The paradox of scale in the real estate business : an analysis based on institutions and policies

Abstract

 China's real estate market has evolved from "too big to fail" to "big ones go down first". A paradox of scale has emerged in China's real estate industry. Before 2020, small firms were more likely to default. But since 2020, the larger the size of a real estate firm, the higher the probability of debt default. This paper proposes a tripartite game framework to explain such a paradox, and combines empirical analysis focusing on the impact of the size of real estate enterprises to provide a feasible way of thinking. In the development process of real estate enterprises, the government, banks and enterprises have formed a game equilibrium based on the logic of project investment. The local government favors large real estate enterprises in land grants because of their underwriting ability as well as their strong investment promotion ability. Due to free-riding behavior and institutional shortcomings in corporate management, banks and other financial institutions have adopted a layering strategy, offering lower loan rates to large real estate enterprises. As a result, real estate enterprises used to have ample incentives to increase their scale through table expansion and debt raising. In such a three-party game, each party is rationally pursuing the maximization of benefits, however, local rationality did not bring about overall rationality, and the whole real estate industry experienced unhealthy growth. Scale becomes a common goal pursued by all three parties and can bring benefits to the participants. The probability of default for large real estate companies is much lower. However, when the external environment has changed, expanding scale is no longer the optimal decision for real estate companies. Enterprises that have become large real estate companies by raising large amounts of debt in the past are no longer able to obtain the benefits of high-quality projects, and it is difficult for them to obtain the financing facilities provided by financial institutions. Large real estate enterprises this "fat" has become the burden of the enterprise. The industry has appeared in the head of the real estate enterprises one after another the phenomenon of default and mine incidents. The larger the real estate enterprise, the higher the probability of default. This article focuses on the scale and default rate of real estate companies, and with the help of data from Chinese real estate companies, it confirms that the logical relationship between scale and default rate in the real estate industry has shifted. before 2020, the one-sided pursuit of scale by real estate companies can also reduce the debt default rate. After 2020, the excessive pursuit of scale by real estate companies will increase the default rate. When the external conditions such as corporate financing have changed significantly, the inflated scale has instead become a burden for the enterprise. The unhealthy development model obsessed with scale cannot be sustained in the long term, and the hidden risks will eventually erupt. Policies such as the "three red lines" have accelerated this process, allowing the problems of real estate enterprises with inflated scales to be exposed in advance.