China real estate: leveraged speculation
Until recently, local governments would sell this land to developers for very little upfront. A firm could buy land worth 5 billion yuan with just 500m yuan ($75.9m) in working capital, says Jinsong Du of Credit Suisse. Even better, the developer could then offer that land as collateral for a loan of, say, 2.5 billion yuan from a bank. And instead of ploughing those borrowed billions into developing the site, they could use it to buy more land. Developers of real estate were not too worried about generating cash flow, because in a pinch they assumed they could always sell the land at a profit or flog as-yet-unbuilt flats to eager buyers on the back of blueprints alone.
The viability of this model depends on ever-growing demand, which often comes from speculative investors looking for a chance of quick capital gains. Some are wealthy private individuals; many are enterprises that have been diverting money from capital investment, hoping for juicier returns from property.