As of April 10, 2017, the Shanghai Planning and Land Resources Administration Bureau formally adopted a new legislation called, “Certain Provisions on Strengthening the Administration on Transfer of Land Plots for Business Purpose” (“New Rules,” in Chinese《关于加强本市经营性用地出让管理的若干规定》).

The intent of the New Rules is generally believed to reduce commercial property flipping in the Shanghai real estate market. For example, local authorities could intervene at an earlier stage of the development cycle by imposing restrictions on the land parcel’s designated use to cut off quasi-residential programs. Another, more straightforward, method is issuing restrictions on strata title sales for commercial properties. Set forth below is an explanation of the key measures.

Under the New Rules, a land grant contract must clearly state that no apartment-style office building may be constructed on a land parcel for office use purposes. Prior, a land grant contract generally remained silent on this matter, such that an apartment-style office building may be constructed so long as subsequent planning and construction permits can be approved and properly secured.[1] This new restriction, however, essentially eliminates the possibility of constructing apartment-style office buildings in Shanghai.

The New Rules also specify that no apartment-style hotels may be constructed on a land parcel for commercial use purposes, unless otherwise permitted in a land grant contract.

Under the New Rules, individual sale of office space, and other commercial spaces, is limited to a floor-by-floor basis only. With that said, strata title sales of separate units are strictly prohibited.

Regarding apartment-style hotels, even when a land grant contract permits constructing an apartment-style hotel, the hotel—upon completion—is still not permitted to be split into separate units for sale under strata titles.  

Retail space ancillary to a residential complex or a local community must be held in its entirety. Thus, developers are no longer permitted to split street-front retail stores within a residential complex to be sold under strata titles.

Finally, the New Rules also imposed a more stringent limitation on the transfer of construction-in-progress. Statutory transfer requirements must be strictly followed or construction-in-progress may not otherwise be transferred either in whole or in part.[2] The transferee may not get around the statutory transfer requirements via upper level share transfers. Even when the statutory transfer requirements are fulfilled, any change in the transferee’s capital contribution, shareholding structure, or ultimate controller requires a prior written notice to the grantor of land use rights.

One clear implication is that these restrictive measures will greatly limit the developer’s exit strategy and place cash flow burdens on them. Developers, then, have to seek alternative exit avenues, in terms of commercial properties. Given the current regulatory regime, commercial mortgage-backed securities (CMBS) may appear to be a promising and realistic approach in the near future.

In the recent past, the central government has encouraged developers to hold long-term leases of residential projects. The State Council, a year ago, issued a notice permitting commercial properties to be converted into residential properties for lease.[3] This provision, however, seems to contradict restrictions on constructing quasi-residential developments under the New Rules.

Moreover, it remains unclear whether the New Rules will achieve its purpose of reducing commercial property flipping.  One criticism warns that eliminating quasi-residential developments will lead to a short supply of strata title units available for sale, which may drive up prices of residential properties.  This would defeat the purpose of the New Rules, and is clearly something regulators would not like to see.

Until the New Rules are further carried out in depth, this regulatory inconsistency remains to be resolved.

[1] The regulation set forth in the Fire Design Technical Provisions of Hotel-style Apartments and Apartment-style Office on September 3, 2003 (in Chinese,《租赁式公寓和公寓式办公楼防火设计技术规定》) defines an“apartment-style office building”as an office building comprised of separate units with exclusive washrooms, in which the construction area of each unit should not exceed 300 square meters. Special fire rules will apply to an apartment-style office building.

[2] Statutory transfer requirements for a construction in progress include the following: i) land premium must be fully paid; ii) the land use rights title certificate, construction planning permit and construction works commencement permit have been secured; and iii) construction has been completed to 25% of the total investment for the development.

[3] Certain Opinions on Facilitating Cultivation and Development of Residential Leasing Market by the State Council on May 17, 2016 (in Chinese,《国务院办公厅关于加快培育和发展住房租赁市场的若干意见》)