How to control financial risks in real estate development?

Architect of China Industrial and Commercial Bank; Xu Gang, PhD, Ohio University (OSU). Without the support of financial capital, real estate development is almost impossible. And real estate and real estate development is a huge potential market for financial capital. Therefore, how to understand and control the financial risks in real estate development has become the most concerned issue for financial capital. Domestic financial institutions are inexperienced, and static means to control risks will be an obstacle to the development of China's real estate financial industry. After the domestic financial market is fully opened, financial institutions in China will lose most of the real estate development market. Establishing a professional risk management industry and carrying out financial capitalization, specialization and dynamic risk management in the development process may be the best solution for domestic financial institutions. How to control the financial risks in the process of real estate development? First of all, we should recognize the staged capital demand and risks in the process of real estate development, including: time function of capital demand, capital source, possible capital risks and so on. According to the time demand of project development progress (that is, phased capital demand), controlling various risks in the process of real estate development by stages is the basic idea to control the financial risk of the whole project development. The development process of real estate projects is divided into four main stages: project start-up, project construction, project completion and project handover. Phased control of development risk With the continuous improvement of domestic real estate laws and regulations, whether developers can obtain land development rights is the key to the start-up stage of the project, and obtaining development rights requires a lot of financial support. In the case that China's financial system, especially the financial system involved in real estate development, is not perfect, it is not surprising that developers use irregular methods or even illegal means to solve the problem of real estate start-up funds. Objectively speaking, these methods have promoted the development and expansion of the real estate market in China. At this stage, unless assisted by experienced risk management managers, financial capital can't control risks at all, so we can only pray for the operational ability of developers. With the assistance of experienced professional investment consultants and management companies, the financial risks at this stage can be effectively controlled. After the development project entered the construction period (obtained five certificates), the development project itself has gradually formed measurable assets. This part of assets is the main guarantee for developers to raise funds during the construction period. For financial capital, the asset protection of this unfinished project has great potential risks. Because financial institutions lack the ability to realize these assets. Controlling the financial risk in the construction stage depends on the judgment of the developer's development ability and construction management ability. Another control method is to hire a professional investment management consulting company to provide third-party risk management. How to judge the value orientation of the real estate market in a specific region? Can development projects be absorbed by the market? Only when the project is sold can it be reflected. The value orientation of real estate market is a barometer of macro-economy and regional economy of the whole country. It takes one or two years for real estate to start investing and put into use, and only God knows how the market will change. The main financial risk at this stage is market risk, which is an unknowable and unpredictable natural irregularity. Although the whole real estate market in China is still in short supply. However, in a specific region and a specific price position, the supply of real estate has exceeded demand. Especially the urban construction waste generated by inexperienced developers will bring huge market potential risks to financial capital. In addition, the start of domestic developers mainly draws on the development experience and model of Hong Kong. Hong Kong is at least 20 years behind the United States in terms of laws, regulations and development model. But also has special geographical environment, economic environment and market characteristics. China has a vast territory and scarce resources. The utilization of land resources and the characteristics of the real estate market are closer to the situation in the United States after World War II. I think financial institutions, real estate economic research institutions and even large real estate development enterprises should seriously study the relationship between macro-trend of real estate and micro-market, including the influence of employed population on real estate economy, the relationship between personal income and housing demand, the road map of housing demand development of specific groups and other market issues. Although no one can predict the sudden changes in the market. However, it is better to study the market than not to study it at all. The only way to control market risk is to take a positive attitude and beg God's help. This is what we often say that real estate is a "gambling game". When the developer hands over the product (building) to the user, the development project is truly completed. In fact, financial capital has not escaped the connection with real estate, and the financial capital involved in project development has transferred the risk to the financial capital holding real estate property (housing mortgage loan). Although the financial risk of housing mortgage loan does not belong to the scope of this paper. However, the sales methods of developers may still create traps for financial capital. There are still potential risks in financial capital in the real estate transfer stage (Hong Kong: occupation or occupancy). The current market is just not fully reflected. The source of risk is the "imaginary" gap between product quality, design style and architectural pattern and auction sales. In the fierce market competition in the future, there will be more and more check-out phenomena in the handover stage. If developers are not allowed to return a house, it is obviously commercial fraud (unless it is customized for property buyers). Otherwise, more and more mature consumers are more and more likely to change their attention during the check-in stage. Check-out may cause developers to be unable to repay development loans. In the United States, there is usually a "bridge loan" to prevent development loans from maturing. Market Value Orientation Risk The market value of real estate is the expression of regional economy, or the real estate value of a certain region depends on the changes of macro-economy and regional economy. For example, the industrial development in a certain area has produced a large number of employed people, and these employed people have stimulated new employment opportunities in this area. Regional industries drive the service industry in the region, the economic structure changes and economic activities become active. Due to the changes in regional economy, the requirements for living and living conditions have increased. Therefore, it determines the market value of real estate. If the economy in this area starts to decline, the industry will lay off a large number of employees, and the tertiary industry (because of the loss of clients) will also close down. At this time, employment opportunities fell sharply, and a large number of residents moved to other places. The value of real estate in this area will plummet. The decline of the oil industry in Houston, USA in the early 1990s is an excellent case. Real estate is the development and utilization of land resources (non-renewable resources). Its value risk also depends on the limited resources. In other words, the less land available for real estate development around the economic core area, the higher the value of its land resources. The reason is that these resources have been fully developed, and the limited land resources are non-renewable. To control market risk, it is necessary to conduct comprehensive survey data and analysis of local regional economy, conduct long-term tracking and market research on regional economy, and investigate and study local demand. It is particularly important to note that the real estate market research is completely different from other consumer goods market research. It is wrong for most real estate market research institutions to adopt the usual concepts and means of consumer goods market research, and it is impossible to correctly describe the market demand of real estate. The correct market research starts with the research of regional economy, plus the research of investment psychology, financial situation, group income and the absorption rate of a local real estate resource, so as to get a complete market demand analysis. What needs to be mentioned here is the "financial trap" of real estate. In the previous stage, many developers adopted the promotion method of "investing in property". Developers actually set a trap for financial capital and property buyers. This trap comes from the market orientation of real estate value. Investors who have no risk-taking ability will be unable to repay their monthly mortgage when the housing rental market fluctuates, resulting in a large number of non-performing loans in financial institutions. Property buyers and financial capital fall into the "trap" set by developers together. Controlling transaction risks With the continuous improvement of China real estate laws and regulations, we can plan and design dozens or even dozens of transaction methods of land resource use rights and real estate ownership. Developers can use various rights transactions to solve the capital needs of development projects. Therefore, controlling transaction risk is the focus of controlling financial risk. This paper only introduces two common trading methods. The first is the long-term income right of selling property. Part or all of the expected income rights of future property assets are sold to investors at a discount to obtain short-term project development funds. There is no redemption problem in the transfer of long-term income rights. At the end of the transfer contract, the investor has fully recovered the capital principal and interest. The main risks considered in the transaction process are: 1, the total amount of the lease contract; 2. Security of assets; 3. The security of the transaction; 4. The security of the lease contract; 5. The annual growth rate of property rent is 2-6%; 6. The reputation of the contracting enterprise; 7. Calculate the discount rate of one-time transfer; 8. Determine the discount according to the discount rate. This transaction is sold to institutional investors with long-term debt maturity, such as insurance companies. The security of the usufructuary trust plan mainly depends on the credibility and operation of the lessee. The financing method is equivalent to the discounted resale of the lease contract. The second transaction method is to sell the rights and interests of development projects. With development projects as the main financing body, developers can take the form of equity transfer and repurchase, and buy back the equity held by investors at a fixed rate of return when the development projects are completed and have sales conditions. The following risks need to be controlled when issuing the equity trust plan: 1, the feasibility of the market prospect of the investment project; 2. Reasonable transaction structure and investment return guarantee; 3. Develop the ability and confidence of enterprises; 4. Require detailed disclosure of development projects; 5. Investors need to lock in the return on investment; 6, need a strong large enterprise guarantee; 7. Correct assessment and countermeasures of investment risks; 8, the ability and credibility of investment management enterprises. The issuance of equity trust plans not only needs to design a rigorous trading structure, but also depends on whether investors have confidence, investment desire and risk control ability in specific investment projects. Therefore, the packaging of the project is also a very important link and factor. The concept of risk management is very important here. Financial planning of development projects The core of real estate development industry is the operation of funds. No matter the pre-sale of auction house or financial credit, there is no external appeal to use market leverage or financial leverage to meet the capital demand of real estate development. However, it should be emphasized that the forms, uses and mutual combinations of market or financial leverage are not just simple sales or loans. It is necessary to plan and design a complete capital chain and a specific implementation plan. In order to develop the source of funds for project planning and design, control the flow of funds and reduce the cost of funds. A. Sources of funds for planning and design There are several sources of funds for this project (Figure 1): Financial planning is to design, confirm and establish financial instruments for the above development projects. According to the specific project progress, it is the core work of financial planning to use different financial tools at different stages to maximize profits. According to different sources of funds, design different financial plans. B. Designing transaction structure The main task of financial planning is to plan and design the structure of project financing, including the principle of benefit distribution, legal guarantee system, profit and cost control, etc. The rationality, scientificity and feasibility of the transaction structure mark the success of the project capital operation. The result of the transaction is to make the development enterprise get the maximum benefit in addition to the financial support of the development project. For example, the dominant idea of the above-mentioned equity trust plan is to transfer the income right of its property assets, and investors will gain capital gains from the property rental income and recover the funds when the contract expires. In addition to the annual property rental income, the income right trust also needs to provide assets or credit guarantee for redeeming the investment principal. The main participants in the transaction are represented by solid borders; Investment projects are represented by double solid lines; The trust plan is represented by a double oval line; The transaction process is represented by a numbered solid line; The management process is represented by numbered dashed lines. Transaction structure description (designed separately as a hint): 1. The solid line indicates the investor's investment in the trust plan and the expected income; 2. Trust and investment companies, as trustees, are responsible for establishing and issuing trust plans; 3. The development company regards its property assets as trust assets, and entrusts and mortgages property rights to trust and investment companies; 4. The trust and investment company entrusts the investment management company to manage and operate the entrusted assets, and ensure its rental rate; 5. The investment management company takes over and manages its entrusted assets, and is responsible for its daily management, lease and sale; 6. The investment management company leases its property to potential lessees, and guarantees the investor's annual rate of return of 6% with the rental of property assets; 7. The funds raised by the trust plan are invested in development projects; The risk of capital investment is supervised by the investment management company; 8. The development company will guarantee the maturity of the trust plan and the repayment of the principal with the proceeds from the development project; 9. Investment management companies will use annual rental income to ensure investors' investment income; 10. Entrusted by developers and trust and investment companies, investment management companies are responsible for asset management, information disclosure and investor relations management. Asset trust is a more flexible way of asset mortgage and management. Assets can be operated, disposed of and sold during the mortgage period. During the period of asset trust, its business and sales activities are not undertaken by developers, but by investment managers. This can not only ensure the normal sales and operation of real estate, but also ensure the safety of investment funds and the interests of investors. C. At the same time of financing promotion, roadshows and fund-raising, it is necessary to plan the promotion, roadshows and investment subscription activities of project financing, and plan the risk management process of project investment, including but not limited to the following work: planning and designing the information of investment roadshows; Pre-listing planning of investment projects; Project investment planning and packaging; Recommend strategic investors and institutional investors; Organize investment briefing; Organize project investment press conference; Organize investors to entertain the party; Organize project investment seminars. D. controlling cash flow and capital cost in financial planning, it is necessary to plan and design means to control cash flow and capital cost. This includes but is not limited to the following contents: cash flow scheduling: according to the specific progress of project development, design and schedule the capital demand plan; Planning and design financial planning: according to the demand for funds, arrange the source of funds and determine the quantity, date and time limit for use; Design financial instruments: according to the developer's own conditions and the assets formed in different stages of project development, select and combine financial instruments to form strong support for development projects and effective control of capital costs; The above contents involve a lot of financial and financial management knowledge, and a lot of technical, legal and risk management problems will be encountered in actual operation. Developers are not advised to operate by themselves. It is more reliable to be a professional financial management company or financial consultant. E. Financial consultant of risk control development project: Jin Xin Land accepts the entrustment of the developer to understand the current financial situation of the development enterprise and put forward professional consultant suggestions; Include: 1. Evaluation of financing status of development enterprises; 2. Planning and timing of capital requirements for development projects; 3. Formulate the portfolio allocation and cost budget scheme of project funds; 4. Forecast the overall capital flow of development projects; 5. Legal tax deferred and tax evasion plans; 6. Feasibility report on the source of funds; 7. Other necessary professional planning and consulting work. All professional financial consulting work related to project financing of development enterprises. The success of using market-oriented capital operation is an important issue that directly affects the operation mode of real estate financial capital and the operation of market-oriented capital. How to control the risk of financial capital?