1. Introduction
It is well known that Chinese governments abolished their welfare housing policies and initiated the market-oriented urban housing provision system reform in 1998. Since then, most urban households have been required to satisfy their accommodation needs through the commodity housing market, and are no longer able to rely on their working units (
Danwei in Chinese). At the same time, China’s traditional affordable housing system was created, consisting of the Economical and Comfortable Housing (ECH) program, the Housing Provident Fund (HPF) program, and the Cheap Rental Housing (CRH) program [
1]. Among them, ECH was developed for urban lower-middle and middle-income families, and CRH was built for the poorest urban households. HPF is a compulsory housing savings program under which both employers and employees are required to contribute a certain percentage of the employees’ wages to a fund for the latter’s future house purchase [
2]. The significance of this traditional affordable housing program is notable. For example, about 429 million m
2 of ECH had been sold nationwide between 1998 and 2010.
However, there are several shortcomings in China’s traditional affordable housing system. First, the nationwide scale and effects of ECH are both limited, because the number of ECH units sold was only about 6% of that of contemporary commodity housing units sold from 1998 to 2010. Second, some wealthier households can purchase and resell ECH illegally, pushing both construction standards and prices of ECH beyond the reach of lower-middle and middle income families [
1]. Third, the availability of CRH is very low, and thus few people could benefit from it. Along with China’s booming price in the commodity housing market in recent years, housing shortages have become pressing socio-economic issues, particularly for those who can neither afford commodity housing nor meet the eligibility requirements for traditional affordable housing [
3].
To address the aforementioned housing problems and improve the Chinese traditional affordable housing system, as well as to stimulate economic growth, a new affordable housing program entitled Public Rental Housing (PRH) was proposed officially by then-Premier Wen Jiabao’s “Report on the Work of the Government” at the Second Session of the Eleventh National People’s Congress on 5 March 2009. Since Wen’s announcement, PRH has been assigned as the very core of China’s new affordable housing system in several official documents such as the National 12th Five-Year Plan (2011–2015). In December 2013, the Chinese central government officially announced the merging of CRH into PRH starting 2014. As a result, ambitious plans for the development of PRH have been rapidly devised by the central government and many local governments. For instance, the Henan provincial government promised to merge CRH into PRH and cover the indemnified targets of ECH by PRH since 2014, in order to house 20% of the urban population in the whole province with PRH. Similarly, in February 2015, the Beijing municipal government announced the abolishment of ECH and the development of PRH starting in 2016. In recent years, nationwide PRH projects have been carried out by local governments with subsidies from the central government, resulting in evitable and evident government failure (e.g., huge fiscal burden and low supply efficiency) [
4]. In fact, Chinese governments are well aware of this situation, and have issued several preferential policies to accelerate the private sector’s participation in the provision of PRH since 2009 [
5].
Unfortunately, except a few private real estate developers that have participated in PRH projects as agents, most of the private sector in China is unwilling to develop and own PRH projects, with the main reason being the fear of the financial unsustainability of such projects [
6,
7]. Is this fear rational or not? If yes, what measures should be taken to optimize the financial status of PRH projects from the perspective of the private sector? Furthermore, which measure is the most cost-effective? These urgent topics are to be discussed in this paper through a case study of a PRH project in Nanjing city, the capital of Jiangsu province in eastern China. The rest of this paper is organized as follows. To begin, recent studies concerning the private sector’s provision of affordable housing in both developed countries and developing countries (including China) are reviewed, followed by the section where basic information of the studied project is described. Then, its financial sustainability is evaluated with profitability and debt-repayment ability indices, from the perspective of the private sector. In the section that follows, four possible scenarios to optimize the financial sustainability of the studied project are proposed and compared, and the most cost-effective one is selected. The last section concludes this paper with policy suggestions and possible future works.
2. Literature Review
In recent years, many developed countries have reduced governments’ direct provision of PRH while increasing the private sector’s provision in this regard, such as the U.S., the U.K., the Netherlands, and Ireland. Many researchers have paid close attention to this trend and analyzed its reasons, effects and/or influences. For instance, one of American HOPE VI’s objectives is promoting the mixed-finance partnerships between public, private and non-profit sectors, through a case study in Louisville, Kentucky [
8]. Recent Irish experiences in increasing private sector provision of social housing with the aid of housing allowances are assessed [
9]. The controversial use of the Private Finance Initiative (PFI) as part of the Labour Government’s Decent Homes program in the U.K., namely the transformation of social housing from the “public housing model” of the welfare state era to the “social housing model” of today is addressed [
10]. The factors which affect the market orientation of semi-public service organizations in their transition from public to private are explained with a case study in Dutch housing associations [
11]. Italian housing policies have shifted from central state provision towards a multi-level local governance organized into partnerships between regions, municipalities, third-sector and private investors since the turn of the new millennium [
12]. The changing roles of private not-for-profit housing associations in English and Dutch housing provision are also explored, revealing that aspects of the work and identity of housing associations shift between public and private domains [
13].
Several developing countries (such as India, Nigeria, and Malaysia) have also attempted to provide PRH for low-income populations through the private sector, which has been discussed ardently in recent years. For example, the contradictions in enabling private developers to provide affordable housing are examined through a case study in India [
14]. The contribution of Public-Private Partnerships (PPP) in improving accessibility of low-income earners to housing in Nigeria is evaluated, suggesting that government provision of land to private developers at zero cost and lowering the high building standards will ensure better results [
15]. A case study on the contribution and challenges of the private sector’s participation in housing in Nigeria is undertaken, indicating that such participation has the potential for improving housing delivery [
16]. The role of the private sector’s participation in housing development for low-income households in both Malaysia and Nigeria is compared, revealing that the success of the private sector depends on the existence of a favorable socio-economic environment and of an effective institutional and regulatory framework [
17]. Applying the multi-case approach and case studies, the control mechanisms used by public agencies in Malaysia under PPP arrangements to ensure private partner compliance are examined, identifying the governance archetypes which prevailed in previous PPP relationships [
18]. Obtaining data through interviews and questionnaire surveys, as well as secondary data sources, a shift from a state-led public housing provision to an enabling approach did stimulate the activities of private house-builders and primary mortgage institutions in Jos, a city in north-central Nigeria [
19].
In China, the necessity of accelerating the private sector’s provision of PRH has also been widely recognized by a lot of scholars, though their suggested means vary. For example, a dual housing provision structure (namely PRH and commodity housing) is believed to be the future of the Chinese real estate industry, and private real estate developers should possess full property rights of PRH projects and run them [
6]. Shortage in funds is declared as the biggest barrier to the development of PRH, and thus a Build-Operate-Transfer (BOT) model to promote the private sector’s provision of PRH is designed [
20]. A theoretical PPP financing model to attract the private sector’s participation in the provision of PRH in China is proposed [
21]. The applicability of three financing models, including Real Estate Investment Trusts (REITs), BOT, and Public Intermediary Private Partnerships (PIPPs) are qualitatively analyzed and compared, revealing that the private sector’s provision with government subsidies is an important way to build new PRH projects [
22]. A strength, weakness, opportunity, and threat (SWOT) analysis of public housing delivery by public-private partnerships in China from the perspective of the public sector is conducted, suggesting that one of the strongest hindrances is “low profits for the private sector to participate in PPP housing” [
7]. Taking Beijing as a case study, the provision of PRH with the incremental upgrading of “villages in the city” are linked through the adoption of partnerships between multilevel governments, the collective organizations, villagers, migrants, the informal sector and other stakeholders [
23].
From those studies, it is clear that many countries value the private sector’s provision of PRH for low-income households. The necessity of promoting privately owned PRH projects in China has also been broadly identified, and a number of quantitative analyses have been carried out from the perspective of the public sector. However, the financial sustainability of PRH projects in China has rarely been evaluated from the perspective of the private sector, despite its importance amongst private developers. This knowledge gap is to be bridged through investigating the financial sustainability and optimization of a PRH project in the city of Nanjing, China.
3. The Framework
To accelerate the construction process and enhance the supply efficiency of planned affordable housing, an agent-construction system has been adopted by the Nanjing municipal government since 2010. Agent companies are usually traditional real estate developers, with rich experience in developing commodity housing and commercial buildings. They can obtain 3% in profits and 1%~2% in agent fees on the basis of total costs, which are to be completely undertaken by the government [
24]. As a result, agent companies have no initiative to reduce the cost of affordable housing, and the financial condition of Nanjing’s municipal government worsens with the adoption of agent-construction system, which may end up crushing the local government financially and in turn halt the provision of affordable housing. To avoid such a predicament and achieve a sustainable provision of affordable housing, especially PRH, it is urgent to explore profitable approaches of PRH projects from the perspective of the private sector, and further promote the private sector’s participation in these projects.
The studied case is a small PRH project in the Daishan affordable housing zone (hereafter Daishan Zone), which is one of the four largest affordable housing zones in Nanjing. It is located in the urban-rural fringe of Yuhuatai District in southern Nanjing, covering an area of 53,546.92 m
2, which is only about 4.28% of the total residential land area in Daishan Zone. Other residential areas are mainly used for ECH and CRH projects. The building structure of the studied case is frame-shear wall, and other indices are shown in
Table 1. In order to conduct the following financial sustainability evaluation successfully, some assumptions have to be made as follows.
- (1)
Although the studied case is actually built by agent companies and owned by the Nanjing municipal government, it is assumed to be built, owned and operated by a private real estate developer called L Company, with the project enjoying all PRH-related policy incentives and satisfying all PRH-related regulations (e.g., design standard, tenant selection and rent price criteria). L Company is a real private real estate developer in Nanjing interested in participating in the provision of PRH.
- (2)
Considering its relatively small scale, for the sake of convenience, this PRH project is assumed to be built from January 2016 through December 2017. Thus, the studied project could be available to qualified PRH tenants by January 2018.
- (3)
In urban China, residential and commercial building owners can only have land use rights for 70 years and 40 years, respectively. However, to reduce long-term uncertainties and be consistent between the two building types, the operation period of PRH buildings and of commercial buildings are both assumed to be 40 years. In fact, the discounted income from PRH buildings in the final 30 years does not noticeably influence the financial sustainability evaluation.
- (4)
PRH buildings are well decorated and furnished to attract tenants, while commercial buildings only have basic decorations.
- (5)
The rent of PRH flats is 70% as much as that of surrounding private rental housing flats, as decreed in Regulations of Public Rental Housing in Nanjing City.
- (6)
The rent of commercial buildings in this PRH project is the same as that of surrounding market-oriented commercial buildings, which can be estimated by market surveys and interviews.
- (7)
To be conservative, 90% of PRH suites, accessory commercial buildings, and parking spaces are leased at average rents. Besides, considering the level of inflation and economic growth in Nanjing, their rents are assumed to increase by 10% after 5 years.
5. Evaluation Indices and Results
After estimating the cost and income of the studied PRH project, the corresponding financial feasibility evaluation indices, which mainly include profitability evaluation indices and debt-repayment ability evaluation indices, can then be calculated. Based on these indices, the financial feasibility of the project can thus be assessed.
The profitability evaluation indices of a construction project can be divided into two categories: (1) static evaluation indices; and (2) dynamic evaluation indices [
26]. The latter is calculated on the basis of discounted cash flow, while the former is computed on the basis of undiscounted cash flow statement and income statement. Subsequently, some important parameters are obtained, such as total profit (369.34 million CNY) and after-tax profit (179.63 million CNY). The static profitability evaluation indices can then be calculated, which are shown in
Table 5. Because the return on investment is very high, this studied PRH project seems rather attractive to the private sector. However, the annual return on total investment is smaller than the on-going risk-free rate of interest, e.g., the annual interest rate of a five-year period term deposit, which is 4.75% since 5 July 2012. In other words, the private sector will obtain less profit from investing in PRH than from depositing in banks. These results render private developers in a difficult situation as to whether they should be involved in the provision of PRH or not. In this case, when the time value and the discounted cash flow of this project are factored in, what will the profitability evaluation results look like?? Is this studied case attractive for private developers or not?
To obtain the dynamic indices of profitability evaluation of the project, the hurdle cut-off rate is needed. There are four recommended mainstream methods to predict the hurdle cut-off rate, including the Capital Asset Pricing Model (CAPM), the Weighted Average Cost of Capital (WACC), the Typical Projects Simulation Method (TPSM), and the Delphi method [
26]. Since only a few PRH projects are developed by private developers in Nanjing, CAPM and WACC, as well as TPSM, they do not seem applicable here. Thus, the Delphi method is considered the most suitable. Based on interviews with five experts and two conductors from the private sector, 10% is determined as the hurdle cut-off rate of the project, taking into account the inflation level, opportunity cost, interest rate of term deposit, and other factors. With this parameter, the dynamic profitability evaluation indices can be computed and also shown in
Table 5. It is clear that the dynamic payback period of total investment is “NA (Not Available)”. In other words, the total investment cannot be recovered in 40 years. In addition, the NPV of total investment is significantly negative, once again proving that this PRH project is not financially feasible. Finally, the Internal Rate of Return (IRR) of total investment is much lower than the hurdle cut-off rate. The dynamic profitability evaluation suggests that this studied PRH project is not financially feasible, and thus is not attractive to the private sector.
As regards to the debt-repayment ability, there are several evaluation indices, such as Interest Coverage Ratio (ICR), Debt Service Coverage Ratio (DSCR), Loan of Asset Ratio (LOAR), and Loan Repayment Period (LRP) [
27]. Since all loans of this project are obtained from local commercial banks, no foreign investment is involved. Hence, only LRP is necessary [
27], which can be calculated with the following equation:
where
Id is the sum of principal and interest, and
Rt is the repayment capital at year
t.
From
Table 3, it is clear that 179.93 million CNY and 270.86 million CNY will be borrowed from local commercial banks in year 2016 and in year 2017, respectively, with an annual interest rate at 6.55%, as shown in
Table 2. The capital for repayment derives from undistributed profits and depreciation, and the method of maximum capacity in repaying principal and interest is adopted [
27], since L Company wants to repay the loan (thus reducing the debt) as quickly as possible. Regarding the undistributed profit, it is the total after-tax profit subtracted by statutory surplus reserve and statutory welfare reserve. According to China’s tax laws, both statutory surplus reserve and statutory welfare reserve are not payable unless the undistributed profit is positive, as they are 10% and 5% of the undistributed profit respectively. As for depreciation, its annual value is 17.84 million CNY (see
Section 4.1). The statement of the repayment of both principal and interest can then be drawn, which shows that the LRP is 34.39 years. After an interview with two conductors of L Company, this LRP is unacceptable, because the operation phase is only assumed to be 40 years. Moreover, as illustrated in
Table 5, the project is not profitable from the perspective of the private sector. It must therefore be optimized if it is to attract private sector participation.
7. Conclusions
This paper has evaluated the financial sustainability of a Public Rental Housing (PRH) project in Nanjing from the perspective of the private sector, based on the estimation of its costs, incomes, and tax deduction. The results obtained from the dynamic profitability evaluation indices show that the project is financially infeasible, although the results from the static profitability evaluation and the debt-repayment ability evaluation seem rather attractive to the private sector. Through analyzing the significant influencing factors of costs and incomes, three optimization options and corresponding four optimization scenarios have been proposed. From the perspective of cost-effectiveness, the optimization scenario with free land use rights and a subsidy of 374 million CNY in the first year (or equivalence in time value) is strongly recommended.
The evaluation results of this studied PRH project represent actual financial situations and corresponding development predicaments of countless PRH projects in China. First, the widely adopted agent-construction system has proved ineffective in controlling the costs of PRH projects, although this system can attract the private sector’s involvement. The privately owned mode is suggested, because the private sector is interested in controlling the total cost of PRH projects now. In addition, this mode will tap into the expertise of the private sector (especially private real estate developers) in building and operating residential communities. Second, common PRH projects are financially infeasible under the present preferential policies, and thus cannot effectively attract the for-profit private sector. To improve this situation and accelerate the development of privately owned PRH projects in China, more preferential policies and greater efforts are required. Since the static profitability indices are attractive and problems exist in dynamic profitability indices, time value proves to be the key influencing factor. The effects of preferential policies will therefore be greater when they are implemented earlier. The most cost-effective optimization measure of the studied case is to provide free land use rights with additional subsidies at the beginning. A comprehensive concession contract is the prerequisite that guarantees the involvement of the private sector in the development of the PRH project (as a privately owned one), enjoying all PRH-related preferential policies and observing whole PRH-related regulations. Third, new valuation methods should be constructed for privately owned PRH projects, since the private sector may obtain option premiums from uncertainties and corresponding management flexibility, which cannot be taken into account in traditional financial feasibility evaluation methods on the basis of discounted cash flows. Therefore, constructing a real option-based valuation model for privately owned PRH projects is a possible direction for future research.