China Land Speculation: Is This What Moving Inland Is About?

April 10th, 2008

While many have reported that China manufacturing is on its knees, I want to assure that a great many of the country’s factories are doing just fine. I visited one manufacturer recently and was not surprised to hear that revenue increased 35% in 2007. While some manufacturers are falling on hard times, others are finding that opportunities abound.

Speaking of which, at one point in my meeting, I was told that the supplier were almost finished with construction on a new plant. I asked where the new factory was going to be located and was told four hours away by car. Four hours! The plan to build a factory four hours inland sounded ridiculous, and I told the factory owner so.

The original factory was located in city where prices were high, I was told, and the factory wanted to build where property values would appreciate faster. What they were looking for was a real estate play. I expressed doubt about the scheme and was taken to school: The company had acquired land for US$1mn and completed construction on a plant that cost around US$3.5mn. Before the project was completed, they had a new real estate appraisal done, and the updated value of the property came in at $3mn for the land and $7mn for the plant. The value of the property had increased over 100%, I was told, before the project was even completed.

Manufacturers in China build new factories all the time. Not always was the move about the need for additional capacity. They built new factories because foreign buyers were cautious and only placed orders after seeing that a factory was impressive looking. Sometimes a nice factory was built in the hope of hooking investors. I figured that the factory owner in this case might want to build and flip the property in this one case, but the goal was even more short-term. The plan was to take the increased property valuation and go to the bank with it. They expected to take out a loan for the increased value of the property.

“But what can you do with the money you borrow?” I asked.

“Anything,” he said.

China banks loan money to industrialists but then don’t push for repayment. Factories are taking advantage by borrowing money and then making minimum payments while they put the money to work. This is a golden opportunity for those in China who have access to capital. Interest rates are low, and real estate valuations in many corners are climbing rapidly. I was told that only a fool couldn’t figure out how to make money on an arbitrage opportunity like this one. The factory owner then detailed some of the company’s real estate holdings outside of manufacturing. They were significant, and they were poised to grow fast.

Questions I came away from the meeting included: (1) Was this the reason for reports that manufacturers were looking to move inland? (2) Could this be how some could afford to make products for next to nothing and still find success?; (3) Could factories that have access to capital be responsible for pushing out those that did not? 

Those who might read this will wonder whether the suggestion is that we are in the middle of an industrial real estate bubble. Another consideration is whether all of this might somehow impact non-performing loans. There is nothing to worry about for the moment on either front, but if the pattern continue unchecked, asset inflation and non-performing loans will almost certainly be among China’s most significant economic challenges down the road. For now, let the good times roll!