Thursday, January 19, 2017

[NOTE: I just published a shorter version of this post (alternate link here) in Foreign Policy. Here's the longer and more academic version, with links to the original documents.]

[FURTHER NOTE: I have replaced the original blog post with this one, which incorporates some important points that were in the Foreign Policy piece but (I realized after posting) not in this one. My thanks to David Wertime at Foreign Policy for his very helpful editorial suggestions.]

China’s Land Counterrevolution? Not Yet.

Both Chinese and western press reports over the last week (Caixin; New York Times; Financial Times) announced startling news about China’s land regime: holders of 20-year residential leaseholds in the city of Wenzhou in Zhejiang province would see their leases renewed automatically and without charge.

If true, this news would be momentous: it would mean nothing less than the return of private land ownership in China. But in fact it looks like the leaseholders got nothing more than temporary squatters’ rights. What’s going on?

Since the early 1990s, urban land in China (all state-owned) has been available for sale in the form of long-term leaseholds called “land use rights” (LURs)—up to 70 years in the case of land designated for residential use. The original rule about what would happen when the leasehold expired was very clear: the land would go back to the landlord (in the case of China, the state). If leaseholders wanted to extend the lease, they would have to pay for it.

Although this rule was absolutely clear in legislation, leaseholders of course didn’t like it. Proving the truth of Upton Sinclair’s dictum that “it is difficult to get a man to understand something, when his salary depends upon his not understanding it,” a widespread belief grew up that the rules about renewal were either unclear or unfair. The picture was further muddied by the 2007 Property Law, which proclaimed that residential LURs would be renewed “automatically”—but without specifying what that meant, and particularly whether it meant “without charge.” A prominent member of the drafting team later admitted that they had simply punted on the issue because it was too controversial. And the reason it was controversial is simple: to specify that a fee would have to be paid would have angered current LUR-holders—a vast and politically important vested 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.

Why? Because a 70-year LUR that renews itself automatically and without charge is no longer a 70-year LUR. It is a permanent right to the land, indistinguishable in practice from the title known in American law as “fee simple”—the kind of title homeowners expect to get when they buy a house. Of course, the Chinese government can take the land (for a public purpose, and upon payment of compensation), it can regulate its use, and it can tax it. But governments in capitalist societies can do the same thing, and nobody has ever supposed that this means capitalist societies can’t have private land ownership.

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 – 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.

Now let’s go back to the Wenzhou LURs. Back in the mid-1990s, Wenzhou offered residential LURs on a number of land parcels for sale for varying terms—some for as many as seventy years, which has become the standard term, but some (about 600 parcels) for as few as twenty. These 20-year LURs, apparently the only ones in China sold in that era, are now coming due, and the leaseholders have been clamoring for a solution to their dilemma (their dilemma being the need to pay, and a solution being a free renewal of their lease).

On December 23rd, the Chinese government offered its response in the form of remarks by a Wang Guanghua, a vice minister of the Ministry of Land and Resources (MLR), at a press conference dedicated to an entirely different matter. If, as widely reported, Wang had said that the Wenzhou leaseholders would be allowed to renew their LURs indefinitely and at no charge, that would have been momentous news indeed, since it would have set an important precedent. After all, the Wenzhou leaseholders had the opportunity to pay for 70-year LURs and opted to buy only 20-year LURs at a lower cost. If they were to be given the windfall of perpetual free renewals, having paid for only twenty years, the case for giving perpetual free renewals to those who paid for seventy years would be much stronger. And perpetual free renewals are indistinguishable from full private ownership as understood around the world. Truly, one could have said that the urban land regime of the People’s Republic of China had come full circle. (Rural land ownership in China is a subject to a completely different set of rules.)

But that is not exactly what Wang said. Instead, he referred to an official document issued by the MLR on December 8th in response to an inquiry from the Zhejiang provincial government about how to handle the Wenzhou LURs. Critically, that document does not grant a renewal of the LURs. A renewal or extension, to be meaningful, must specify either (a) a future date on which the new term ends, or (b) that the term continues indefinitely. The MLR document does not do this. Instead, it says: (a) that leaseholders need not apply for a renewal upon expiration of the LUR; (b) that local land administration bureaus shall not collect a fee, and (c) that when the LUR is transferred, normal procedures for titling and registration should be followed. This means that the transfer will not be disallowed, as it otherwise would have been, on the grounds that the LUR to be transferred no longer exists.

Most importantly, the document states that the specified term for the transferred LUR should be the original starting and ending dates, with a note added saying that “relevant procedures have been undertaken in accordance with” the MLR document.

In other words, what the current leaseholders have received is an assurance that for the time being they can stay in their homes without having to pay anything. What they did not get, however, is significant. They did not get a renewal: new LUR with a new expiration date twenty years or more from now. They had something saleable before, but do not have something saleable—something that a transferee would confidently pay money for—now. All they have to offer a transferee is an LUR with an expired term and a vague and cryptic annotation. Will anyone pay good money for that?

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.

https://lawprofessors.typepad.com/china_law_prof_blog/2017/01/chinas-land-counterrevolution-not-yet.html