Simon 0:02

Hi Edward. Evereyone likes a good Chinese takeaway!

0:07

Yes, I agree with you. Chinese takeaways are a convenient, flavorful, and very satisfying way to enjoy Chinese, uh, food at home. But today, Simon, um, the takeaways we're gonna be talking about are the lessons I've learned and which I want to impart on, uh, our listeners, uh, red flags and, and generally to, learn lessons from the past, mistakes of, other investors, and how they were taken advantage of by very cunning and deceitful promoters. In Chinese real estate. of course, the lessons that we learned from that will apply to real estate investment opportunities all over the world. So when people are evaluating real estate investments elsewhere in other countries overseas, there are things that they can look out for and I want to make sure that the ability of fraudsters to get away with it is, uh, significantly reduced as best I can.

Simon 1:12

So what would you like to acheive with this episode?

1:15

Well, I thought it would be a good idea to, uh, give, listeners some insights into the sort of various shenanigans and frauds that I've seen, blatantly carried out, in the Chinese, uh, real estate. It does get to be sort of rather murky. When you have promoters bringing investors into China to buy real estate, it's a world where for some reason promoters feel opportunistically that they can take advantage of investors. I think it tells us something about the psyche of human nature because the number of frauds I've seen in, uh, China, uh, has been quite, uh, you know, proportionately very high for the number of schemes I've seen. And, I don't know, I think it's just a combination of. The different cultures, um, western businessmen arriving in China, seeking out these opportunities, for clients back home, meeting local Chinese people, working with them, collaborating with them and just getting a sense that if it's possible to. Make some extra money at the expense of the investors that then that's, fair game. I think promoters become, emboldened because of the geographical distance involved. First of all, I mean. Most, of the investors back home in their home countries, they don't come to China. They're not coming to check their investments. They've probably never been to China. They know very little about it other than then there's this fascination with China

Simon 2:46

I can see that Investing in China is a specialised area and not for unsophisticated investors

2:52

You have to remember also that. The window of opportunity of investing in China has been very, very small. And the ability, or the possibility of investing in China only really started, um, as China started opening up and, uh, for many years, the Chinese country was a closed, uh, a closed country. And then the opening up started and, manufacturing was the main, uh, preoccupation with, with the western businessman. I mean, China became the manufacturing powerhouse of, of the world. But the, the investment side, came later and, certainly it was a, it was a frontier land. It wasn't, easy to do business in China. It's never been easy to do business in China. But the window of investment for a residential investment, uh, has only been a period of about six years. I don't think a lot of our listeners will, really, uh, appreciate that. I mean, it's only really around the millennium, around the year two thousands that foreigners really started to be able to, to go into China. China needed foreign capital and, um, so there was a period from 2000 to 2006. When foreigners were buying, in 2006, the, the Chinese government, brought in legislation to stamp out speculation and foreign ownership in residential investment. Uh, you, you know, you couldn't buy unless you were living in Shanghai or one of the main cities for at least a year. You weren't entitled to own property after 2006, after the middle of 2006. And, uh. Uh, and to this day because in 2013, the, um, the Chinese government moved again to bring in further restrictions.

Simon 4:35

But in that short window of opportunty there was a real appetite for foreign investors to put their money to work in China.

4:41

You know, gotta remember the, real reasons for, for investors coming to China was that, um, there was this massive urbanization that was taking place. As people in China were moving from the, countryside into the cities. Um, as you had this, huge, emerging middle class, I mean, the numbers are mind boggling. I don't think we can ever appreciate the sheer numbers of it. And of course, there was this huge insatiable demand, to provide, uh, residential accommodation in first, second, third tier cities throughout China.

Simon 5:14

So you have this short window of opportunity but it seems it was a very fertile ground, while it lasted, for promoters and managers to take advantage and exploit investors back home.

5:24

So. Yeah, so you've got, you've got these, uh, promoters who, uh, who who went out, saw the opportunity back in 2000, 2001, 2002, et cetera. I, myself was out there, and I also set up a, an investment, uh, division, bringing, high net worth individuals, to buy, apartments, and to invest in large scale residential development projects. I think a lot of promoters going there also just felt, that distance that was involved, made it sort of, uh, easy pickings. Now I know some of these guys, had a professional front and a lot of them were, well-educated and well-trained, I mean. I've seen situations where, a number of ex uh, bankers, guys who had worked for major financial institutions in the uk, uh, and Ireland, uh, companies like, uh, working for companies like JP Morgan, um, leaving to set up these, Shanghai, platforms for people to invest through them, bringing projects, promoting them, presenting them. So these guys were professionals. Uh, they had that professional veneer about them, and, uh, and people trusted them. But from what I've seen, In collusion with, uh, local Chinese partners that were, prepared to help and were prepared to collaborate with them, they were able to sort of, take. The money

Simon 6:44

Take the money and run. it seems as if there was a bunch of crooks operating in this area and they were using similar techniques to defraud their victims.

6:53

the thing about it is there was, certain common themes that I noticed running through a number of these frauds and the individuals involved. A lot of them are certainly living, um, great lifestyles today because they, enrich themselves at the expense of, gullible investors. Bad actors, if you want to call them, that were able to take advantage. because of the lack of transparency, because of the lack of regulations and take advantage, Of investors far away.

Simon 7:22

Okay, so can you give us a list of the main frauds that were being perpetrated to deceive investors: Well, the first one was, inflate the price that the, overseas investors had to pay. Um, so typically a lot of these investment opportunities were where investors, were acquiring. Either individual apartments or a share in a, uh, in a building. So the, um, the promoter would work with the, in collaboration or in collusion. Uh, with the local developer, often to, uh, inflate the prices for overseas investors compared to local, purchases who are much, obviously much more savvy and understood the market, and what market values were. The second way was to have the investors pay for the fit out, and decorations and furnishings, for the apartments in the building. And of course, in many cases. Where these developments were primarily aimed at overseas investors, generally developers would, um, go further than just providing a bare shell. The investors, uh, would be told that there was a fit out cost and have to be charged a sum on top of the purchase price when there was no fit out cost. And, uh, you know, absent them going all the way to China, sort of to check the condition of a building if documentation was provided or representation were made. The investors simply had to rely on that from their point of view. Uh, the third one was, to, misrepresent the amount of the conveyance in costs that were involved and to rely on the, uh, ignorance of overseas investors. In terms of local markets, rules and regulations, and often they would be able to create, uh, a fictitious, categories or amounts of conveyancing costs and, uh, and add those on again for a, an additional secret profit into their own, into their own pockets. And the fourth way was, what I would refer to as the rent reduction scam. And this is where the, the rents that are being paid to the investors are for one reason and another, reduced. And I'll go into that in a little bit more detail'cause it's quite an interesting scam. The fifth and, final broad category of scams, uh, is a scam where. The apartment building, let's say, had other uses, other spaces, for example, uh, commercial space, uh, perhaps on the ground floor, perhaps a car park in the basement. And the promoters, particularly the sort of brazen and, very, um, opportunistic promoters, uh, to call them that, uh, they would, not inform the investors that this other space was available and would effectively, uh, obtain rents on those spaces, uh, and keep it for their own, for themselves. And, not pay any of the, those sums to the investors, even though the investors would have, had ownership to, or had the right to that income because they effectively owned the, uh, the whole building on block. So this was, uh, another audacious scam that, uh, was a less frequent, But which I did observe being perpetrated, Okay, so we have some pretty audacious scams being carried out and some of them by different promoters. Can you give us an overview and put some meat on the bones, so to speak, of the more intricate and sophisticated ones. So a lot of these, uh, schemes were being promoted to Irish investors on the basis that the, uh, rental income would be guaranteed by the tenant. And this was obviously a very attractive thing for, uh, for those investors. As time went on, the investors were making good money. The buildings were appreciating in value, uh, albeit unrealized returns, but everybody could see the property market was booming. And the operators and managers of these, uh, investment schemes in China, I think felt that these guaranteed rentals were quite onerous on them. And of course they then were subletting and, letting down to occupiers. But, typically they were locked into 6% or 7% guaranteed rental returns. Um, means they had to work quite hard to turn a profit, on their side. And I think they felt it was time to balance the books a little bit. So what they did is, uh, in different ways, many of them concocted reasons, wrote to the shareholders and investors back in Ireland, in the uk, and, um, started to make, uh, excuses as to reasons why they couldn't maintain the rental income. I've got a few schemes I can refer to paperwork, uh, in, one of those schemes in 2008, the management company, that was paying the rent. said that they couldn't afford to continue to pay the 6% guaranteed rental that was being paid, that it was creating a great burden for the company that the company wasn't able to sublet at higher levels. Uh, that the costs were rising. And they said, if we continue to pay the 6% yield to you, the company will go into bankruptcy in the next two years. And then they say that how disastrous that would be for the, for the investors. And you have a situation where, they, wrote to investors saying, we're having to reduce the rent. And in this particular case, the rent was gonna be reduced, uh, in 2008. And this was before the financial crash in 2008. So they didn't have that to lean on. So if you bear that in mind for a little bit later on, but they wanted to reduce the rent from 6% to 4%. That's a 2% reduction. And uh, clearly that's a, you know, a 33% reduction in rent, massive in anybody's book. But they would've justified it, uh, on the basis that, well, well, the investors have got it, getting a nice capital appreciation. Um, uh, and I say we want a bit of that action. So in their own minds, that's how they would've justified it. So you've got that particular rent reduction, um, a 33% rent reduction. Happening just prior to the, to the financial crash. And of course investors back home in UK and Ireland had to just, uh, had to accept it because they weren't none the wiser, and they assumed that the, the pleadings of the, uh, of the rental company were genuine. Then you had the crash in 2008. This, this provided a nice, uh, backdrop, if you like, for. For the, local, Chinese, rental company. Again paying a guaranteed rental income to, to argue that this was causing huge difficulties. And we have this in another particular development and in that particular case, we're talking in, September, 2008. We had the financial crash and investors were informed that the rental payments would unfortunately have to reduce, uh, and the global financial crisis was blamed, uh, there was gonna be a large reduction in rent. In this particular case, the reduction in the rents was from 6% to 3.3%. Uh, so that's a 45%. Uh, reduction. Again, very significant. And so you have the situation before the crash coming up with certain excuses, and, uh, so you got, after the crash, you've got the muting, that is the excuse. Unbelievable And generally they were able to get away with it. Uh, and it did catch up with one or two of them. Um, as you will have heard in an earlier episode of my podcast, uh, the Shanghai Surprise, where there was, uh, legal proceedings taken against the promoter for Secret Profits, a, a rent reduction. That was, not warranted, uh, according to the investors. And there was a settlement that was reached out of court. I've got another example in, another development, a large development, a lot of overseas investors, and in, uh, February, 2012. The asset manager wrote to investors, and in this case, they basically were saying that there was a lot of uncertainty in the marketplace that their initial five year rental contract was, ending, that the new contract couldn't be on the same basis. That the, uh, market rents in Shanghai had fallen and were under a lot of pressure, and that they were really pushing the investors to accept, the, reduced rents. They also said that there was a, new underground metro subway was being constructed right outside the building in the coming months, was gonna last for two to three years, and therefore, there, there was nobody else, no other companies such as themselves that would be interested in managing the building. And ironically, they went on to say that, this development that current rental company has proven their professionalism and integrity with zero rental default over the last five year contract. Even through a global financial crisis. So they're, while they're patting themselves on the back for having not had any rent reductions during the financial crisis, you saw earlier on where other schemes were using the financial crisis to get rent reductions. Anyway, the initial guaranteed rent in this particular scheme had been 7%, and the, uh, rent reduction, which was effectively forced upon the, uh, investors after the initial five year period, uh, it was a reduction of 49%, so a staggering reduction in the amount of income that was going to be generated by the property. I suppose the investors wouldn't have been in a strong position to challange the frauds anyway? I would say that, uh, from the investor's point of view, they would think, well, we got our money back home. We, made money on our, on the deal. The buildings, you know, would've been sold eventually, apartments would've been sold. Uh, and from their perspective, the, from the investor's perspective, it's water under the bridge. And they maybe just wanted to turn a blind eye to whatever may or may not have happened. so it was win-win for everybody. And, the investors still won on the capital appreciation side of things. But the point of the matter is they didn't get what they ought to have got according to the original investment, uh, proposal, or an original investment memorandums. And a lot of the promoters, the middlemen, if you like, came away with substantial profits that were effectively undisclosed and in breach of contract, et cetera. I know a number of those individuals, uh, I know who they are, but I was never a direct investor in these schemes, and so there's no obligation on me and, no interest for me to pursue them. But some investors were not happy at having been duped and did want answers? Yes, so. Yeah, we did pursue some. I worked with a number of solicitors, particularly in Ireland, to try and get certainly some answers to questions from the promoters. A number of those, early schemes. Where the platforms had been set up to bring Irish and UK investors into the Shanghai real estate market. Those promoters had moved on. Uh, some of them had moved abroad. For reasons that are best known to themselves, but there were questions to be answered and in and around 2014 in that, in and around that timeframe, There was one particular case where, uh, the individual who'd been an owner and founder of one of those, uh, early platforms. And they had moved abroad and we managed to track him down. And the solicitors with my input, uh, contacted him, uh, put a lot of questions to him in writing about the purchase price, uh, about the fit out costs, about conveyancing costs, and, there was clearly concerns that were jumping out at us. And I could see from my review and my, uh, understanding of what had gone on, uh, that there may be some, allegations, to be faced here. And the individual did respond a little bit, uh, from Farfield. Uh, but the main purpose of his correspondence, was to point out that back in 2006, so many years before around that time, the marketing and sales offices of the company, uh, abroad were broken into, and he said a number of items were stolen, including some laptops, which contained, uh, all of his marketing sales. Uh, communications records in relation to a number of the projects, including the one particular project that we were interested in getting some answers to our questions, uh, where investors had concerns and he gave a police reference number and he said that those laptops were never found or recovered. And, uh, so, he didn't have access to the information we were looking for. And he also said that severed his connection with the company back in 2006. Uh, so he was basically saying, don't ask me. You know, I'm not to blame. I don't have the answers. I've not done anything wrong here. So that's his case. Uh, listeners will have to infer from it, what they will, Well, Edward, your takeaway has certainly given our listeners some things to chew on, something sweet,, and sour, if you'll excuse the pun! Yes. I take your point. Uh, regarding the pun on the Chinese takeaway. I suppose what I would say to conclude is that when evaluating investment opportunities in order to spot the red flags, I would say to listeners, it's really important. To pay attention a hundred percent attention to everything you are being promised and everything you are being told. And don't let yourself be blindsided by, you know, blue sky pictures that are being presented to you. And, raise queries and if when you raise your queries, the promoters, uh, investment managers push back on this at all. Uh, that should set alarm bells ringing. And you should be prepared to walk away. So let me finish by saying it's better to cook something simple at home yourself, rather than having a bad Chinese takeaway.