Sunday, February 18, 2024

The Effect of Chinese Government Policy on the Failures of High-rise Residential Towers in Los Angeles and Other World Cities

Graffiti-clad Oceanwide Towers in LA

In March 2019 I reported on the failure of three 40-story residential towers being built in downtown Los Angeles. ( Lendlease, the Australian general contractor, had rocked the LA real estate world by announcing that it had halted construction on Oceanwide Plaza over unpaid bills. The interior remains to be built. There were rumors that the lender had pulled out of the project, but no explanation of why. A press release from China Oceanwide explained the need for capital restructuring and that construction would resume in February 2019. With my own eyes I see the project rotting and covered in graffiti five years later in February 2024. Its location is less than ideal, being across the street from a sports and concert arena occasionally plagued by basketball riots.

At the same time, similar residential towers in LA, New York, Malaysia, Australia and Vietnam, among other countries, have also been failing, towers which were effectively being built for Chinese millionaires trying to get their money out of China. Most did not intend to occupy their new condos.

The Towers of the Waldorf Astoria, developed by Chinese Developer Dajia, is one such project that is also languishing without sales for its 374 units. The Chinese government seized the insolvent Anbang Insurance Goup to sell off its U.S. hotel assets, acquired for $7.45 billion during 2014 to 2016, which includes the Waldorf Astoria Hotel in New York at a price of $1.95 billion. 

One of my first blog posts in 2010, now deleted, was the Forest City development on the Iskandar peninsula of Johor Bahru, Malaysia, and directly across the strait from Singapore. This particular luxury project was also directed towards Chinese investors. I went to an international property buyer conference in Singapore in 2010 and found this to be the most heavily promoted project at the conference, but the scale seemed outrageous in scope -- $100 billion to build 300,000 homes on 4 man-made islands off the southern coast of Malaysia close to Johor Bahru, a bedroom community to Singapore. I deleted my post after being told “Don’t count out Chinese investors!” 
Nowadays, only a fraction of these homes have been built, and most that have been built are still vacant. In hindsight I was really being told not to count out lemmings, even though lemmings can be counted on to eventually jump off the cliff. 

There are two major Chinese government policies that have slowed the demand and financing for such projects:

1. Chinese capital controls on citizens, instituted at the end of 2016 by Chairman Xi Jinping, are preventing the necessary funds from leaving China. The purpose of the new regulations was to reduce “irrational outbound investment.” China has been cracking down on capital flight, characterized by Chinese investors purchasing foreign condos, perhaps to place ill-gotten gains away from capture or perhaps due to distrust of the government. The PRC wants the money back. One expert estimated that the ratio of outbound Chinese capital (back to China) to inbound capital was about 10 to 1 at the time of my last blog post in March 2019. These same controls have caused other Chinese developers to place their North American assets for sale. Greenland, developer of a similar project called Metropolis, a few blocks north of Oceanwide Plaza, placed one of their three residential towers plus their Indigo hotel for sale. 

 2. The “Three Red Lines” policy. This might sound like a cute maxim from Chairman Mao, but it is actually sound banking policy instituted by Chairman Xi Jinping back in 2020. The three red lines are: debt-to-cash, debt-to-equity, and debt-to-cash. If a developer wants a loan from a Chinese bank, these tests must be met. These new controls have sent some major Chinese developers, such as Evergrande and Oceanwide, reeling into bankruptcy.

3. The Communist Party policy switch to "Common Prosperity" in August 2021.  This follows the famous open door policy started by Chairman Deng Xiaoping in 1978, igniting unbridled capitalism with the proclamation, "It is glorious to be rich!" The switch to "Common Prosperity"  is to "reasonably regulate excessively high incomes, and encourage high-income people and enterprises to return more to society.” This might not be good for real estate developers.

Indeed, the Minister for Housing and Urban-Rural Development promised no bailouts for real estate developers, stating "For real estate companies that are seriously insolvent...those that much go bankrupt should go bankrupt or restructured."

Now China and Chairman Xi are facing an American-style real estate collapse, too. The Chinese government did what they had to do, but too late. It was like taking the punchbowl away from a festive party that was already out of control. 

As for the outcome of Oceanwide Plaza, I laid out the following scenarios back in 2019: 

1. A white knight lender from outside China will provide necessary funds to finish this project, 

2. The property will need to be auctioned off to a more solvent owner, 

3. Or in the worst case, if building and safety laws were allowed to continue to be violated, Oceanwide Plaza could end up being 3 decaying 40+ story hulks sullying the downtown L.A. skyline. Scenario number one was a possibility back in 2019. I had at least two inquiries as to whether I wanted to appraise the property, but the clients changed their minds. So, what we see today is Scenario number three, with 40-story towers covered in graffiti and serving as jumping bases for wannabe “spidermen” and their YouTube audiences.

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