Moving towards the future, how can property developers respond to liquidity challenges?
Since the COVID-19 outbreak, China's economy is facing both structural and periodic economic downturns. The Real Estate industry, known as “high leverage and high turnover”, have been facing various strategic and operational risk. Since China has made significant progress in epidemic prevention and control, all industries and sectors have resumed or will soon resume business under the guidance of the efficient central government. To further facilitate economic recovery, a range of policies (such as fiscal relief and monetary easing polices) are expected to be rolled out. Nevertheless, it is not clear whether circulating funds will flow to property developers, who are still facing challenges. While performing our social responsibility to jointly fight the epidemic, Deloitte has provided insight into the seven cash flow challenges that property developers and related industries face, as well as the recommendations to address cash flow management based on our service experience in the property development industry.
Challenge #1: Special cash-flow management under the epidemic
The coronavirus broke out without warning at the end of 2019 and spread rapidly. Businesses have been overwhelmed by the epidemic and the uncertainty added to the mounting difficulties facing companies. During this crisis, establishing the correct cash flow management mechanism is pivotal for property developers to ensure effective overall planning and adequate liquidity to avoid capital short falls and a possible debt crisis.
Comments: We recommend that property developers design a cash flow budgeting and monitoring mechanism that is suitable to address the epidemic circumstances by increasing budget monitoring, improving sensitivity analysis, designing for comprehensive budget management, and coordinating the procurement, engineering, cost, sales, and human resource departments in budget formulation.
We also recommend that developers create an emergency management mechanism, to identify crisis signals and early warning indicators. Large real estate groups should enhance cash flow management at the group level, with a special focus on concentration of payment authority and centralized management of capital. Comprehensive property groups that operate in multiple industries should pay special attention to the group's overall financial forecast and the operation of the monitoring mechanism, and isolate risks to avoid disproportionate distribution of capital in different industries and related risks. Businesses that are at the edge of a cash flow crisis should act quickly in decision-making, to centralize projects and regions and cash out certain projects to survive.
Challenge #2: Slowing collection of payment for credit sales/rentals leads to sluggish cash flow performance
To effectively prevent and control the spread of COVID-19, multiple local government authorities have issued guidelines to suspend promotion activities involving mass gatherings. Certain regions temporarily closed the online contract registration channel, while some even held back the issuance of presale permits. Under such circumstances, the collection of payment for credit sales as part of the cash generating link in the real estate industry, if went unstable, could have an impact on the overall capital turnover which cannot be underestimated. For developers holding commercial property, the impact of the epidemic on physical industries has added to the pressure and complexities of rental collection. Meanwhile, value-added tax will not be exempted by reason of difficulties in payment collection, which increased the burden on businesses.
Comments: We recommend that property developers start with a comprehensive review of projects, formulating an analysis report about inventory value and understanding the capital pressure, construction progress, tenant mix, regions, and local policies regarding each project, to identify the projects and tenants with sales capacity and centralize limited resources to increase investment, integrate online sales, and to reasonably reduce prices. In the meantime, developers should make a list of customers who have signed contracts but have not yet completed full payment, and consider providing further preferential offers including but not limited to higher discounts, more property management benefits to accelerate payment collection. For currently operational commercial real estate projects, developers should check the amount that cannot be collected as agreed in the contract, and make tax planning as early as possible to prevent additional tax-related cash outflows.
Challenge #3: Cash turnover compromised by the unbalanced upstream supply and the slowing construction progress
Due to the ongoing epidemic, businesses may need to offer higher prices or adopt stricter payment terms to acquire the construction materials they need, which will undoubtedly put extra pressure on project funds. Circumstances involving slowing sales and payment collection, large input taxes from paying project funds cannot be deducted timely also cause a capital tie-up. Meanwhile, the impact of the lockdown and work suspension is still slowing construction schedules. In addition, failing to deliver property on time may cause expected damages for breach of contract as well as litigation risk.
Comments: We recommend that property developers take multiple measures and strategies to address the current crisis. Businesses should frequently communicate with the prime contractor to adjust construction progress and payment schedules and mitigate the impact of cash flow from various aspects. In the respect of upstream supply, businesses should communicate with their current suppliers about procurement and supply plans and closely follow up on the supply schedules while developing more supply channels. For project management, given the lag of cash inflow and outflow of individual projects, businesses should track and analyze the construction progress of each project and consider delaying or suspending the construction and investment of the projects that cannot obtain presale permits in the short term. With regards to contract protection, we recommend businesses take a look at the relevant terms and conditions in the supplier contract and the sales contract, and consider the implications of force majeure and change of situation in contract defense circumstances. When dealing with capital pressure from taxes, businesses should consider tax optimization plans and apply for rebate of VAT credit retained with local tax authorities. For construction and installation costs, businesses should pay attention to the cost impact of varied work resumption timelines of various projects under construction in different regions, including human cost, additional material cost, as well as overtime payment for meeting the deadline and epidemic control expenses, make evaluation and reasonable payment arrangements, and reach agreement with the prime contractor and suppliers in a timely manner.
Challenge #4: Debt risk due to difficulties in capital turnover and financing
During the epidemic, the collection of payment for credit sales slowed while costs and expenses increased, which tightened capital turnover and adds to the pressure for the debt payment terms that are due immediately or soon.
Comments: We recommend property developers broaden external financing channels while focusing on extension of repayment, interest rate reduction and other preferential policies under the epidemic. Developers should keep communicating with banks and other financial institutions to apply for extending repayment of loans, to avoid cross default risks due to possible lowering of credit ratings. At the same time, businesses should review the assets and obligations to adjust financing arrangements under the epidemic.
Challenge #5: Increasing cost during the epidemic
During the epidemic, multiple regions delayed planned work schedules or implemented remote working policies. Businesses, however, would still have to pay rents, wages, and other fixed costs, as well as related taxes. And the expenses for epidemic control escalated the pressure of capital outflows.
Comments: We recommend that developers establish a strict cost management plan. To control expenditure, businesses should reduce or delay expenses that are unnecessary or of low priority, while implementing a more stringent expense approval system, including tightening approval authority, second review for approval, centralized coordination of capital use by the finance department, and daily capital reporting. The payment of expenses needs to be based on the cash flow forecast with quantitative indicators. To adjust payment terms, businesses should communicate with suppliers proactively for extension or arrange payments to be made in installments. To benefit from tax and fiscal policies, businesses should pay attention to tax and social insurance preferential policies as well as other government support to make effective planning and apply for payment extension. For tax management, businesses should check whether the tax prepayments for the projects under construction are relatively high or if there is any tax refund opportunities for delivered projects, and apply for adjustments or refunds as soon as possible. For human resource management, developers should comply with government policies regarding leave in lieu and increase communication to guide and calm employees.
Challenge #6: Decreased investment opportunities and increased risks in short term
The epidemic is still going on, for property developers, insufficient land holdings is not helpful to sustainable growth and capital turnover over the long term. And radical investment would cause a cash flow crisis if losses occur.
Comments: We recommend that developers respect the principle that "cash is king" to implement strategies based on needs, times, and regions. During the early and middle stages of the epidemic, businesses can consider collaboration within the industry through cooperative development to share resources and risks, to avoid a cash flow crisis due to investment risks. When the epidemic comes to an end, businesses should pay attention to preferential land policies and opportunities to buy under-performing assets and invest with low cash outflows.
Challenge #7: The emerging cash flow crisis and the restructuring exploration
Over the past couple of years the central government has emphasized "house to live, not to speculate", leading to the tightening of real estate policies. Under the circumstances of the unexpected, uncertain epidemic, businesses that are or will be facing difficulties should start restructuring or make preliminary restructuring arrangements immediately.
Comments: We recommend that the developers who have already encountered liquidity problems consider the pros and cons of their situation, adjust strategies in a timely manner, and make the necessary changes to survive. For the businesses who have sensed certain signals of a possible crisis and whose liquidity is still acceptable, we recommend they rigorously promote both business restructuring and debt restructuring. From the perspective of assets, businesses should separate core assets from non-core assets. They should sell the non-core assets as soon as possible or use them to pay debts. At the same time, they can identify capable companies in the industry for cooperative development of promising core assets, to mitigate cash flow pressure by brand and resource sharing. As for debts, businesses can reduce their debts by term modification, offering debt to equity swap arrangements and other means. With regards to financing, we recommend businesses expand financing channels. In addition to debt financing with traditional financial institutions, they can also utilize corporate bonds, private equity funds and other channels, or seek strategic cooperation with strong real estate developers through equity transfers.
For the developers with a serious liquidity crisis, such as litigation or debt default, we recommend they start preliminary restructuring and communicate with creditors to balance the interests of stakeholders before starting proceedings of corporate reorganization. An agreement-based reorganization is highly recommended to earn the initiative in the crisis and prepare for resumption of operation and asset activation in the future. During the aforesaid restructuring measures, businesses should make reasonable tax planning to reduce or delay tax-related cash outflows.
Consistent with our insight into the limited impact of the epidemic on the macro economy, the epidemic has limited influence on most industries over the medium and long term, and will not cause substantial changes to the development logic of these industries. For property developers, the COVID-19 epidemic has provoked challenges and pressure along with the economic downturn, but it also brings opportunities and changes. During this time, Deloitte will work with all property developers to focus on key matters and implement policies that are right for these special times, to jointly address the current crisis and solve challenges.