Cash flow problems could lead to developers defaulting

BEIJING - A headline-making debt woe afflicting a small Chinese property developer has highlighted an ongoing cash-flow headache in the sector. Industry analysts said they expected some smaller companies to default and home prices to decline in third- and fourth-tier cities.

Zhejiang Xingrun Real Estate Co, a privately-owned small developer in East China's Ningbo city, is struggling to pay a 3.5-billion-yuan ($573.8 million) debt after its capital chain snapped.

More Chinese cities see home prices decline

First bond default signals market progress

Of the debt, some 2.4 billion yuan was borrowed from banks, who are working with local governments to find solutions. Two owners of the real estate firm have been detained by police on suspicion of illegal fundraising.

A preliminary investigation showed that plummeting land prices was one of the major contributors to the money crunch. It is estimated that the company has lost about 1.4 billion yuan from its purchased land because of shrinking value.

Most of Zhejiang Xingrun's business was in Fenghua, a small city under Ningbo. Fenghua has a population of about 500,000. Its land price at the end of 2013 was approximately halved compared with that in early 2010.

"There are high stockpiles in medium and small cities, and the performance of developers based in third- and fourth-tier cities was sluggish in the first two months of 2014," said Zhang Dawei, chief analyst with property agent Centaline.

A possible default by Zhejiang Xingrun is "symptomatic of major themes in the industry - polarization in favor of larger, better funded homebuilders; oversupply in smaller cities; and significantly slower growth rates and profit margins," Fitch Ratings said in a note.

Zhejiang Xingrun had run into trouble since, firstly, it is a privately owned company, meaning it has limited access to equity funding. Chinese regulations limit the ability of homebuilders to use bank borrowings to purchase land, Fitch said.

Private companies are likely to be more reliant on non-traditional sources like trust funding, which come with high costs.