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By Huixia Sun

On September 16, Li Ming, who requested a pseudonym for privacy concerns, received a notice from an agent at Chengpu Apartments, a long-term apartment rental company. It read that the firm had applied for bankruptcy and that “please go to the company to safeguard your rights as soon as possible.”  

Three days after moving into the apartment in Guangzhou in southern China, Li is facing the possibility of being kicked out by the landlord. He had paid 12 months of rent to the company upfront in order to get a discount. His landlord would have received rent payments on a monthly basis without the sudden closure of the company. Hundreds of landlords and tenants have confronted the company demanding a solution.

There were signs the abrupt bankruptcy was coming. An agent revealed that the company’s legal representative changed and the rent was reduced significantly in August. The subsidiary of Chengpu Apartments in Xi’an in western China is teetering on the brink of bankruptcy.  

Guangzhou police have started an investigation into the legal representative and senior executives of the firm. The authorities are collecting evidence such as rental agreements, payment proof and identity document photocopies.

Similarly in Hangzhou and Chengdu, Woke Apartments and Youke Apartments, among others, have been shuttered due to insolvency. In late August, TMTPost found that the head office of Youke Apartments in Hangzhou was sealed with tape by municipal authorities.

Flawed Business Practices

The Chinese government has been encouraging the business of long-term rental firms in order to satisfy the over-a-month rental needs of university graduates and elderly people. However, some rental firms collapsed in 2018, leaving many unpaid landlords and tenants who paid in advance sorting out the mess. That marked the first wave of long-term rental firm bankruptcies, which was caused mainly by the firms’ embezzlement of the rent for their principal high-interest lending business.    

This year, apartment rental companies went bankrupt due to another fundamentally flowed business model, where the middleman platform firms offer payments higher than market prices to landlords while luring tenants with a rent lower than market prices. In a common practice, the apartment rental firm signs an entrustment contract with a homeowner, who authorizes the firm to renovate and rent out their property in the name of the firm and waives the right to strike a deal directly with a tenant. The firm collects half a year or one year of rent from tenants in advance, and then pays homeowners on a monthly basis.

When the macroeconomic conditions were robust, the money-burning strategy could have worked by introducing new capital from venture capital firms, PEs or strategic investors to fill the gap. However, amid economic slowdown in China and a worsening U.S.-China trade war, the model of subsidizing both landlords and tenants to fuel fast expansion is doomed to fail.    

Fragile Links Amid the Pandemic  

Long-term rental firms backed by big real estate brokerages with deep pockets tend to be more prudent about liquidity management. Although they also pay landlords more than the amount received from tenants, they have taken actions to mitigate the risk. Real estate brokerage 5j5j.com told a landlord that there would be a two-month vacancy and landlords could receive only 10 months of rent in a year. Suiyu of Dexin Group, a real estate brokerage, would charge landlords over RMB10,000 (about US$1,430) for renovation costs.

By comparison, smaller companies like Youke and Woke are reckless. A homeowner, who preferred to use the pseudonym Xiao Lu, told TMTPost that Youke claimed that they were backed by large stated-owned enterprises. Youke also offered her rental payment much higher than their rivals.

The market rent price for Lu’s apartment is about RMB2,000 per month. While Youke promised to pay her RMB2,500, a tenant paid only RMB1,500 per month when the yearly rent was paid upfront. The price gap of RMB1,000 is difficult to bridge even if the money is invested in a bull stock market. Some rental firms just walked away with the pre-paid rent when a liquidity crunch pinched.    

Youke opened four branches in Ningbo in 2020, two of which started operations on August 5 and August 20. However, it was shut down in late August. Some landlords cut off water or electricity supply to force the tenants to leave since they did not receive any payment any more. In some cases, a tenant even paid two-year or three-year rent in advance.

Many landlords or tenants did not question the sustainability of the business model mainly because they assumed that a big deep-pocket shareholder could afford the money-burning game in order to scale up their business.

Since the coronavirus outbreak in January, rent prices have gone down across China. In August, things got even worse after a hike in transactions in July when university graduates started working.

There are over 500 long-term rental firms that registered with the municipal regulator in Hangzhou, according to the website of Hangzhou Housing Rental Supervision Services.  Late last year, Hangzhou authorities introduced regulations that mandate rental firms set aside two-month rent as a cushion for liquidity risks. Due to the coronavirus outbreak, the implementation of the bylaw was delayed. Apartment rental firm associations in a few cities across China have issued warnings to tenants and landlords about potential risks.