The most consistent question I get from all of you these days is — what’s up with Beike $BEKE, the real estate platform company that we did a podcast episode on a year ago when it went IPO? Since then, it lost its founder to lung cancer this May, and has experienced a precipitous decline in stock price, -62% in the last two months. Most people think it’s because of downward pressure on the Chinese real estate market, as the government tries to rationalize property prices in an effort to solve the demographic crisis and slow growing social inequality. Well, let’s take a look at all the factors that have been mentioned:
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Rumored agent fee cuts.
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The rumor is that agency fees will be capped at 3x local average salaries (in Chinese), which would be a big hit to Beike’s chief revenue. Note that Beike stirred up controversy earlier this year for adjusting upwards its secondhand homes transaction fees from 2% to 3% (in Chinese). However, they are within legal rights to do so, since the maximum is 3%.
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The ratio of home price to average salary varies quite a bit in China, but even taking rough estimates, ranges from more than 30x for the first-tier cities, to mid-teens for second-tier cities (based on 2016 data). So it would really affect mostly first-tier cities, if at all.
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A quick search shows that Beijing has an average income of ~100K RMB, which when tripled, means you can buy a 10MM RMB or $1.5mm USD house at 3% commission.
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Edit: It appears that the rumor was on monthly income and not annual income, even though the word it used is typically an annual income. Although duh, that would make sense, since YEARS of (average) income spent on agency fees would be pretty bad, even though that’s exactly what it’s looking like in Beijing! Anyway, if that is indeed the case, then we’re looking at a ~90% reduction in agent fees, of course. Most experts don’t think that makes any sense, however (in Chinese), and China is already on the low end of real estate transaction fees in the world. I still think this is mostly fake news …
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I think it’s important to point out that the rumor was attributed to a competitor, Dafangya, whose decentralized business model is a standard 19,900 RMB charged per sale. (Dafangya has since denied they said anything and is even paying for reports of such rumors, 😆). The state-owned newspapers don’t seem to take too hard of a stance, and The Paper’s coverage on this largely covers quotes from economists at real estate firms who of course all point out that this does not seem like a particularly effectual way to cool down the housing market and that agent fees should be a product of the free market (in Chinese). I give up trying to predict what is actually happening here.
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Antitrust investigation.
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While Reuters reported that Beike is under antitrust investigation (as of late May 2021), the company has denied it. Of course, just because a formal investigation is not under way doesn’t mean that Beike is free of scrutiny. Competitor 58 has been very vocal about accusing Beike of 2-choose-1, which looks to be the easiest way to get in trouble with Chinese antitrust authorities right now. So far, there does not seem to be consensus amongst experts as to whether or not Beike’s “exclusive arrangements” with landlords trigger antitrust (in Chinese). That’s because exclusivity is fine as long as it’s not coerced. In addition, depending on how you define the market, Beike really has either a pitifully small or majority market share (~4% of nation, or 50%+ of Beijng). So a lot hinge on how SAMR sees things.
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Compelling pieces of evidence that they do have dominant market power would be the increase to 3% commission I mention above and the fact that again, for a city like Beijing where they’re the biggest player by far, they’ve managed to increase commissions for new housing to 5%+ (as high as 10%) from 1% before.*** [See below for important clarification.] That seems like problematic behavior, but I don’t know what the remedy would be, a fine? A law requiring lower commissions? If you’re as confused as I am … don’t worry, Xinhua doesn’t really take a side either (in Chinese). We’re getting into advanced antitrust territory here, not Alibaba’s egregious AML 101 that was super obvious to everyone.
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Perhaps the more existential crisis facing the company would be some sort of breakup between its platform and agency business because there is an inherent conflict of interest. But I think that is a low probability event, because such arrangements exist throughout the business world and China is still catching up in terms of antitrust, I’m not sure it’s ready to be more aggressive than the developed world just yet.
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The recent 10% decline might have been due to a transfer of voting rights following the founder’s passing. But it was to another co-founder and the price has since recovered? So it only took one day for people to change their mind and think it’s NBD?
In addition to the above, the real risk to Beike, IMO, is just the general pricing pressure on real estate. First of all, various cities have already pushed out stricter purchase requirements and the government has made some moves to reduce developer credit etc. in an effort to tamp down on prices. But also, it seems that the government is signaling some fundamental change in inventory:
In an essay (in Chinese) by the Chief Analyst YANG Chang at Zhongtai Securities, he explains that the future is in shared ownership housing and rental housing. Even though I worked in real estate investing in China from 2007-9, and actually owned property there, I was unfamiliar with the term “shared ownership housing” (SOH). But here is the definition:
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In China, you own the housing together with the government or affiliated entity. You may be required to live there, own no other properties, and typically have a few other restrictions such as the inability to re-sell for a period, and the government will have ROFR when you do decide to sell. The government will always own their portion of the housing regardless. Beijing introduced such a system back in 2017, for example (official portal here).
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It is noted that shared ownership housing is used in developed countries to alleviate high housing prices. You can read this blog here about the various flavors that exist in the US (there are a lot!).
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As for rental properties, these are not public properties, but private units meant to accommodate low-income individuals. Technically, the word is “guaranteed rental housing” 保障性租赁住房. The government has just issued guidelines on this (in Chinese), which mostly revolve around incentivizing private developers or property owners to build new or retrofit existing properties into units that would fulfill this criteria.
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China has a dual-tiered system for urban-rural land use.* Rural land must enter into the urban system in order to be developed for commercial real estate purposes. Some experts are arguing (in Chinese) that the new initiatives pushing for guaranteed rental housing would basically circumvent the dual-tiered rule and unleash a lot of land supply, since from the perspective of renters, there is no difference between urban and rural land. I don’t know how to think about this in depth, and would welcome some feedback here.
*China has a unique land use system in which there are two types of land ownership, namely, state-owned urban land and farmer collective-owned rural land. Despite strict restrictions on the use rights of farmer collective-owned land, rural land is, in fact, developed along two pathways: it is formally acquired by the state and transferred into state ownership, or it is informally developed while remaining in collective ownership. (Source)
TL;DR: I’m not sure I have one! There are so many uncertainties / headwinds against Beike that it’s very difficult to know what the business looks like in the near term. Real estate reform is always on top the government’s mind, but as many have noted, change has been much slower than promised. After reading into it, though, the antitrust fears about being broken up don’t seem justified to me, the agency fee caps don’t seem particularly real, and while a general lowering of fees from 3% back down to 2% (which could happen under anticompetitive reasons) would hurt much more*, obviously, any other pain I can think of comes from anticipating real estate pricing or transaction curbs in general. (*Beike commissions are 2.8%*** probably much higher for new homes this latest Q and 2.7% for existing homes.) And on that, I don’t think anyone has any idea what the government is prepared to do, but the healthier the rest of the economy, the more aggressive they can be with this aspect …
Edit: literally as I’m writing this the company came out with revenue guidance that is 25%+ lower than the same period last year. Ouch …
*** New Home Commissions
As Daye Deng rightly pointed out, we have to separate the platform commission from the agency commission that Beike gets for new homes, and this is one of the few things that the management does not break out. GTV for New Homes is 415Bn RMB Platform vs 84Bn Lianjia. The revenue is 13.9. Assuming the take rate for platform 1.5%, which would be 5x the 0.3% it charges for secondhand homes, then Lianjia’s commission would be 9.2%. **See Steven Shi ‘s rebuttal on this math below, although it is still a fact that this would be actually consistent with what I read in the news & mentioned above about Beike being able to charge as high as 10% commission for new homes in certain cities (新房分销佣金).
An acceptable rate for the industry should be 2-4%, just from what the developer can typically bear (in Chinese). However, it’s been steadily creeping higher in parts of China due to developers unable to shed their inventory, and a growing reliance on commission based selling through channels such as Beike. Whereas before developers used to buy advertising and have internal staff to sell the houses, now it’s been overtaken by these channel providers who do all the sales (in Chinese). Beike’s market dominance is what some folks think has them charging premium rates, but they don’t seem to be the only ones (5% seems to be market practice). Obviously, since new homes are a much easier transaction than secondhand, the commission rate should not be so artificially high. (It’s also been blamed for the massive number of real estate agents in China, a disproportionately large amount, because of the $$ involved. And of course, for the various bad practices in the industry, such as false advertising, hiring actors to pretend to be other buyers, etc.) The concerns around these sky high commissions got so bad that both Anhui and Tianjin governments came out with guidelines on how much agents could charge (~2%, in Chinese). However, these were just guidelines and not laws, so I’m not sure they did that much. Since new home commissions (especially if they are so high!) directly contribute to the real estate bubble and the “peoples’ burden,” and if the government is really serious about lowering it, I’d definitely expect more explicit, harsher rules in the future. And if I had to guess the limit … based on past judgments and the fact that 2% is an acceptable average for secondhand homes? 2%! You can play around with the commissions but at the lower end supposing new homes are 0.3% platform fees and 2% Lianjia fees we’re looking at a decrease of 80% in new home revenues, which would be a decrease of 40% in the latest quarter … so yeah … ouch.
Finally, you can read this speech by $SFUN Chairman on the future of the Chinese real estate agency business (in Chinese) if you’re interested! He acknowledges the market is a mess & commissions are too high, but thinks more transparency will fix things. And of course, making sure there are no monopolies. 😜
