Soho Case Study

1 January 2017

Pan Shiyi and Zhang Xin, two Chinese entrepreneurs, started a real estate development company called SOHO China that has used new, unique, and innovative concepts in order to become one of the largest in its market based on revenue. Pan began working as a staff worker in the Ministry of Petroleum when he decided to leave this comfortable government job for the newly developing private sector assuming great personal risk for the possibility of greater rewards.

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He started a real estate shareholding company named Vantone Group and oversaw development of a commercial property in Hong Kong where he gained experience and a positive reputation within the real estate industry. Zhang grew up in turbulent times working at a sweat shop at 15. She earned enough money to graduate from high school and left China for England. Over time she received a Masters in Economics from Cambridge and worked in the investment banking industry with Goldman Sachs and Travelers before meeting Pan and returning to China.

Pan and Zhang were married and both quit their jobs to start a real estate development company called Redstone Industrie in 1995. Both Pan and Zhang believed in the freedom of open markets and believed that there was a huge opportunity for real estate development in China due to the repressive past of the housing market in the country. From the 1950’s until housing reform started in the early 1990’s most housing was distributed to people through government welfare programs. Housing was usually owned by the state and distributed by employers as part of their employment.

The housing was either free or a nominal rent but individuals had no ownership rights and their ability to have a house was based on their employment status. The quality of housing was also dismal. Insulation was poor, heating systems were outdated, hot water was rarely available, and families had to share 500 square feet of living space. In the 1990’s, the government began to allow people to own property. However the commercial housing market did not develop due to the fact that the general public could not get mortgage loans. The largest banks in China were state owned and were very uncomfortable loaning money to people.

It took them until the late 1990’s to offer personal mortgage loans. Pan and Zhang knew that there was huge number of people that would be interested in luxurious apartment space if they had access to it. The challenges that they have had from the beginning have been their ability to get financing. Without the ability to get financing from banks, Pan and Zhang were able to use their customer’s ability to get a mortgage by pre-selling the apartments to finance the building of them. This process has been successful and has given them the capital that they have needed for their developments up until now.

However, due to increasing government regulations, they need the ability to get financing from other sources and are considering using international capital equity markets to get the additional funding that they need for their projects. Critical Issues and Key Facts There are a number of critical issues and key facts that are important to know about SOHO China. The first is that their business philosophy is based on the fact that they believe that there are a large number of people in the market that want to and are able to purchase luxury apartments.

They believe that in order for them to be on top of the market, they need to offer space that is quality and innovative in design. They have shown their ability to be this way through their development of the idea of Small Office Home Office (SOHO) which integrated living and office space and had walls that moved in order to change the size of the room. They have also hired highly talented architects to create landmark developments that are creative and unique to the Chinese market.

They believe that in order to stay on top they need to continue to be the leaders in innovation because there are large numbers of copycat competitors that are already following in their footsteps. A second critical issue that is important to know is that the Chinese government traditionally likes to have control of the country. Most of the development has previously been state owned and the government is only beginning to open up the market. They have been slow to allow for private ownership rights, they were slow to offer private home mortgages, and they tend to be quick to make new regulations that impact the market.

An article by Barry Naughton dated June 22, 2010 from globalasia. org stated that after the recent global financial crisis the Chinese government took swift action to buffer the economy from the effects of the crisis. Some of the actions the Chinese government took was to restrict bank credit for people looking to purchase a home, implemented a property tax, and ordered the increase the supply of affordable housing. This has slowed down the real estate market for high end luxury apartments and prices have stopped increasing.

The government believes that they must exert more control over economic decision making and control the bank loans more closely to control the rising cost of housing. This will affect the ability for real estate developers such as SOHO China to gain access to financing and will decrease the ability of customers to purchase apartments. Three Options The company has a need for capital for future financing and has thought about going on the stock exchange, so the first option is to move forward by going to the equity capital market to finance their future projects.

Pro: The pro to getting equity capital money is that SOHO China would be able to access large amounts capital in order to increase their ability to advance new and innovative developments which would allow them to hire more people and contribute to the growing Chinese economy. Con: The immense pressure of being accountable to the public will be a new and an additional challenge to the organization. The shareholders are going to want to see the company growing and SOHO China will need to be very cautious about the decisions they make to continue growth.

I am concerned that this oversight by the public will stifle their philosophy of innovation and creativity and will remove their current competitive edge. A second option would be to diversify their portfolio by also investing in low income housing using government backed money. Pro: The government has a vested interest in low income housing and will support SOHO China’s endeavors to invest in it. The company will also be able to weather storms that the government creates as it tries to control the immense growth of the housing market and put restrictions on the growth of high end housing.

Con: The main negative is that there is not as much margin on low income housing and they would decrease their profits. They also would most likely not have enough capital to grow as much as they would like to and could be surpassed by their competition. Innovation could also be decreased because there would not be the room to be innovative and still be affordable. The third option would be to find money privately possibly from investment firms in other countries. Pro: This would decrease the control of the Chinese government and public shareholders which would allow them to continue their philosophy of innovation and unique architecture.

Con: There may not be a private investment company in the world that is willing to invest in China due to the wayward behavior of their government and the young nature of the housing market. Private investment firms may also have restrictions or financing rates that are much higher than utilizing the capital equity market would. Decision The recommendation I would propose for Pan, Zhang, and their executive team is to take the risk that they would decrease their ability to be innovative and go on the stock exchange to gain capital.

They would still have to deal with the fact that many potential homeowners could not get personal loans, but they may be able to help people finance loans with money from the equity capital market.

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