Article by Jonathan Keats, Norton Rose LLP
The real estate market in China has developed beyond recognition in the last 10 years, but real estate law in China remains very different to that in other countries. This article is intended to be the first in a series of articles exploring real estate issues in China and will focus on:
- the general nature of land ownership in China
- providing a brief overview of the land acquisition process where a developer is bidding to obtain
- land for development from the State.
Ownership of Land in China
China applies a system of public ownership to all land. As a general rule, land in urban areas is owned by the State and land in rural areas is owned by 'collectives' (rural collective economic organisations) and can only be used for agricultural purposes.
The State retains ownership of state-owned land at all times. An investor in such land only acquires the 'use' of that land for a certain period - known as 'Land Use Rights' (LURs). It is important to note that LURs are only given in respect of state-owned land, not collectively-owned land.
LURs may be either 'granted' or 'allocated' by the land authorities to Peoples Republic of China (PRC) nationals or PRC body corporates (so foreign companies must incorporate in China to obtain LURs). LURs are 'granted' in exchange of payment of a premium or 'allocated' on a quasi-free basis. LURs are evidenced by a certificate issued by the local land bureau.
In a particular quirk of PRC law, land and building ownership titles are distinct and can be issued on separate certificates. However, ownership of a building follows the land - therefore land and buildings may only be transferred or mortgaged together despite the theoretical distinction drawn between then.
Granted LURs are broadly similar to long leasehold tenures in other jurisdictions - for a premium, the title holder has the benefit of the land for a specified period but must use and develop the land for a designated purpose.
The duration of a granted LUR depends on the proposed land use - for instance, the maximum grant term of land used for industrial purposes is 50 years. Granted LURs are documented in a "land use right grant contract" with the local land authority and can be transferred to third parties, leased and mortgaged by the title holder.
The State may only requisition a granted LUR if it is in the public interest and upon payment of compensation. The land use term can be renewed if the land authority consents and if a further premium is paid. If the land use term is not renewed, the land together with the buildings will be taken back by the State when the term expires and no compensation will be payable.
Allocated LURs may only be:
- held by Chinese state-owned enterprises, government authorities and public entities
- used for certain prescribed purposes - for example, military installations and infrastructure projects.
Allocated LUR land may be requisitioned by the state at any time and without compensation. As such, allocated LURs are unsuitable for private investment.
An allocated LUR may be converted to a granted LUR by the payment of a land grant premium to the land authority.
Bidding for Real Estate Projects
Real estate projects where LURs have already been issued to private entities are commonly disposed of on the secondary market by way of company sale rather than as an asset transfer of the LURs.
This article does not explore the mechanics of a company sale in China or of a transfer of existing LURs, but instead focuses on the process involved in bidding for LURs for new projects.
Four principal types of bidding processes have evolved in the Chinese real estate market. These bidding processes are in theory regulated by the Ministry of Land and Resources. However, enforcement of this can vary from city to city. The four common types of bidding processes are:
- Invitation to Tender - where the local authority invites specific companies to tender to develop a site. A committee appraises the bids and awards the winning tender based on a number of different factors including design and price.
- Public Tender - where the tender is open to all comers. A public tender is appraised in the same way as an Invitation to Tender.
- Public Auction - where anyone can bid to develop the site, and the sole determinant is highest price.
- Listed Land Grants - similar to a Public Auction where the highest price wins, but where bids are submitted over a longer period of time.
The first official announcement of a tender is often when the local authority posts details of the development and bid process on its website. There are no specifications set by law as to how a bid committee should appraise a bid or determine the winning tender.
A standard qualification requirement to be able to place a bid is for each bidder to remit an amount of money - designated as 'surety money' - for the duration of the bid process. This will be returned to unsuccessful bidders. The time between the bid deadline and announcement of the winning tender may be surprisingly short - it can be as little as 10 days.
PRC law requires that a foreign real estate developer operate through a PRC foreign invested enterprise - here, a foreign invested real estate enterprise (a FIRE). However, the establishment of a FIRE will not be approved until some time after a bid has been won. Consequently, during the bid process and immediately after a tender is awarded, a foreign developer (or its Chinese partner) will act on behalf of the FIRE until its establishment is approved.
After the tender is awarded the winning bidder must enter into an LUR contract with the local authority within the time limit set out in the 'Tender Award Confirmation Letter' and then pay a deposit.
The LUR contract is intended to be between the local authority and the project developer. However, where the developer is a foreign entity, the FIRE will not have been established at this stage. The foreign developer or its Chinese partner (as the case may be) will enter into the LUR contract on behalf of and prior to the establishment of the FIRE.
After the FIRE is established, a new LUR Contract will be entered into between the land authority and the FIRE, whereby the FIRE will assume all the rights and obligations of the foreign developer or the Chinese partner under the previous (and now terminated) agreement.
Payment of bid price
The FIRE pays the remainder of the bid price to the local authority only after it has been established, after the various foreign exchange registrations and approvals have been obtained and after the FIRE has opened a foreign exchange account with a domestic bank. The price must be paid entirely with registered capital - no debt may be used.
At present, newly established FIRE's may not obtain foreign currency loans. The only sources of funding for a FIRE are its registered capital (i.e. an equity contribution) or lending from domestic financial institutions. Domestic debt is not easy to draw down - utilisation may only be authorised on delivery of certain construction permits issued at specific stages of the construction process, and provided that the FIRE's registered capital is fully paid up and the LUR certificate has been issued.
Further restrictions apply to FIRE's, the full detail of which will be explored in future articles. These include a minimum 50% equity contribution to the FIRE and strict controls on the transfer of FIRE's and their assets. These restrictions have made foreign investment in Chinese real estate significantly more difficult in recent years - however, there are rumours that some of these restrictions may be eased.
If a foreign investor can navigate these hurdles, the potential upsides to investment in China can be seen on the skylines of its booming cities.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.