Chinese cash policy puts the squeeze on ambitious Johor project

Contributor 5 Feb 2018

Forest City crop

The beach at Forest City in Johor, Malaysia. BroNrw/Shutterstock

What do Beijing’s capital outflow controls mean for the future of Forest City?

By Steve Finch 

As the old philosophical question goes: “If a tree falls in a forest and no one is around to hear it, does it make a sound?” At Forest City, a mega-project built by Country Garden, China’s third-largest residential developer, recent silence has been deafening.

The Guangdong-based firm announced in 2016 its Forest City project would generate huge annual sales of CNY20 billion (USD3 billion) out of total company revenues of CNY300 billion – or nearly 7 percent of total sales.

Forest City ranks as the largest residential development in Iskandar Malaysia, a special economic zone just a few miles from Singapore dubbed the “new Shenzhen” by sponsors including the Sultan of Johor after whose father Iskandar is named.

In recent months, previously bold pronouncements have all but dried up. Beijing has announced stricter capital controls designed to shore up the faltering yuan and quell outflows of cash overseas for acquisitions deemed “irrational” in sectors including real estate.

“The outward restrictions have really been more on the corporate side,” Andrew Polk, a founding partner of the Beijing-based investment advisory firm Trivium China, says. “But they’ve also been trying to shut down illegal forms of purchasing houses.”

As a non-convertible currency, the yuan must be converted inside China, but there’s a catch: currency can only be exchanged for approved purchases, which does not include real estate. Individual Chinese citizens are nonetheless allowed to change up to USD50,000 per year for travel and other personal expenses overseas.

Eager to circumvent these strict rules, many Chinese have taken to what is known as ‘smurfing’: pooling individual currency quotas among family members and friends who then send small sums overseas to avoid scrutiny by banks and financial regulators.

Country Garden appeared to tailor Forest City perfectly to this system. Many of its units went on sale for about USD200,000 paid for through instalments. Then Beijing started to close these loopholes. Alipay, the popular mobile payment platform, has stopped processing overseas payments under pressure from the Chinese central government. In March, UnionPay, the primary bank card platform in mainland China, followed suit as it barred mainland customers from making transactions in Hong Kong to pay for property.

Many Chinese had been making overseas payments by crossing into the territory where currency restrictions are more relaxed.

Suddenly, the flood of Chinese crossing over to Johor from Singapore has slowed. Country Garden had been flying over plane-loads of mainland Chinese, reporting that 50 percent ended up signing contracts to buy apartments. Then in March, Country Garden announced it was closing showrooms across China to comply with Beijing’s tighter capital controls.

The developer has subsequently found itself caught in a difficult spot. It wants to maintain the huge flow of potential customers from China into Johor to keep sales ticking over but must appease a government it knows can do more serious damage to its overall multi-billion-yuan business.

This in turn has created a marketing problem. The illusion of demand – now lost – has been vital for Country Garden, according to David Hong, head of research at China Real Estate Information Corp which tracks property trends in China.

“They get a lot of Chinese tourists to visit these projects to make them seem highly attractive so that more locals [Malaysians] and Singaporeans will come and have a look,” he says. “If you look at Country Garden in lower-tier cities in mainland China you also see a similar strategy.

“They try to attract tier-one and tier-two city buyers who have high purchasing power to visit projects for free. Half of the buyers are actually locals who think large numbers are going to invest in that project and earn a profit from reselling.”

The disappearance of Chinese buyers has pushed Country Garden to redouble its marketing and sales effort to potential customers in the likes of Thailand, Singapore and the Middle East. Meanwhile, Chinese buyers who paid a down-payment but can longer meet instalment obligations are desperately trying to get their money back.

On WeChat, China’s most popular social media platform, disgruntled buyers have formed a group called ‘Quit Forest City and get refunds’, and many have tried to seek out lawyers to fight back.

Assessing just how many Chinese buyers have been impacted and what this means for occupancy rates at Forest City remains difficult. Many in the property sector have maintained silence around a development upon which fortunes depend, including the Sultan of Johor, a joint-venture partner at Forest City alongside Country Garden. Indeed, several sources including Country Garden itself and UEM Sunrise, the biggest landowner in Iskandar, declined to comment for this article.

Recent figures from analysts don’t make great reading. In its first half report of Malaysia’s property market Knight Frank reported a 6.8-percent decline in residential transactions in Johor. It cited Chinese capital controls as a key factor “amid a widening gap between supply and demand” for high-end condos across Malaysia.

While the state of Johor, its economy and buyers at Forest City face an uncertain future, Country Garden appears largely unaffected. Its share price has soared in Hong Kong trading in 2017, prompting DBS Group – among other analysts – to upgrade the stock to ‘buy’ in August. The same month, Moody’s upheld its Ba1 rating for Country Garden without mentioning its Malaysia woes, or capital controls imposed by Beijing.

“For projects overseas by Country Garden there would be some execution risk,” Franco Leung, a Hong Kong-based vice president and senior credit officer at Moody’s, says. “But we see that any impact from that project is manageable.”

So at least some good news for a firm that has staked so much on Johor. But given the scale of the development and the brake on its momentum, it remains to be seen if Forest City itself will make it out of the woods.


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