforced. The collapse of the property market soon afterward played a pivotal role in 'vetoing' this policy. Another reason cited was the lack of clear guidelines. Many local governments eager to grow and develop their cities simply charge 1-2% on sales proceeds as land VAT.

Valuing land like stocks is not science, and often a property valuer sounds no different from a stock analyst who will beat yesterday's self in no time. Take One Silver Sea in HK as an example, a mid-market residential land acquired at the bottom of the property cycle and then repackaged and sold successfully as an ultra luxury property project like those on the peak. How are we to divide up the profit between (i) that due to the appreciation of land during the time of development and (ii) that due rightfully to the competence of Sino Land. Or when Thomas Lau reaped a huge profit from breaking up a Wanchai shopping mall into 100 or so smaller shops and then selling them out successfully, was there land appreciation involved? You can argue yes because that's exactly what's in Mr. Lau's pocket, but you can also argue no since most, if not all, buyers lost money afterward. Money was made timely from the sentiments of the buyers but not the land.

Now the guidelines have been set and it's passed on to the local government and tax bureau to enforce it. From what I read from the paper the land VAT appears to be a profit tax but done on individual project level (I'm waiting for details as to how this 'profit' is calculated). Luxury property sector is predicted to be hit the hardest as the profit is the highest. On every dollar of profit made from land development now the government wants a bigger slice. (It's like 'oh! the land I sold you last year was sold too cheap and now you are rich and I want compensation!'). In communist fashion the rates charged are progressive too, starting at 30% and topping out at 60%. Together with a 25% unified profit tax rate, the effective tax rate will be from 47.5% to as high as 70%! Just imagine what this'll do to the supply equation.

I know Canada (many say it's the most communist non-communist country) has a progressive personal income tax that also tops out at around 60% or maybe slightly less. The natural result, intended or not, is nobody would want to work that hard when the government is receiving more than they do on the marginal income, i.e. putting up 1 dollar effort but getting only 40 cents. Some even deny promotion as it'd make them earn 'less' overall! In the end there's more harmony than prosperity.

The intent of the government is clearly to curb speculation and rises in property prices, but the foreseeable result is also that there will be lesser supply in the future, especially in the luxury sector where developers are 'encouraged' to move away from. How contradictory this is? Or does the China government believe it has the right prescription for this overheating property market?

(To be continued)