Hong Kong’s Fix for China’s Mortgage Boycotts

The refusal of some Chinese consumers to pay mortgages on unfinished homes has shed light on the sales model that dominates the country's trillion dollar real estate market. Presold units are the majority of residential home sales.

When a contract is signed, a homebuyer's down payment and mortgage proceeds are wired into an account. The developer can get some of the money for construction, but only when the home is handed over.

The top 100 developers have been put into default in the past year. The developers that are now out of cash to complete the homes they sold drew money from the buyers' escrow accounts. Many frustrated buyers in China accuse the companies and banks of failing to safeguard their mortgage loans.

The presales model isn't an invention from China. It was borrowed from Hong Kong, a place with a system that goes back to the 1950's. It wasn't until the mid-'90s that presales began to spread across the mainland. Presales can be used as a hedging tool. The project can become unprofitable if a developer buys land during a housing boom. Presales are a way to lock in profits before they happen. Lower down payments are required for pre sales, so they work for consumers.

Builders in Hong Kong are delivering on their promises while those in the mainland are running out of money. There is governance going on here. Consumer rights have been protected by Hong Kong for decades. The financial ability to complete a project is the only thing a developer can offer. The funds that homebuyers pay during the pre-sale stage are held by lawyers and released to developers as construction progresses.

The Hong Kong model was all wrong. The money in the accounts should be enough to finish construction even if the developer goes bust. Builders have a lot of power, thanks to land sales and corporate loans. Many builders are able to withdraw funds from the escrow accounts because of the lack of oversight.

During his recent trip to Hong Kong, the President praised the beauty of the framework. One really appreciates the beauty of rule-based governance. Hong Kong has a lot to teach mainland China.

Mortgage boycott shows how deep China's property crisis is.