Defrauding Tenants – A Cautionary Tale From China

How some rental operators flew too close to the sun, and burned their wings in the process

I love the Chinese startup and proptech ecosystem for 3 reasons –

  1. They have a scale which is virtually unmatched in any other part of the world (US included)
  2. Chinese startups scale REALLY fast
  3. Entrepreneurs don’t mind getting their hands dirty and getting into operations and services, and don’t restrict themselves purely to building/selling technology

These reasons, and a few more, sum up why Chinese home rental startups have built such large businesses in relatively short amounts of time. Over 100 rental companies including ZiroomQingkeDanke and a host of others have popped up over the past 10 years and collectively manage millions of rental apartments units.

These companies follow a property management + coliving (or shared housing model). They take apartments from landlords on long term leases, furnish/upgrade it, and then sub-lease it to tenants on a shared model with a mark up in the lease amount.

This model works perfectly well in most cases, but as you can imagine, there are significant capital expenses into every apartment and even an associated ‘holding cost’ for operators. Marketing is never cheap in real estate, and payroll expenses add up quickly.

They needed sources of non-traditional capital to help them scale up their businesses in a meaningful way, and they found an interesting route.

Rise of ‘Rental Loans’ in China

Photo of Shanghai by zhang kaiyv from Pexels

Rental operators in China started offering tenants attractive schemes for paying the full annual rental amount upfront (Ex. “Pay your annual rent today, and get flat 10% off on the full amount”). Obviously, this is a great way for tenants to get some discount on the surging rental rates in urban China, but many who were interested did not have the money readily available to make the payment upfront.

Rental operators promptly partnered with banks who were willing to offer ‘rental loans’ to tenants at low rates of interest, which allowed them to avail the discounted rental rates offered by the operator. Once the paperwork was signed, the bank paid at the annual rent to the operator (on behalf of the tenant), and the tenant started paying EMIs to the bank to repay the loan.

Seemingly, this is a ‘win-win-win’ for all parties.

  • Tenants get a hefty discount on the annual rents
  • Rental operators get their annual revenue upfront, although their payments to landlords were done monthly or quarterly
  • Banks have a new customer base for a new product, which seems relatively safe

This system can really work, if it is not abused or attacked externally.

A system which can be abused, will be abused

The rental loans eco-system started showing cracks even a couple of years ago. Problems started to arise when tenants cancelled their rental contracts before completion, or owners off-boarded their property from any of the rental operators. In both cases, tenants were still stuck repaying the rental loans to the bank (Even though were weren’t staying in the property anymore!). Neither rental operators nor the banks had provisioned for these cases in their contracts, and tenants were stuck in a bad situation.

What was worse were the allegations that many tenants had no idea what they were signing up for. Apparently, sales executives for these rental operators didn’t disclose the full terms of the deal to the tenants, but made them sign the rental loan contracts with the bank, and told them to ‘pay the rent to the bank’ (which in reality was the EMI for the loan). Tenants only found out about this when they cancelled their rental contracts, but were still forced to pay the EMI to the banks.

The Covid-19 complication

2020 has been a bad year for most businesses, but has been brutal to rental operators (both commercial and residential). With many tenants leaving urban cities to go back and live with their parents, occupancy rates as well as rental rates have significant drops across the globe.

Tenants who had taken rental loans faced even more complications than before. With many landlords across China given full waivers on rent to operators (or even discounts), the same was not passed forward to the tenants as they had already paid the annual rent. Given that many tenants had already left cities like Wuhan and gone back to their home towns, they were now stuck repaying EMIs for rental properties they were not occupying, despite the operator getting rental waivers from the owners!

It is clearly a bad deal for the tenant.

Consequences

Most operators have acknowledged that the systems is broken and needs fixing, and have put in place teams to help tenants come out of this mess. They have also promised to correct the underlying issues which caused in mess in the first place. There are a few consequences which are easy to guess –

  1. Loss of consumer confidence in rental operators – Tenants are now preferring a ‘direct lease’ or a rental directly from landlords without any agents or operators in the middle
  2. Dip in credit ratings – Many tenants who refused to pay the rental loan EMI are have seen their credit ratings dip, despite not doing anything wrong
  3. Rental loss – Tenants are still paying EMIs for properties they are not renting anymore! This is a bad waste of their money

This newsletter and article is read by many in the real estate and rental industry, and the reason I wanted to highlight this story is this – It is bad for the entire industry when a few actors turn bad.

Many rental operators in China evaluated the ‘rental loans’ option for growth but decided against pursuing the same. Unfortunately, they will still be bucketed under the ‘greedy rental companies’ category by the public at large. It is unfair, but it how the world works.

Is the short term momentum really worth the long term loss of consumer confidence in the industry?

The answer seems obvious.

This blog was originally posted by our co-founder Ajay Kumar on his personal blog here.

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TheHouseMonk Team

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