Winnie Chen, Nestor Gounaris and Michael Rosenthal
October 2007
With sustained annual double digit growth, and real estate prices in Beijing and Shanghai significantly lower than those in Hong Kong and Tokyo, the People‟s Republic of China (the “PRC”) is an attractive and dynamic property market. According to the National Development and Reform Commission, foreign companies invested US$1.7 billion in Chinese real-estate during the first quarter of 2007, a rise of 154.4 percent from the same period last year1. In addition to capital appreciation, continued strengthening of the Reminbi (“RMB”) is likely to create additional return on investment for the foreseeable future. Nevertheless, for foreign nationals and off-shore companies there remain numerous restrictions and obstacles to owning and transferring real property in the PRC.
Land Use Rights
In China, land is not owned by individuals (local or foreign), but instead belongs either to the State or collectives2, which is evidenced by land use rights. Individuals obtain land use rights in the form of either (i) granted land-use rights or (ii) allocated land-use rights, the latter of which can only be used for a certain purpose by a specific entity and cannot be transferred by such entity unless first converted to granted land-use rights. Land use rights can be leased from the State or transferred3 from one party to another (if granted land use rights).
Generally, land use rights in urban areas are subject to State ownership and land use rights in rural areas are subject to collective ownership. Collectively owned land use rights can only be owned by the collective. Nevertheless, there are instances in which foreign invested entities established in China (“FIEs”) utilize collectively owned land use rights in cooperation with the collective.
Maximum land use right terms are seventy years for residential use, fifty years for industrial/educational/science/technology/health/sports uses and forty years for commercial/recreational/tourist uses, with a catch-all fifty year lease for all other uses.
Building Ownership
In contrast to land, which may only be leased in the form of land use rights, buildings can be purchased and owned. This gives rise to a conflict between the temporary nature of land use rights and the permanent ownership of buildings. What should a home owner or factory owner do if the land use rights on which her building rests are about to expire?
Article 149 of new property law4 attempts to resolve this conflict. The seventy-year term for land use rights for residential use will automatically renew upon expiration. However, the law does not clearly define the term of such renewal (e.g., 40 years) or the number of times such a renewal may be granted. The owner of a non-residential building may apply to renew his land use rights one year prior to its expiration, provided such building is being used in accordance with the land use rights. Unless the land use rights are needed for a public interest, such as the construction of public facilities or transportation infrastructure, a renewal application is likely5 to be approved6. If the renewal is denied, ownership of the building will revert to the State upon the expiration of the land use rights.
Since we have yet to experience the expiration of land use rights under the present property regime, there is no precedent. Nevertheless, for both commercial and other practical reasons, we can expect both reasonable and equitable action to address this issue.
Permissible Foreign Purchases
Recent policies aimed at reducing real estate speculation have restricted foreign investment in real estate7. Foreign ownership is now only permitted by Chinese law in the following contexts:
Personal Use: A foreign individual may purchase one residential property if he has worked or studied in China for one year or longer. This restriction generally does not apply to Chinese living overseas or residents of Hong Kong, Macao and Taiwan. Properties rented to third parties for residential use and not utilized as a residence by the owner are considered commercial properties.
Commercial Use: According to the Opinions on Regulating Market Access and Administration of Foreign Investment in the Real Estate Market, property acquired by non-Chinese for commercial purposes (all uses other than residential) may only be acquired by an FIE, such as a wholly foreign owned enterprise or joint venture. Off-shore legal companies cannot acquire property for commercial purposes. Additionally, such land may only be acquired in the locality where the FIE has been registered and the FIE must meet significant equity8, residence and licensing9 criteria.
Registration
The definitive legal basis for property rights is the registration of the title with the local housing, land and resource administration bureau where the property is located. It is advisable to register ownership of the property at the earliest possible time after the transfer of the property. If a buyer paid a reasonable purchase price and duly registered her ownership, then the buyer‟s claim should trump any post-registration claimants who may have a contesting claim to the property.
Financing
China imposes various restrictions on real estate loans in an attempt to shield domestic banks from real estate market fluctuations, although many question the effectiveness of these restrictions. Buyers must be prepared to make a down payment of at least 30 percent, or as high as 50 percent, of the purchase price to the seller10. An FIE purchaser must provide a warranty letter guaranteeing its performance under the state-owned land use rights grant contract (which sets out the terms and time frame within which the land must be improved) and a construction land planning permit. An FIE with registered capital less than 35 percent of the total value of a real estate project or which fails to obtain a land-use certificate will not be allowed to borrow from domestic or foreign lenders for such a project.
If a loan application is subsequently denied, the seller must return the down payment paid by the buyer. As this may require legal action, care must be taken to ensure the purchase agreement is adequately drafted and the deposit is kept in an escrow account until the loan is officially approved. Moreover, given the borrowing limits written into FIE regulations11, only those with a significant amount of registered capital will be capable of acquiring large properties. This encourages the merger or acquisition of real estate enterprises to pool capital.
Taxes and Fees
In order to make housing more affordable for the middle and lower economic classes, reduce speculation, and increase government revenue, various taxes are imposed on property transactions. These taxes include:
- capital gains tax of 5.5 percent on properties resold within five years of purchase, an increase from the previous two year requirement;
- individual income tax of 20 percent of the profit realized by the sale of real estate or two percent of the sale price, whichever is greater; and
- income tax of 5.5 percent on rental income.
All state-owned property is subject to land use fees12. Such fees are usually determined by variables such as geographical location and usage terms. However, there is no set of uniform standards for assessing the fee and thus the land use fees of comparable properties may vary considerably. This is due both to the lack of clear standards (and corresponding legal provisions) and a shortage of qualified survey professionals.
Property transfers may also be subject to the following fees:
- Transaction fee of 0.025 to 0.5 percent of the contract price or RMB2.5-3 per square meter;
- Contract tax of 1.5 to 3 percent of the sale price;
- Contract stamp tax of 0.05 percent of the sale price; and
- Notarization fee of 0.15 percent of the sale price.
These fees are charged in accordance with various laws and regulations, which vary due to usage.
Foreign Exchange The sale and purchase of real estate in China must be conducted using RMB. Importantly, on 1 September 2006 the Chinese government issued the Notice of Foreign Exchange in Connection with the Regularization of the Real Estate Market. This notice allows individuals to freely convert up to US$50,000 (or the equivalent amount in foreign exchange) to RMB; excess amounts must be expressly approved. This significantly limits the ability of foreign buyers to obtain RMB and compels prospective buyers of real estate to plan the procurement of RMB.
Exchange of funds must take place at the buyer’s bank with the funds directly transferred to the seller’s bank; cash withdrawals or payments are not allowed. All such exchanges require proof of identity, a copy of the sales agreement, and proof of payment of all taxes related to the property and the sale. The bank will only convert the foreign currency into RMB and transfer the amount to the seller‟s account after reviewing the necessary documents and verifying the authenticity of the transaction.
If, for some reason, the transaction is not completed, the funds are repatriated by applying to the original bank. Needless to say, if the seller is not cooperative in unwinding the transaction, the buyer will experience considerable anxiety and may need to take legal recourse. Furthermore, foreigners must obtain approval from the State Administration of Foreign Exchange before repatriating the proceeds of the sale of Chinese property. This requires the submission of an application to purchase foreign exchange, the property sale contract and proof of payment of relevant taxes.
Real Estate Agencies
Currently, there are approximately 25,000 real estate brokerage agencies in China employing over 200,000 real estate agents, as well as an estimated 20,000 property management companies employing more than 2 million people. Many of the brokerage companies, however, are not duly licensed. For instance, it was reported that less than 1,000 of the 4,000 real estate agencies currently operating in Beijing, have the necessary licenses. During a recent inspection in Shanghai, almost 1,000 real estate agencies were operating without appropriate registration. As a result, consumer complaints are commonplace, the most frequent include misleading advertising, premium prices paid for low quality housing and unnecessarily delayed transactions. A legally and contractually-sound transaction is only one component of a healthy real estate transaction; buyers must understand the market and have the ability to assess the quality of the property.
Conclusion
While the China property market continues to have exceptional growth and potential, recent changes to the laws have restricted property ownership by non-Chinese individuals, off-shore companies and FIEs. Nevertheless, it remains an attractive market. In conducting any property transactions it is important to ensure that:
(i) all agreements for the purchase of real estate are carefully drafted with special attention paid to unwinding transactions;
(ii) the subject property is duly registered as soon as practicable after the change in ownership;
(iii) all financial issues have been fully considered, especially monetary conversion; and
(iv) real estate agencies with which one is working are properly licensed.
Additional Notes
Strategic Alliance
As of September 2007 China Solutions LLC established a link with the law firm Metaxas & Associates of Athens, Greece. The two service providers can deliver seamless service in cross-border transactions between both China and Greece and China and Europe.
Metaxas & Associates advises clients in all areas of law with particular strength lying in commercial and business law, competition law, corporate law and corporate governance, banking law, transport law, as well as in the fields of administrative law and public procurement. In addition, the firm has unique and exceptional capabilities in advising on all aspects of European law, with a specific strength in delivering results in regulatory and administrative issues arising from EU law.
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The CS Mentoring Program is a reflection of CS‟ commitment and ability to deliver meaningful legal and operational solutions by maintaining broad and deep connections in China.