Learning about China's property boom and its "ghost" cities has given me a whole new perspective on my four decades in the building, land development and consulting fields. During these periods our economy has had various ups and downs. In ‘up’ times, the rise in construction of new housing and growth in commercial developments has been quite obvious. What I have always had a problem understanding is why there seemed to be new housing projects and commercial projects that sprouted up during the bad times.
Unlike this current recession — and I do believe that it is still current, despite the rhetoric that it's over — past economic downturns were localized. As an example, I lived in Detroit in 1973 during the first gas crunch, when there were long lines to fill up. Unemployment in Detroit was a huge problem, and there was no work for a young ‘planner’ for new suburban developments, nor the prospect of anything turning around soon.
I eventually decided to move to the south, where it was thought to be better. As I crossed into Texas, there weren't any more gas lines. It seemed the entire State was booming. I drove through to Houston, picked up a phone book, and made a phone call to Paul Lederer Land Surveying and Engineering, which had a display ad that stuck out. Paul answered, and when I explained that I wanted to work as an apprentice to expand my knowledge into his field he hired me over the phone. I settled down, and after a year was ready to buy a home of my own.
Detroit was still in economic hardship, with housing requiring a 20% down payment for a mortgage. At the same time, in Houston, homes were so much in demand that we had only minutes to make an offer once a home we wanted came on the market. Financing required only a 5% down payment.
When a wealthy Detroit businessman heard that I could buy homes with only 5% down in a market that was escalating in sales and pricing I was offered a business proposition. I was asked to buy 50 homes at 5% down, and then resell them to a shell company for at least 10% more than our original purchase price. The homes would then be re-financed elsewhere with 5% down. The shell company would then default on the loans, and we would split the profits.
In other words, if we paid an average of $30,000 each for 50 homes, we would have $1,500,000 in real estate, for which we had put $75,000 down. In theory, if I sold the homes to a shell company for $2,000,0000 with a $100,000 down payment, we would each walk away with $200,000 profit (roughly $790,000 in today’s dollars after inflation) if we defaulted on the loans. I was not interested in something that I considered fraud for a quick dollar, but it would not have been difficult to do this in real estate at that time.
A few years later, Detroit was still in an economic downturn, and another person I knew was building large residential and commercial projects. These were new developments with hundreds of units and high-rise office towers.
I mentioned to someone close to this developer that I was unimpressed with a venture to build at a time when there was not a market for either condominium buyers or office tenants, and curious as to why it was being pursued. A 20 story office tower would impress me if it were leased out; one sitting empty would not be so impressive.
The answer was a lesson in economics. It was explained to me that the office tower was built for $10 million, but financed for $20 million, made possible by some inventive appraisals. Yet the bank needed only $1 million down. In other words, if the developments failed spectacularly there were still millions to be made, even if the properties went back to the banks. Ironically, Detroit in the late 1970’s and early 1980’s recovered somewhat, and the developments in question became financially viable and successful.
I have no doubt that every industry, not just the development of land, has stories of financial shenanigans, but these are two examples of only a few that I have been exposed to during my 43 years in the development business.
So today, whenever I see areas with aggressive construction that exceeds market potential, it makes me wonder…
In light of this history, see what you think about development in China. Check out this 15 minute video from a major Australian broadcaster on China's ghost cities.
Rick Harrison is President of Rick Harrison Site Design Studio and Neighborhood Innovations, LLC. He is author of Prefurbia: Reinventing The Suburbs From Disdainable To Sustainable and creator of Performance Planning System. His websites are rhsdplanning.com and performanceplanningsystem.com.
Photo: Expensive waterside apartments in Shekou Shenzhen by DC Master.