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The Paradox at the Heart of China’s Property Regime

The Paradox at the Heart of China’s Property Regime

Late December brought reports of startling news about China’s land regime: holders of 20-year residential leaseholds in the prosperous coastal city of Wenzhou would see their leases renewed automatically and without charge. If true, this would have been momentous: it would mean nothing less than the return of private land ownership in China. Instead, it looks like leaseholders are getting nothing more than temporary squatters’ rights. In effect, the state punted on a nasty dilemma that goes to the heart of socialist rule, one that will face the ruling Communist Party on a far larger scale in 50 years, and possibly before: what exactly are Chinese people getting when they “buy” a place to live?

This dilemma, while sharp, has been no less predictable than the Y2K problem. Although the Party did not abolish private ownership of urban land when it took power in 1949, it gradually restricted the rights of owners over the years. In 1982, the law finally caught up with reality when China formally nationalized all urban land. Since the early 1990s, however, urban land has been available for sale in the form of long-term leaseholds, or “land use rights” (LURs), which last up to 70 years on residential land and for shorter periods for industrial and commercial land. This system allowed the state on the one hand to obtain the economy-wide benefits of market allocation of land as well as the revenues from leasehold sales, while on the other hand to maintain that the principle of state ownership of land had not been compromised: after all, buyers got “merely” leaseholds of several decades, not ultimate ownership. The original rule about what would happen when the leasehold expired was unambiguous: the land would go back to the landlord, i.e., the state. If leaseholders wanted to extend the lease, they would have to pay for it.

The rule was clear enough as written, but leaseholders naturally didn’t like it. A widespread belief grew up that the rules around renewal were unclear and unfair. The picture was further muddied by China’s 2007 Property Law, which proclaimed that residential LURs would be renewed “automatically” — but without specifying whether that also meant “without charge.”

A prominent member of the drafting team later admitted that the team had simply punted on the issue because it was too nettlesome. To specify that a fee need be paid would have angered current LUR holders — a vast and politically important interest group (probably 80 to 90 percent of urban families). But to specify that no fee need be paid would have meant overturning a sacred tenet of Chinese socialism: that private land ownership is anathema. After all, a 70-year leasehold that continually renews itself automatically and without charge is no longer a leasehold; it is a permanent right to the land, indistinguishable in practice from the kind of outright ownership (called fee simple) that most homeowners in common-law countries like the United States take for granted.

Whatever the ambiguity, it has not noticeably stifled China’s residential real estate market, and real estate now accounts for more than 70 percent of overall household wealth, and 80 percent in large cities such as Beijing or Shanghai. At the time of purchase, 70 years is a long way off – likely beyond the typical purchaser’s lifetime, and almost certainly beyond the lifetime of the building in which the residence is located, given construction standards and the pace of urban change. So far rising prices have meant that even resales – which necessarily involve a shorter term than 70 years, since the term is not renewed at transfer – are often for more, sometimes much more, than the purchase price.

But although most Chinese residential leaseholds won’t expire for a few more decades, dark clouds of uncertainty are already visible on the horizon. With the clock ticking ever downward, Chinese homebuyers are already starting to think about whether they will ultimately have anything left to pass on. They fear that as the end of their leaseholds approaches, they will find it more and more difficult to get a good price if they try to sell. Uncertainty about whether a homebuyer has a 70-year leasehold or a permanent fee simple doesn’t much matter in year one, because the difference in value is tiny under any realistic set of economic assumptions. But if a Chinese leaseholder is trying to sell in year 40, the price buyers will pay for the 30 remaining years is a lot less than what they will pay if they are confident they are getting a permanent property interest. Even if buyers are foolish enough to be willing to pay a price that assumes they can keep the property permanently, they will have trouble getting mortgage lenders to be equally foolish – and that’s bad for sellers as well. Once these problems start cropping up in earnest, leaseholders will start clamoring for certainty (in their favor, of course) decades before the leases are scheduled to expire.

Hence the outsize importance of the Wenzhou case as a bellwether. In the mid-1990s, Wenzhou offered residential LURs for sale for varying terms — some for as many as 70 years, but some (about 600 parcels) for as few as 20. (Other cities may have offered similarly short leases, but Wenzhou seems to have been the first.) These 20-year LURs are now coming due, and, predictably, leaseholders have been clamoring for a solution to their dilemma — their preferred solution being free lease renewal.

But if those leaseholders who opted to save money by buying only 20-year LURs were to be given the windfall of perpetual free renewals, it would be politically very hard to deny the same benefit to those millions across China who paid for 70-year LURs. In other words, renewing the leases of those 600 Wenzhou homebuyers free of charge could have heralded the effective return of private land ownership to China.

The Chinese Ministry of Land and Resources (MLR) surely understands this dilemma, and on Dec. 23 it made its solution public. Although it was reported as offering reassurance to leaseholders, the fine print says otherwise: leaseholders did not, in fact, get a renewal of their LURs. Instead, they got the equivalent of squatter’s rights: an assurance that for the time being they can stay in their homes without having to pay anything. If they wish to sell the property, the buyer’s LUR certificate will still carry the original starting and ending date (i.e., two dates in the past) as well as an annotation stating that “relevant procedures have been undertaken in accordance with” the MLR’s cobbled-together solution. Put another way, Wenzhou’s 20-year leaseholders did not get anything that another buyer would confidently pay (or a bank lend) money for — just an expired term and a vague and cryptic annotation.

What happened in Wenzhou will, in time, become a full-blown national issue. In some 50 years, the first batch of 70-year residential leaseholds will start coming due. Well before that, however, leaseholders will start having problems with buyers who are unwilling to pay large amounts of money for a leasehold with only a few years left on it and no guarantee of renewal. The state will have to choose: enrage about 90 percent of China’s urban population or admit that the 70-year residential leasehold is a mirage, an admission that would violate a core tenet of socialist rule.

Incredibly, 68 years after the founding of the People’s Republic of China and 38 years into the era of post-Mao economic reform, the Chinese government is still unable to state clearly what kind of residential real estate ownership system it wants to have. The system remains shrouded in uncertainty, and buyers cannot know for certain what they are getting. It’s likely that when the time comes, the government will blink – if there are any arch-conservative defenders of old-school socialism left, they will almost certainly be LUR holders themselves. But it has not blinked yet; for the time being, uncertainty still reigns.

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