Form 20-F
Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 20-F

 

 

(Mark One)

¨ REGISTRATION STATEMENT PURSUANT TO SECTION 12(b) OR 12(g) OF THE SECURITIES EXCHANGE ACT OF 1934

OR

 

x ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For The Fiscal Year Ended December 31, 2009.

OR

 

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934

For The Transition Period From              To             

OR

 

¨ SHELL COMPANY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934

Date of event requiring this shell company report

Commission file number: 001-33863

 

 

XINYUAN REAL ESTATE CO., LTD.

(Exact name of Registrant as specified in its charter)

 

 

N/A

(Translation of Registrant’s name into English)

Cayman Islands

(Jurisdiction of incorporation or organization)

27/F, China Central Place, Tower II

79 Jianguo Road, Chaoyang District

Beijing 100025

People’s Republic of China

(Address of principal executive offices)

Tom Gurnee

Xinyuan Real Estate Co., Ltd

27F, China Central Place, Tower II,

79 Jianguo Road, Chaoyang District

Beijing 100025

People’s Republic of China

Tel: (86-10) 8588-9390

Fax: (86-10) 8588-9300

Mob: (86) 136 0127 0907

(Name, Telephone, E-mail and/or Facsimile number and Address of Company Contact Person)

 

 

Securities registered or to be registered pursuant to Section 12(b) of the Act:

 

Title of Each Class

  

Name of Each Exchange on Which Registered

American Depositary Shares, each representing two

common shares, par value US$0.0001 per share

   New York Stock Exchange

Securities registered or to be registered pursuant to Section 12(g) of the Act:

None

(Title of Class)

Securities for which there is a reporting obligation pursuant to Section 15(d) of the Act:

None

(Title of Class)

 

 

Indicate the number of outstanding shares of each of the Issuer’s classes of capital or common stock as of the close of the period covered by the annual report. 151,688,262 common shares, par value US$0.0001 per share, as of December 31, 2009.

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.    Yes  ¨    No  x

If this report is an annual or transition report, indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934.    Yes  ¨    No  x

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  ¨    No  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer  ¨                Accelerated filer  x                Non-accelerated filer  ¨

Indicate by check mark which basis of accounting the registrant has used to prepare the financial statements included in this filing:

 

U.S. GAAP  x   

International Financial Reporting Standards as issued

by the International Accounting Standards Board  ¨

   Other  ¨

If “Other” has been checked in response to the previous question, indicate by check mark which financial statement item the registrant has elected to follow.    Item 17  ¨    Item 18  ¨

If this is an annual report, indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  x

(APPLICABLE ONLY TO ISSUERS INVOLVED IN BANKRUPTCY PROCEEDINGS DURING THE PAST FIVE YEARS)

Indicate by check mark whether the registrant has filed all documents and reports required to be filed by Sections 12, 13 or 15(d) of the Securities Exchange Act of 1934 subsequent to the distribution of securities under a plan confirmed by a court.    Yes  ¨    No  ¨

 

 

 


Table of Contents

TABLE OF CONTENTS

 

          PAGE
ITEM 1.    IDENTITY OF DIRECTORS, SENIOR MANAGEMENT AND ADVISERS    3
ITEM 2.    OFFER STATISTICS AND EXPECTED TIMETABLE    3
ITEM 3.    KEY INFORMATION    3
          A.    Selected Financial Data    3
          B.    Capitalization and Indebtedness    5
          C.    Reasons for the Offer and Use of Proceeds    5
          D.    Risk Factors    5
ITEM 4.    INFORMATION ON THE COMPANY    23
          A.    History and Development of the Company    23
          B.    Business Overview    23
          C.    Organizational Structure    50
          D.    Property, Plants and Equipment    51
ITEM 4A.    UNRESOLVED STAFF COMMENTS    51
ITEM 5.    OPERATING AND FINANCIAL REVIEW AND PROSPECTS    51
          A.    Operating Results    51
          B.    Liquidity and Capital Resources    78
          C.    Research and Development, Patent and Licenses, etc.    81
          D.    Trend Information    81
          E.    Off-Balance Sheet Arrangements    81
          F.    Tabular Disclosure of Contractual Obligations    81
          G.    Safe Harbor    83
ITEM 6.    DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES    84
          A.    Directors and Senior Management    84
          B.    Compensation    85
          C.    Board Practices    88
          D.    Employees    89
          E.    Share Ownership    89
ITEM 7.    MAJOR SHAREHOLDERS AND RELATED PARTY TRANSACTIONS    91
          A.    Major Shareholders    91
          B.    Related Party Transactions    91
          C.    Interests of Experts and Counsel    92
ITEM 8.    FINANCIAL INFORMATION    92
          A.    Consolidated Statements and Other Financial Information    92
          B.    Significant Changes    93


Table of Contents
          PAGE
ITEM 9.    THE OFFER AND LISTING    93
          A.    Offer and Listing Details    93
          B.    Plan of Distribution    93
          C.    Markets    93
          D.    Selling Shareholders    94
          E.    Dilution    94
          F.    Expenses of the Issue    94
ITEM 10.    ADDITIONAL INFORMATION    94
          A.    Share Capital    94
          B.    Memorandum and Articles of Association    94
          C.    Material Contracts    94
          D.    Exchange Controls    94
          E.    Taxation    94
          F.    Dividends and Paying Agents    98
          G.    Statement by Experts    98
          H.    Documents on Display    98
          I.    Subsidiary Information    98
ITEM 11.    QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK    98
ITEM 12.    DESCRIPTION OF SECURITIES OTHER THAN EQUITY SECURITIES    100
ITEM 13.    DEFAULTS, DIVIDEND ARREARAGES AND DELINQUENCIES    100
ITEM 14.    MATERIAL MODIFICATIONS TO THE RIGHTS OF SECURITY HOLDERS AND USE OF PROCEEDS    100
ITEM 15.    CONTROLS AND PROCEDURES    100
ITEM 16    RESERVED    102
ITEM 16A.    AUDIT COMMITTEE FINANCIAL EXPERT    102
ITEM 16B.    CODE OF ETHICS    102
ITEM 16C.    PRINCIPAL ACCOUNTANT FEES AND SERVICES    102
ITEM 16D.    EXEMPTIONS FROM THE LISTING STANDARDS FOR AUDIT COMMITTEES    103
ITEM 16E.    PURCHASES OF EQUITY SECURITIES BY THE ISSUER AND AFFILIATED PURCHASERS    103
ITEM 16F.    CHANGE IN REGISTRANT’S CERTIFYING ACCOUNTANT    103
ITEM 16G.    CORPORATE GOVERNANCE    103
ITEM 17.    FINANCIAL STATEMENTS    103
ITEM 18.    FINANCIAL STATEMENTS    103
ITEM 19.    EXHIBITS    104


Table of Contents

INTRODUCTION

Unless otherwise indicated and except where the context otherwise requires, references in this annual report on Form 20-F to:

 

   

“we,” “us,” “our company,” “our,” “the Group” or “Xinyuan” refers to Xinyuan Real Estate Co., Ltd., its predecessor entities and its subsidiaries and, in the context of describing our operations and consolidated financial data, also includes Xinyuan Real Estate, Ltd. and its subsidiaries;

 

   

“shares” or “common shares” refers to our common shares, par value US$0.0001 per share;

 

   

“ADSs” refers to our American depositary shares, each of which represents two common shares, and “ADRs” refers to the American depositary receipts that evidence our ADSs;

 

   

“China” or “PRC” refers to the People’s Republic of China, excluding, for the purposes of this Form 20-F only, Taiwan, Hong Kong and Macau;

 

   

“GFA” refers to gross floor area. The amounts for “total GFA” in this annual report are the amounts of total saleable residential and commercial GFA and are derived on the following basis:

 

   

for properties that are sold, the stated GFA is based on the sales contracts relating to such property; GFA may be adjusted based on final examination upon delivery of the property;

 

   

for unsold properties that are completed or under construction, the stated GFA is calculated based on the detailed construction blueprint and the calculation method approved by the PRC government for saleable GFA, after necessary adjustments; and

 

   

for properties that are under planning, the stated GFA is based on the land grant contract and our internal projection; and

 

   

“RMB” or “Renminbi” refers to the legal currency of China and “US$” or “U.S. dollars” refers to the legal currency of the United States.

At present, there is no uniform standard to categorize the different types and sizes of cities in China. In this annual report, we refer to certain larger and more developed cities as Tier I and Tier II cities based on the categorization used by the CIHAF Valuation Report on Real Estate Investment in PRC Cities published by China Real Estate Business, an authoritative real estate publication in China, YUBO Media and Institute of Finance and Trade Economics of Chinese Academy of Social Sciences. Based on this approach, there are currently four Tier I cities and 35 Tier II cities in China.

This Annual Report on Form 20-F includes our audited consolidated financial statements for the years ended December 31, 2007, 2008 and 2009 and as of December 31, 2008 and 2009.

Our financial statements and other financial data included in this annual report are presented in U.S. dollars. Our business and operations are primarily conducted in China through our PRC subsidiaries. The functional currency of our PRC subsidiaries is RMB. The financial statements of our PRC subsidiaries are translated into U.S. dollars, using published exchange rates in China, based on (i) year-end exchange rates for assets and liabilities and (ii) average yearly exchange rates for revenues and expenses. Capital accounts are translated at historical exchange rates when the transactions occurred. The effects of foreign currency translation adjustments are included as a component of accumulated other comprehensive income in our shareholders’ equity. We make no representation that any RMB or U.S. dollar amounts could have been, or could be, converted into U.S. dollar or RMB, as the case may be, at any particular rate or at all. See “Item 3. Key Information—A. Selected Financial Data—Exchange Rate Information.”

We completed an initial public offering, or IPO, of 20,125,000 ADSs, each representing two common shares, in December 2007. On December 12, 2007, we listed our ADSs on the New York Stock Exchange, or the NYSE, under the symbol “XIN.” The closing price of our ADSs on the NYSE as of March 29, 2010 was $4.02 per ADS.

 

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Table of Contents

FORWARD-LOOKING STATEMENTS

This annual report contains forward-looking statements that involve risks and uncertainties. All statements other than statements of historical facts are forward-looking statements. These statements involve known and unknown risks, uncertainties and other factors that may cause our actual results, performance or achievements to be materially different from those expressed or implied by the forward-looking statements.

You can identify these forward-looking statements by words or phrases such as “may,” “will,” “expect,” “is expected to,” “anticipate,” “aim,” “estimate,” “intend,” “plan,” “believe,” “potential,” “continue,” “is/are likely to” or other similar expressions or negatives of such expressions. These forward-looking statements include, among others, statements about:

 

   

our anticipated growth strategies;

 

   

our future business development, results of operations and financial condition;

 

   

our expectations with respect to our ability to acquire adequate suitable land use rights for future development; and

 

   

our belief with respect to market opportunities in, and growth prospects of, Tier II cities in China.

We have based these forward-looking statements largely on our current expectations and projections about future events and financial trends that we believe may affect our financial condition, results of operations, business strategy and financial needs. However, a number of known and unknown risks, uncertainties and other factors could affect the accuracy of these statements. Among the important factors to consider in evaluating our forward-looking statements are:

 

   

our ability to continue to implement our business model successfully;

 

   

our ability to secure adequate financing for our project development;

 

   

our ability to successfully sell or complete our property projects under construction and planning;

 

   

our ability to enter into new geographic markets and expand our operations;

 

   

our ability to maintain strict cost control;

 

   

the marketing and sales ability of our third-party sales agents;

 

   

our ability to obtain permits and licenses to carry on our business in compliance with applicable laws and regulations;

 

   

competition from other real estate developers;

 

   

the growth of the real estate industry in China, particularly Tier II cities;

 

   

fluctuations in general economic and business conditions in China;

 

   

fluctuations in interest rates in China; and

 

   

PRC laws, regulations and policies relating to real estate developers and the real estate industry in China.

You should read thoroughly this annual report and the documents that we refer to herein with the understanding that our actual future results may be materially different from and/or worse than what we expect. We qualify all of our forward-looking statements by these cautionary statements. Other sections of this annual report include additional factors which could adversely impact our business and financial performance, including the risks outlined under “Item 3. Key Information – D. Risk Factors”. Moreover, we operate in an evolving environment. New risk factors emerge from time to time and it is not possible for our management to predict all risk factors, nor can we assess the impact of all factors on our business or the extent to which any factor, or combination of factors, may cause actual results to differ materially from those contained in any forward-looking statements.

This annual report may also contain third party data relating to the real estate industry in China that includes projections based on a number of assumptions. The real estate industry in China may not grow at the rates projected by market data, or at all. The failure of this market to grow at projected rates may have a material adverse effect on our business and the market price of our ADSs. Furthermore, if one or more of the assumptions underlying the market data turns out to be incorrect, actual results may differ from the projections based on these assumptions. You should not place undue reliance on these forward looking statements.

You should not rely upon forward-looking statements as predictions of future events. The forward-looking statements made in this annual report relate only to events or information as of the date on which the statements are made in this annual report. We undertake no obligation to update or revise any forward-looking statements, whether as a result of new information, future events or otherwise, except as otherwise required by applicable securities laws.

 

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Table of Contents

PART I

 

ITEM 1. IDENTITY OF DIRECTORS, SENIOR MANAGEMENT AND ADVISERS

Not Applicable.

 

ITEM 2. OFFER STATISTICS AND EXPECTED TIMETABLE

Not Applicable.

 

ITEM 3. KEY INFORMATION

A. Selected financial data

Our Selected Consolidated Financial Data

The following selected consolidated statement of operations and other financial data for the years ended December 31, 2005, 2006, 2007, 2008 and 2009, other than the earnings per ADS data, and the consolidated balance sheet data as of December 31, 2005, 2006, 2007, 2008 and 2009 have been derived from our audited consolidated financial statements which are included elsewhere in this annual report on Form 20-F. Our audited consolidated financial statements have been prepared and presented in accordance with United States generally accepted accounting principles, or U.S. GAAP. Except for changes in operating subsidiaries, our consolidated financial statements have been prepared as if our current corporate structure had been in existence throughout the relevant periods.

The selected consolidated financial data should be read in conjunction with, and are qualified in their entirety by reference to, our audited consolidated financial statements and related notes and “Item 5. Operating and Financial Review and Prospects” included elsewhere in this annual report.

 

     Years Ended December 31,  
     2005     2006     2007     2008     2009  
     US$     US$     US$     US$     US$  
     (in thousands, except share, per share and per ADS data)  

Consolidated Statements of Operations Data(1)

          

Total revenues

   61,942      142,367      309,725      356,632      448,984   

Total costs of revenues

   (42,632 )   (108,196 )   (208,135 )   (356,981 )   (359,739

Selling and distribution expenses

   (2,175 )   (2,996 )   (10,515 )   (13,578 )   (11,443

General and administrative expenses

   (1,696 )   (3,626 )   (17,077 )   (32,343 )   (22,215

Operating income/(loss)

   15,439      27,549      73,998      (46,270 )   55,587   

Net income/(loss) before minority interest

   9,548      16,120      45,663      (23,640 )   42,419   

Net income/(loss)

   9,563      16,123      45,663      (23,640 )   42,419   

Accretion of Series A convertible redeemable Preference shares

   —        (942 )   (2,739 )   —        —     

Deemed dividend(2)

   —        —        (182,229 )   —        —     

Net income (loss) attributable to ordinary shareholders(2)

   9,563      15,181      (139,305 )   (23,640 )   42,419   

Earnings (loss) per share

          

—Basic

   0.16      0.21      (1.28 )   (0.16 )   0.28   

—Diluted

   0.16      0.21      (1.28 )   (0.16 )   0.26   

Shares used in computation

          

—Basic

   60,000,000      72,694,467      108,690,267      149,149,309      151,252,815   

—Diluted

   60,000,000      72,694,467      108,690,267      149,149,309      160,871,387   

Earnings (loss) per ADS(3)

          

—Basic

   0.32      0.42      (2.56 )   (0.32 )   0.56   

—Diluted

   0.32      0.42      (2.56 )   (0.32 )   0.52   

Other Operating Data

          

Number of projects launched

   2      3      6      3      —     

Aggregate GFA delivered (m2)

   161,717      370,105      513,878      519,100      1,591,132   

 

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The following table presents a summary of our consolidated balance sheet data as of December 31, 2005, 2006, 2007, 2008 and 2009:

 

     As of December 31,
     2005    2006    2007    2008    2009
     US$    US$    US$    US$    US$
     (in thousands)     

Consolidated Balance Sheet Data(1)

              

Cash and cash equivalents

   14,929    34,914    309,315    135,659    157,800

Restricted cash

   5,385    32,011    48,267    57,951    40,240

Real estate property under development(4)

   64,857    106,804    388,881    623,203    560,590

Total current assets

   90,357    174,426    770,347    778,013    849,357

Total assets

   108,702    204,956    807,195    936,166    881,782

Total current liabilities

   82,228    118,840    154,374    417,990    369,098

Long-term bank loans

   7,435    12,806    137,858    105,007    53,015

Preference shares

   —      22,309    —      —      —  

Capital stock

   —      7,570    14,840    15,102    15,148

Total shareholders’ equity

   17,000    46,583    389,899    400,255    446,912

 

(1) Our financial information is first prepared in RMB and then translated into U.S. dollars for assets and liabilities, at the year-end exchange rate, and for revenues and expenses, at the yearly average exchange rate. The rates used are set forth in the table below. Capital accounts are translated at their historical exchange rates when the transactions occurred.

 

     As of and for the Year Ended December 31,
     2005    2006    2007    2008    2009

Period-end US$: RMB exchange rate

   8.0702    7.8087    7.3046    6.8346    6.8282

Period average US$: RMB exchange rate

   8.1734    7.9721    7.6079    6.9480    6.8311

As of March 20, 2010, the US$: RMB exchange rate was 6.8269.

 

(2) On November 13, 2007, the holders of the Series A convertible redeemable preference shares, or Series A preference shares, agreed to waive the contingent conversion option. The modification was deemed to be substantive and was treated for accounting purpose as an extinguishment of the Series A preference shares. In connection with this, we recognized a dividend of approximately US$182.2 million to the Series A preference shareholders, representing the difference between the fair value of the convertible preference shares immediately after the modification and the carrying value of the preference shares immediately prior to the modification. This deemed dividend did not affect our net income or cash flows. However, it reduced the net income attributable to ordinary shareholders and retained earnings for the year ended December 31, 2007 by the amount of the dividend.
(3) Earnings per ADS are calculated based on each ADS representing two common shares.
(4) Includes real estate property under development recorded under current assets and non-current assets.

Exchange Rate Information

Our financial statements and other financial data included in this annual report are presented in U.S. dollars. Our business and operations are primarily conducted in China through our PRC subsidiaries. The functional currency of our PRC subsidiaries is RMB. The financial statements of our PRC subsidiaries are translated into U.S. dollars, using published exchange rates in China, based on (i) year-end exchange rates for assets and liabilities and (ii) average yearly exchange rates for revenues and expenses. Capital accounts are translated at historical exchange rates when the transactions occurred. The effects of foreign currency translation adjustments are included as a component of accumulated other comprehensive income in our shareholders’ equity. We make no representation that any RMB or U.S. dollar amounts could have been, or could be, converted into U.S. dollars or RMB at any particular rate, including the rate stated below.

The RMB is not freely convertible into foreign currency. The PRC government imposes control over its foreign currency reserves in part through direct regulation of the conversion of the RMB into foreign exchange and through restrictions on foreign trade. Since January 1, 1994, the People’s Bank of China, or the PBOC, has set and published daily a base exchange rate with reference primarily to the supply and demand of RMB against the U.S. dollar in the market during the prior day. On July 21, 2005, the PBOC announced a reform of its exchange rate system and revalued the RMB to RMB8.11 to US$1.00. Under the reform, the RMB is no longer effectively linked to the U.S. dollar but instead is allowed to fluctuate within a narrow and managed band against a basket of foreign currencies, according to market demand and supply conditions. The PBOC announces the RMB closing price each day and that rate serves as the mid-point of the next day’s trading band.

The following table sets forth, for each of the periods indicated, the low, average, high and period-end noon buying rates in New York City for cable transfers, in RMB per U.S. dollar. These rates are provided solely for your convenience and are not necessarily the exchange rates that we used in this annual report or will use in the preparation of periodic reports or other information to be provided to you.

 

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Table of Contents
     Noon Buying Rate(1)

Period

   Period End    Average(2)    Low    High
     (RMB Per US$1.00)

2005

   8.0702    8.1826    8.0702    8.2765

2006

   7.8041    7.9597    7.8041    8.0702

2007

   7.2946    7.6058    7.2946    7.8127

2008

   6.8225    6.9221    6.8225    7.2946

2009

   6.8259    6.8307    6.8176    6.8470

September

   6.8262    6.8277    6.8247    6.8303

October

   6.8264    6.8267    6.8248    6.8292

November

   6.8265    6.8271    6.8255    6.8300

December

   6.8259    6.8275    6.8244    6.8299

2010

           

January

   6.8268    6.8285    6.8258    6.8295

February

   6.8258    6.8269    6.8258    6.8330

March (through March 26)

   6.8269    6.8262    6.8254    6.8270

 

(1) For December 2008 and prior periods, the noon buying rate refers to the noon buying rate as reported by the Federal Reserve Bank of New York. For January 2009 and later periods, the noon buying rate refers to the exchange rate as set forth in the H.10 statistical release of the Federal Reserve Board.
(2) Annual averages are calculated by averaging the exchange rates on the last business day of each month or the elapsed portion thereof during the relevant period. Monthly averages are calculated using the average of the daily rates during the relevant period.

B. Capitalization and Indebtedness

Not Applicable.

C. Reasons for the Offer and Use of Proceeds

Not Applicable.

D. Risk Factors

Risks Related to Our Business

Our business is sensitive to the current global economic crisis. A severe or prolonged downturn in the global economy could materially and adversely affect our revenues and results of operations.

Recent global market and economic conditions have been unprecedented and challenging with tight credit conditions and recession in most major economies continuing into 2010. Continued concerns about the systemic impact of potential long-term and wide-spread recession, energy costs, geopolitical issues, the availability and cost of credit, and the global housing and mortgage markets have contributed to increased market volatility and diminished expectations for economic growth around the world. The grim economic outlook has negatively affected business and consumer confidence and contributed to volatility of unprecedented levels.

The PRC economy also faces challenges in the short to medium term. The stimulus plans and other measures implemented by the PRC government may not work effectively or quickly enough to avert a severe downturn in economic activity. Continued turbulence in the international markets and prolonged declines in consumer spending, as well as any slowdown of economic growth in China, may adversely affect our liquidity and financial condition.

If we are unable to successfully manage our expansion into other Tier II cities, we will not be able to execute our business plan.

Historically, our business and operations have been concentrated in Zhengzhou. Since 2006, we have been expanding our residential property development operations into other Tier II cities, consisting of Chengdu in Sichuan Province, Hefei in Anhui Province, Jinan in Shandong Province, and Suzhou, Kunshan and Xuzhou in Jiangsu Province. We plan to expand into other Tier II cities as suitable opportunities arise. The development of real estate projects in other Tier II cities will impose significant demands on our management and other operational resources. Moreover, we will face additional competition and will need to establish brand recognition and market acceptance for our developments in these new markets. Each of these Tier II cities has its own market conditions, customer requirements and local regulations related to the real estate industry. If we are unable to successfully develop and sell projects outside of our current markets, our future growth may be limited and we may not generate adequate returns to cover our investments in these Tier II cities. In addition, as we expand our operations to Tier II cities with higher land prices, our costs may increase, which may lead to a decrease in our profit margin, or impairments resulting from land value decreases.

 

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Our business requires access to substantial financing. Our failure to obtain adequate financing in a timely manner could severely adversely (1) restrict our ability to complete existing projects, expand our business, or repay our debts and (2) affect our financial performance and condition.

Our property development business is capital intensive. To date, we have funded our operations primarily through bank borrowings, shareholder loans, proceeds from sales and pre-sales of our properties and proceeds from issuance of equity and debt securities. We obtain commercial bank financing for our projects through credit lines extended on a case-by-case basis. Our ability to secure sufficient financing for land use rights acquisition and property development and repayment of our existing onshore and offshore debt obligations depends on a number of factors that are beyond our control, including lenders’ perceptions of our creditworthiness, market conditions in the capital markets, investors’ perception of our securities, the PRC economy and the PRC government regulations that affect the availability and cost of financing for real estate companies or the property purchasers. Since 2003, commercial banks have been prohibited, under guidelines of the PBOC, from advancing loans to fund the payment of land use rights and projects can be only partially funded based on loan-to-value ratios. In January 2010, the PRC State Council issued a circular to control the recent rapid increase in housing prices. The circular instructed the PBOC and the China Banking Regulatory Commission to tighten the supervision of the bank lending to the real estate sector. Subsequently, the PBOC raised the reserve requirement ratio for commercial banks by 0.5% to 16.5%. This was the second increase in 2010. The increase in the reserve requirement ratio will reduce the amount of commercial bank credit available to businesses in China, including us. We generate significant cash flow through pre-sales, which are subject to government restrictions. In particular, the PRC regulations on the pre-sales of properties generally provides that the proceeds from the pre-sales of a real estate project may only be used for the construction of such project. Any potential government restrictions on pre-sales could significantly increase our financing needs. Moreover, our ability to move cash through inter-company transfers or transfer funds from onshore subsidiary to offshore parent company is limited by PRC government regulations, limiting our ability to use excess cash resources in one subsidiary to fund the obligations of another subsidiary or the offshore parent company.

Furthermore, various other PRC regulations restrict our ability to raise capital through external financing and other methods, including, without limitation, the following:

 

   

we cannot pre-sell uncompleted residential units in a project prior to achieving certain development milestones specified in related regulations;

 

   

we cannot borrow from a PRC bank for a particular project unless we fund at least 35% of the total investment amount of that project from our own capital;

 

   

we cannot borrow from a PRC bank for a particular project if we do not obtain the land use rights certificate for that project;

 

   

property developers are strictly restricted from using the proceeds from a loan obtained from a local bank to fund property developments outside the region where that bank is located; and

 

   

PRC banks are prohibited from accepting properties that have been vacant for more than three years as collateral for loans.

As of December 31, 2009, our contractual obligations amounted to US$641.9 million, primarily arising from contracted construction costs or other capital commitments for future property developments and debt obligations. Of this amount, US$582.3 million is due within one year. In addition, in the last four months of 2009, we acquired five parcels of land total with an aggregate consideration of US$341.0 million, of which we have already paid US$190.8 million as of December 31, 2009, paid US$17.2 million in January 2010 and are required to pay off the remaining balance by May 2010. Moreover, our US$75.0 million floating rate notes will be due in April 2010 and the holder of our US$25.0 million convertible notes has the right to demand us to repurchase such convertible notes at 120% of the principal amount (plus accrued and unpaid interest) on June 15, 2010, unless we have exercised our redemption right to redeem such convertible notes upon a change in tax laws or regulations.

There can be no assurance that our internally generated cash flow and external financing will be sufficient for us to meet our contractual and financing obligations in a timely manner. Due to the current measures imposed (as well as other measures that may be imposed by the PRC government in the future) which limit our access to additional capital, we cannot assure you that we will be able to obtain sufficient funding to finance intended purchases of land use rights, develop future projects or meet other capital needs as and when required at a commercially reasonable cost or at all. We may choose to explore potential refinancing arrangements with holders of our floating rate notes or convertible notes as well as other potential investors. Our failure to obtain adequate financing or refinance our floating rate notes or convertible notes in a timely manner and on reasonable terms could severely adversely (1) restrict our ability to complete existing projects, expand our business, or repay our debts and (2) affect our financial performance and condition.

 

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We may be unable to acquire desired development sites at commercially reasonable costs.

Our revenue depends on the completion and sale of our projects, which in turn depends on our ability to acquire development sites. Our land use rights costs are a major component of our cost of real estate sales and increases in such costs could diminish our gross margin. In China, the PRC government controls the supply of land and regulates land sales and transfers in the secondary market. As a result, the policies of the PRC government, including those related to land supply and urban planning, affect our ability to acquire, and our costs of acquiring, land use rights for our projects. In recent years, the government has introduced various measures attempting to moderate investment in the property market in China. Although we believe that these measures are generally targeted at the luxury property market and speculative purchases of land and properties, we cannot assure you that the PRC government will not introduce other measures in the future that adversely affect our ability to obtain land for development. We currently acquire our development sites primarily by bidding for government land. Under current regulations, land use rights acquired from government authorities for commercial and residential development purposes must be purchased through a public tender, auction or listing-for-sale. Competition in these bidding processes has resulted in higher land use rights costs for us. In addition, we may not successfully obtain desired development sites due to the increasingly intense competition in the bidding processes. We may also need to acquire land use rights through acquisition, which could increase our costs. Moreover, the supply of potential development sites in any given city will diminish over time and we may find it increasingly difficult to identify and acquire attractive development sites at commercially reasonable costs in the future.

Our current debt indentures contain certain financial and other covenants that restrict our ability to pay dividends, raise further debt and take other corporate actions which may adversely affect our business.

In April 2007, we issued US$75 million of floating rate notes and US$25 million of convertible notes and entered into related indentures. These indentures contain a number of significant financial and other covenants. Such covenants restrict, among other things, our ability and the ability of our subsidiaries to incur additional debt or guarantees, make restricted payments, make investments, pay dividends or distributions on our or our subsidiaries’ capital stock, repurchase our or our subsidiaries’ capital stock, pay subordinated indebtedness, make or repay inter-company loans or enter into non-ordinary course business transactions. Among other restrictions, we are limited in the dollar amount of mortgage guarantees we may provide if we do not maintain a minimum consolidated interest expense coverage ratio, or interest coverage ratio.

As a result of the covenants, our ability to pay dividends or other distributions on our common shares and the ADSs may be limited. These covenants also restrict our ability to raise additional capital in the future through bank borrowings and debt and equity issuances and may restrict our ability to engage in some transactions that we expect to be of benefit to us. The covenants may also limit the amount of units we may sell in any period by limiting the amount of mortgage guarantees we can provide to purchasers if we do not maintain the requisite interest coverage ratio.

The notes are secured by the mortgage of our shares in our wholly owned subsidiary, Xinyuan Ltd., which indirectly holds all of our assets and operations in China. If we default under the notes in the future, the holders may enforce their claims against these shares to satisfy our obligations to them. In such an event, the holders of our notes could gain ownership of the shares of our wholly owned Cayman subsidiary and, as a result, own and control all of our subsidiaries in China. We conduct substantially all of our operations in China and all of our assets are located in China and, if we default under the notes, we would lose control or ownership of our assets and operations in China and there may be no assets remaining from which your claims could be satisfied. In addition, our floating rate notes and convertible notes are also secured by (i) the pledge of all of the Cayman subsidiary’s shares in Xinyuan (China) Real Estate, Ltd., or Xinyuan China and (ii) the pledge of a loan from the Cayman subsidiary to Xinyuan China.

We provide guarantees for the mortgage loans of our customers which expose us to risks of default by our customers.

We pre-sell properties before actual completion and, in accordance with industry practice, our customers’ mortgage banks require us to guarantee our customers’ mortgage loans. Typically, we provide guarantees to PRC banks with respect to loans procured by the purchasers of our properties for the total mortgage loan amount until the completion of the registration of the mortgage with the relevant mortgage registration authorities, which generally occurs within six to 12 months after the purchasers take possession of the relevant properties. In line with what we believe to be industry practice, we rely on the credit evaluation conducted by mortgagee banks and do not conduct our own independent credit checks on our customers. The mortgagee banks typically require us to maintain, as restricted cash, 0% to 10% of the mortgage proceeds paid to us as security for our obligations under such guarantees. The guarantees granted to the bank providing mortgages for our customers do not constitute continuing involvement by the Group under Accounting Standards Codification (“ASC”) Section 360, or SFAS 66, due to the large down payments (minimum of 20%) received from all customers in accordance with PRC laws. If a purchaser defaults on its payment obligations during the term of our guarantee, the mortgagee bank may deduct the delinquent mortgage payment from the security deposit. If the delinquent mortgage payments exceed the security deposit, the banks may require us to pay the excess amount. If multiple purchasers default on their payment obligations, we will be required to make significant payments to the banks to satisfy our guarantee obligations. Factors such as a significant decrease in housing prices, increase in interest rates or the occurrence of natural catastrophes, among others, could result in a purchaser defaulting on its mortgage payment obligations. If we are unable to resell the properties underlying defaulted mortgages on a timely basis or at prices higher than the amounts of our guarantees and related expenses, we will suffer financial losses. For the three years ended December 31, 2009, we experienced certain defaults on mortgage loans by our customers in an aggregate principal amount of approximately US$120,000.

 

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As of December 31, 2007, 2008 and 2009, our outstanding guarantees in respect of our customers’ mortgage loans amounted to US$209.6 million, US$384.0 million, and US$509.2 million, respectively. If substantial defaults by our customers occur and we are called upon to honor our guarantees, our financial condition and results of operations will be materially adversely affected.

Our level of indebtedness could have an adverse effect on our financial condition, diminish our ability to raise additional capital to fund our operations and limit our ability to explore business opportunities.

As of December 31, 2009, the outstanding balance of our total indebtedness amounted to US$251.9 million. Our level of indebtedness could have an adverse effect on us. For example, it could:

 

   

require us to dedicate a large portion of our cash flow from operations to fund payments on our debt, thereby reducing the availability of our cash flow to fund working capital, capital expenditures and other general corporate purposes;

 

   

increase our vulnerability to adverse general economic or industry conditions;

 

   

limit our flexibility in planning for, or reacting to, changes in our business or the industry in which we operate;

 

   

limit our ability to raise additional debt or equity capital in the future or increase the cost of such funding;

 

   

restrict us from making strategic acquisitions or exploring business opportunities; and

 

   

make it more difficult for us to satisfy our obligations with respect to our debt.

Our financing costs are subject to changes in interest rates.

The rate of interest payable on our floating rate notes varies according to the six-month LIBOR. In addition, the rates of our long-term bank loans are adjustable based on the range of 95% to 135% of the PBOC benchmark rate. As of December 31, 2009, the principal amount of our aggregate outstanding variable rate debt was US$135.3 million. A hypothetical 1% increase in annual interest rates would increase our interest expenses by US$1.4 million based on our debt level at December 31, 2009.

We may be required to record impairment charges in the future.

If the projected profitability of a given project deteriorates due to a decline in the pace of unit sales, a decline in selling prices, or some other factor, such project is reviewed for possible impairment by comparing the estimated future undiscounted cash flows for the project to its carrying value. If the estimated future undiscounted cash flows are less than the asset’s carrying value, the asset is written down to its estimated fair value. In the fourth quarter of 2008, Suzhou International City Garden was identified as an unprofitable project subject to recognition of impairment. On a quarterly basis we are required to conduct impairment tests on our projects. If business conditions deteriorate, there is a potential risk that future impairment charges will be recorded.

We rely on third-party contractors.

Substantially all of our project construction and related work are outsourced to third-party contractors. We are exposed to risks that the performance of our contractors may not meet our standards or specifications. Negligence or poor work quality by contractors may result in defects in our buildings or residential units, which could in turn cause us to suffer financial losses, harm our reputation or expose us to third-party claims. We work with multiple contractors on different projects and we cannot guarantee that we can effectively monitor their work at all times. Although our construction and other contracts contain provisions designed to protect us, we may be unable to successfully enforce these rights and, even if we are able to successfully enforce these rights, the third-party contractor may not have sufficient financial resources to compensate us. Moreover, the contractors may undertake projects from other property developers, engage in risky undertakings or encounter financial or other difficulties, such as supply shortages, labor disputes or work accidents, which may cause delays in the completion of our property projects or increases in our costs.

We may be unable to complete our property developments on time or at all.

The progress and costs for a development project can be adversely affected by many factors, including, without limitation:

 

   

delays in obtaining necessary licenses, permits or approvals from government agencies or authorities;

 

   

shortages of materials, equipment, contractors and skilled labor;

 

   

disputes with our third-party contractors;

 

   

failure by our third-party contractors to comply with our designs, specifications or standards;

 

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difficult geological situations or other geotechnical issues;

 

   

onsite labor disputes or work accidents; and

 

   

natural catastrophes or adverse weather conditions, including strong winds, storms, floods, and earthquakes.

Any construction delays, or failure to complete a project according to our planned specifications or budget, may delay our property sales, which could harm our revenues, cash flows and our reputation.

Under PRC laws and regulations and our pre-sale contracts, we are required to compensate purchasers for late delivery or failure to complete our pre-sold units. For the three years ended December 31, 2009, we paid an aggregate amount of US$1.3 million of compensation to our customers due to late delivery. If the delay extends beyond the contractually specified period, the purchasers may become entitled to terminate the pre-sale contracts and claim damages. Proceeds from pre-sale of our properties are an important source of financing for our property developments. Under PRC laws, we are not permitted to commence pre-sales until we have completed certain stages of the construction process for a project. Consequently, a significant delay in the construction of a project could restrict our ability to pre-sell our properties, which could extend the recovery period for our capital outlay. This, in turn, could have an adverse effect on our cash flow, business and financial position.

Changes of laws and regulations with respect to pre-sales may adversely affect our cash flow position and performance.

We depend on cash flows from pre-sale of properties as an important source of funding for our property projects. Under current PRC laws and regulations, property developers must fulfill certain conditions before they can commence pre-sale of the relevant properties and may only use pre-sale proceeds to finance the construction of the specific developments. On August 5, 2005, PBOC issued a report entitled “2004 Real Estate Financing Report,” in which it recommended that the practice of pre-selling uncompleted properties be discontinued because, according to the report, such activity creates significant market risks and generates transactional irregularities. This and other PBOC recommendations have not been adopted by the PRC government and have no enforceability. However, there can be no assurance that the PRC government will not ban the practice of pre-selling uncompleted properties or implement further restrictions on the pre-sale of properties, such as imposing additional conditions for a pre-sale permit or further restrictions on the use of pre-sale proceeds or that cities will not voluntarily suspend or restrict pre-sales. For example, the city of Nanning in the Guangxi providence (in which we do not have any operations) has announced that it will suspend pre-sales of commercial property for a trial period in 2010. Any measures prohibiting or further restricting pre-sales by the PRC government or province or city government affecting cities in which we operate will adversely affect our cash flow position and force us to seek alternative sources of funding for much of our property development business.

Our results of operations may fluctuate from period to period.

Our results of operations tend to fluctuate from period to period. The number of properties that we can develop or complete during any particular period is limited due to the substantial capital required for land acquisition and construction, as well as the development periods required before positive cash flows may be generated. In addition, several properties that we have developed or that are under development are large scale and are developed in multiple phases over the course of one to several years. The selling prices of the residential units in larger scale property developments tend to change over time, which may impact our sales proceeds and, accordingly, our revenues for any given period.

The recognition of our real estate revenue and costs relies upon our estimation of total project revenues and costs.

We recognize our real estate revenue based on the full accrual method and the percentage of completion method depending on the estimated project construction period. Under both methods, revenue and costs are calculated based on an estimation of total project costs and total project revenues, which are revised on a regular basis as the work progresses. Any material deviation between actual and estimated total project revenues and costs may result in an increase, a reduction or an elimination of reported revenues or costs from period to period, which will affect our gross profit and net income.

We may be required to pay additional corporate income taxes in China.

Based on the current levy method applied by the Zhengzhou local tax bureau, our subsidiaries in Zhengzhou are paying corporate income tax, or CIT, on a deemed profit basis, where taxable income is deemed to be 15% of cash receipts, regardless of actual income generated in that year. According to PRC tax regulations, the deemed profit basis should only be applicable to companies that are unable to keep accounting books or whose accounts are incomplete and inaccurate. These circumstances do not apply to us and, accordingly, we may be subject to CIT on our actual taxable income. We have made provision for the full amount of applicable CIT calculated in accordance with the relevant PRC tax laws and regulations, but we pay CIT each year as required by the local tax authorities. We cannot guarantee that we will not be required to pay additional taxes in accordance with the PRC tax laws and regulations or that our accrued deferred tax liabilities will be sufficient to cover any additional CIT payments we will be required to pay in the future with respect to past financial periods.

 

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Dividends we receive from our PRC subsidiaries located in the PRC may be subject to PRC withholding tax.

The PRC Corporate Income Tax Law, or the CIT Law, and the Implementation for the CIT Law issued by the PRC State Council became effective as of January 1, 2008. The CIT Law provides that a maximum income tax rate of 20% may be applicable to dividends payable to non-PRC investors that are “non-resident enterprises,” to the extent such dividends are derived from sources within the PRC, and the State Council has reduced such rate to 10% through the Implementation for the CIT Law. We are a Cayman Islands holding company and substantially all of our income may be derived from dividends we receive from our PRC subsidiaries. Thus, dividends paid to us by our subsidiaries in China may be subject to the 10% income tax if we are considered as a “non-resident enterprise” under the CIT Law. If we are required under the CIT Law to pay income tax for any dividends we receive from our PRC subsidiaries, it will materially and adversely affect the amount of dividends received by us from our PRC subsidiaries.

We may be deemed a PRC resident enterprise under the CIT Law and be subject to the PRC taxation on our worldwide income.

The CIT Law also provides that enterprises established outside of China whose “de facto management bodies” are located in China are considered “resident enterprises” and are generally subject to the uniform 25% corporate income tax rate as to their worldwide income (including dividend income received from subsidiaries). Under the Implementation for the CIT Law, “de facto management body” is defined as a body that has material and overall management and control over the manufacturing and business operations, personnel and human resources, finances and treasury, and acquisition and disposition of properties and other assets of an enterprise. Under the Notice on the Issues Regarding Recognition of Overseas Incorporated Domestically Controlled Enterprises as PRC Resident Enterprises Based on the De Facto Management Body Criteria, which was retroactively effective as of January 1, 2008, an overseas incorporated domestically controlled enterprise will be recognized as a PRC resident enterprise if it satisfies certain conditions. However, it is still unclear whether PRC tax authorities would require (or permit) us to be treated as a PRC resident enterprise. If we are treated as a resident enterprise for PRC tax purposes, we will be subject to PRC tax on our worldwide income at the 25% uniform tax rate, which could have an impact on our effective tax rate and an adverse effect on our net income and results of operations, although dividends distributed from our PRC subsidiaries to us could be exempt from Chinese dividend withholding tax, since such income is exempted under the new CIT Law to a PRC resident recipient.

Dividends payable by us to our foreign investors and gain on the sale of our ADSs may become subject to taxes under PRC tax laws.

Under the Implementation for the CIT Law, PRC income tax at the rate of 10% is applicable to dividends payable to investors that are “non-resident enterprises,” which do not have an establishment or place of business in the PRC, or which have such establishment or place of business but the relevant income is not effectively connected with the establishment or place of business, to the extent such dividends have their sources within the PRC. Similarly, any gain realized on the transfer of ADSs by such investors is also subject to 10% PRC income tax if such gain is regarded as income derived from sources within the PRC. If we are considered a PRC “resident enterprise,” it is unclear whether dividends we pay with respect to our ADSs, or the gain you may realize from the transfer of our ADSs, would be treated as income derived from sources within the PRC and be subject to PRC tax. If we are required under the Implementation for the CIT Law to withhold PRC income tax on dividends payable to our non-PRC investors that are “non-resident enterprises,” or if you are required to pay PRC income tax on the transfer of our ADSs, the value of your investment in our ADSs may be materially and adversely affected.

The relevant PRC tax authorities may challenge the basis on which we have been paying our land appreciation tax obligations and our results of operations and cash flows may be affected.

Under PRC laws and regulations, our PRC subsidiaries engaging in property development are subject to land appreciation tax, or LAT, which is levied by the local tax authorities. All taxable gains from the sale or transfer of land use rights, buildings and their attached facilities in the PRC are subject to LAT at progressive rates ranging from 30% to 60%. Exemptions are available for the sale of ordinary residential properties if the appreciation values do not exceed certain thresholds specified in the relevant tax laws. Gains from the sale of commercial properties are not eligible for this exemption.

We have accrued all LAT payable on our property sales and transfers in accordance with the progressive rates specified in relevant tax laws, less amounts previously paid under the levy method applied by relevant local tax authorities. However, provisioning for LAT requires our management to use a significant amount of judgment with respect to, among other things, the anticipated total proceeds to be derived from the sale of the entire phase of the project or the entire project, the total appreciation of land value and the various deductible items. If the LAT provisions we have made are substantially lower than the actual LAT amounts assessed by the tax authorities in the future, our results of operations and cash flows will be materially and adversely affected.

We rely on our key management members.

We depend on the services provided by key management members. Competition for management talent is intense in the property development sector. In particular, we are highly dependent on Mr. Yong Zhang, our founder, Chairman and Chief Executive Officer, Ms. Yuyan Yang, our co-founder and Mr. Tom Gurnee, our Chief Financial Officer. We do not maintain key employee insurance. In the event that we lose the services of any key management member, we may be unable to identify and recruit suitable successors in a timely manner or at all, which will adversely affect our business and operations. In 2008 particularly, we experienced high turnover at the COO, CAO, CFO and subsidiary general manager positions. Moreover, we may need to employ and retain more management personnel to support an expansion into other Tier II cities on a much larger geographical scale. If we cannot attract and retain suitable human resources, especially at the management level, our business and future growth will be adversely affected.

 

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Increases in the price of raw materials may increase our cost of sales and reduce our earnings.

Our third-party contractors are responsible for procuring almost all of the raw materials used in our project developments. Our construction contracts typically provide for fixed or capped payments, but the payments are subject to changes in government-suggested prices for certain raw materials we use, such as steel. Any increase in costs which may result in adjustments in payments under our construction contracts could result in an increase in our construction costs. In the event that the price of any raw materials, including cement, concrete blocks and bricks increases in the future, such increase could be passed on to us by our contractors, and our construction costs would increase accordingly. Any input cost increase could reduce our earnings to the extent we are unable to pass these increased costs to our customers.

Our proposed acquisition of the 55% equity interest in Jiantou Xinyuan is subject to a public listing and auction process for the transfer of state-owned assets, unless the sellers obtain government approval for exemption from the process. If we are required to participate in the auction process, we cannot assure you that we will win the auction process to acquire such the equity interest at the terms we previously negotiated with the sellers, or at all.

On September 25, 2009, we, through our indirectly wholly owned subsidiary Henan Xinyuan Real Estate. Co., Ltd., or Henan Xinyuan, `entered into an Equity Transfer and Profit Distribution Agreement, or ETA, with Zhengzhou General Construction Investment Company and Zhengzhou Jiantou Project Consulting Co., Ltd., or collectively the Sellers, to acquire their 55% interest in Jiantou Xinyuan, or the 55% Equity. We currently own the remaining 45% equity interest in Jiantou Xinyuan through Henan Xinyuan.

As the Sellers are state-owned enterprises, our proposed acquisition of the 55% Equity is deemed a transfer of state-owned assets, which under the PRC laws and regulations are required to be sold or disposed of through a public listing and auction process unless a proposed sale or disposal has been exempted by the relevant authority from such listing and auction process. Under the ETA, the Sellers are responsible for obtaining the government approvals necessary for the transfer, including, if available, an exemption of the proposed transfer of the 55% Equity as contemplated under the ETA from the public listing and auction process. The Sellers have not obtained from the Zhengzhou municipal administration of state-owned assets an exemption of the proposed transfer.

Accordingly, we currently anticipate that the Sellers will be required to list the 55% Equity in the local assets and equity exchange for a competitive auction and determine the purchaser of, and the transfer price for, the 55% Equity based on the results of such auction. The listing price will be based on an independent asset appraisal. We currently intend to participate in the auction process to make a bid based on the purchase price agreed in the ETA, but we cannot guarantee you that we will win the auction. As an existing shareholder of Jiantou Xinyuan, Henan Xinyuan is entitled to a right of first refusal on the sale of the 55% Equity. If any third party bidder participates in the auction, we currently plan to exercise such right to match any reasonable competitive bid that exceeds our bid price. However, even if we manage to win the auction for the 55% Equity, regardless of whether or not through exercising our right of first refusal, we cannot assure you that the final purchase price for the 55% Equity will not exceed the price as provided in the ETA or that the other terms of the final purchase will not be different from the terms we agreed with the Sellers in the ETA. Furthermore, we might decide not to enter the auction process, or exercise our right of first refusal with respect to the 55% Equity, if we determine that the listing price or the price bid by a third party is unreasonably high. In such an event, we would not acquire the 55% Equity and, depending on the results of the auction, we may have joint ownership of Jiantou Xinyuan with one or more new joint venture partners with whom we may not be familiar. If we do not develop and maintain a good relationship with such new partner(s), Jiantou Xinyuan’s results of operations may be adversely affected, which in turn may adversely affect our results of operations.

We may engage in joint ventures, which could result in unforeseen expenses or disruptive effects on our business.

From time to time, we may consider joint ventures with other businesses to develop a property. For example, one of our project companies, Jiantou Xinyuan, is a joint venture established under PRC Law. Any joint venture that we determine to pursue will be accompanied by a number of risks. We may not be in a position to exercise sole decision-making authority regarding the joint ventures. We may not be able to control the quality of products produced by the joint venture. Depending on the terms of the joint venture agreement, we may require the consent of our joint venture partners for the joint venture to take certain actions, such as making distributions to the partners. In addition, our joint venture partners and the joint venture themselves may hold different views or have different interests from ours, and therefore may compete in the same market with us, in which case our interest and future development may be materially adversely affected.

 

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If we do not maintain good relationships with our institutional shareholders, our business and operations may be adversely affected.

Our institutional shareholders, Blue Ridge China Partners, L.P., or Blue Ridge China, and EI Fund II China, LLC, or Equity International, have substantial ownership of our shares. As of December 31, 2009, Blue Ridge China owned 18.4% of our outstanding share capital and Equity International owned 12.2% of our outstanding share capital. Each of Blue Ridge China and Equity International has appointed one director to our board. With this substantial ownership, our institutional shareholders may be able to successfully oppose certain shareholder actions even if they are supported by our principals, Mr. Yong Zhang and his spouse, Ms. Yuyan Yang, who beneficially owned 39.7% of our outstanding share capital, including actions related to mergers and consolidations and other significant corporate actions which would be important to our ability to conduct business. Since our IPO in December 2007, Blue Ridge China and Equity International no longer have any rights to appoint directors to our board, however, the two directors designated by them (Yue (Justin) Tang and Christopher J. Fiegen) are and will continue to be directors of our company until their resignation or removal. The two directors have memberships on various committees established under our board of directors, including our compensation committee and corporate governance and nominating committee. In the event we do not maintain good relationships with our institutional shareholders, one or both of these two directors may decide to resign from their memberships, in which case we would have vacancies on our board of directors and certain committees. If we were not able to fill these vacancies in a timely manner, it may impact the operations of our company and our corporate governance procedures. If we do not maintain a good relationship with either Blue Ridge China or Equity International, certain actions taken by our other shareholders may be successfully opposed, our corporate governance procedures may be weakened and our business operations may be adversely affected.

We are a holding company that depends on dividend payments from our subsidiaries for funding.

We are a holding company established in the Cayman Islands and operate all of our business and operations through our subsidiaries in China. Therefore, our ability to pay dividends to our shareholders and to service our indebtedness depends upon dividends that we receive from our subsidiaries in China. If our subsidiaries incur indebtedness or losses, such indebtedness or loss may impair their ability to pay dividends or other distributions to us. As a result, our ability to pay dividends and to service our indebtedness will be restricted. Regulations in China currently permit payment of dividends only out of accumulated profits as determined in accordance with accounting standards and regulations in China. Each of our PRC subsidiaries, including wholly foreign-owned enterprises and domestic companies, is required to set aside at least 10.0% of its after-tax profit based on PRC accounting standards each year to its general reserves or statutory capital reserve fund until the accumulative amount of such reserves reaches 50.0% of its respective registered capital. As of December 31, 2009, our statutory reserves under PRC GAAP amounted to US$24.4 million, and our accumulated deficit amounted to US$117.2 million. Our statutory reserves are not distributable as cash dividends. The indentures for our floating rate notes and convertible notes contain restrictions on our subsidiaries’ ability to pay dividends. In addition, restrictive covenants in bank credit facilities, joint venture agreements or other agreements that we or our subsidiaries currently have or may enter into in the future may also restrict the ability of our subsidiaries to make contributions to us and our ability to receive distributions. Therefore, these restrictions on the availability and usage of our major source of funding may impact our ability to pay dividends to our shareholders and to service our indebtedness.

If the value of our brand or image diminishes, it could have a material adverse effect on our business and results of operations.

We intend to continue promoting the “Xinyuan” brand in selected Tier II cities by delivering quality products and attentive real estate-related services to our customers. Our brand is integral to our sales and marketing efforts. Our continued success in maintaining and enhancing our brand and image depends to a large extent on our ability to satisfy customer needs by further developing and maintaining quality of service across our operations, as well as our ability to respond to competitive pressures. If we are unable to satisfy customer needs or if our public image or reputation were otherwise diminished, our business transactions with our customers may decline, which could in turn adversely affect our results of operations.

Any unauthorized use of our brand or trademark may adversely affect our business.

We own trademarks for “ LOGO ” in the form of Chinese characters and our company logo. We rely on the PRC intellectual property and anti-unfair competition laws and contractual restrictions to protect brand name and trademarks. We believe our brand, trademarks and other intellectual property rights are important to our success. Any unauthorized use of our brand, trademarks and other intellectual property rights could harm our competitive advantages and business. Historically, China has not protected intellectual property rights to the same extent as the United States or the Cayman Islands, and infringement of intellectual property rights continues to pose a serious risk of doing business in China. Monitoring and preventing unauthorized use is difficult. The measures we take to protect our intellectual property rights may not be adequate. Furthermore, the application of laws governing intellectual property rights in China and abroad is uncertain and evolving, and could involve substantial risks to us. If we are unable to adequately protect our brand, trademarks and other intellectual property rights, our reputation may be harmed and our business may be adversely affected.

We may be subject to additional payments of statutory employee benefits.

According to PRC central government and local regulations, we are required to pay various statutory employee benefits, including pensions, housing fund, medical insurance, work-related injury insurance, unemployment insurance and childbearing insurance for all employees, to designated government agents. We pay statutory employee benefits based on the local government pre-set contribution ratio, while we accrue provisions for unpaid employee benefits based on relevant central government regulations. We cannot be certain that such accrued amount will be sufficient to meet any additional employee benefits payments that we are required to pay in the future. In addition, we have underpaid certain employee benefits based on the local government pre-set ratio in the past. We may need to settle the underpaid amount plus late payment interest, and may also be subject to fines or penalties for the underpayment, which may have a material adverse effect on our financial condition.

 

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We do not have insurance to cover potential losses and claims.

We do not have insurance coverage against potential losses or damages with respect to our properties before their delivery to customers, nor do we maintain insurance coverage against liability from tortious acts or other personal injuries on our project sites. Although we require our contractors to carry insurance, we believe most of our contractors do not comply with this requirement. Our contractors may not be sufficiently insured themselves or have the financial ability to absorb any losses that arise with respect to our projects or pay our claims. In addition, there are certain types of losses, such as losses due to earthquakes, which are currently uninsurable in China. While we believe that our practice is in line with the general practice in the PRC property development industry, there may be instances when we will have to internalize losses, damages and liabilities because of the lack of insurance coverage, which may in turn adversely affect our financial condition and results of operations.

We may fail to obtain, or may experience material delays in obtaining, necessary government approvals for any major property development, which will adversely affect our business.

The real estate industry is strictly regulated by the PRC government. Property developers in China must abide by various laws and regulations, including implementation rules promulgated by local governments to enforce these laws and regulations. Before commencing, and during the course of, development of a property project, we need to apply for various licenses, permits, certificates and approvals, including land use rights certificates, construction site planning permits, construction work planning permits, construction permits, pre-sale permits and completion acceptance certificates. We need to satisfy various requirements to obtain these certificates and permits. To date, we have not encountered serious delays or difficulties in the process of applying for these certificates and permits, but we cannot guarantee that we will not encounter serious delays or difficulties in the future. In the event that we fail to obtain the necessary governmental approvals for any of our major property projects, or a serious delay occurs in the government’s examination and approval progress, we may not be able to maintain our development schedule and our business and cash flows may be adversely affected.

We may suffer a penalty or even forfeit land to the PRC government if we fail to comply with procedural requirements applicable to land grants from the government or the terms of the land use rights grant contracts.

According to the relevant PRC laws and regulations, if we fail to develop a property project according to the terms of the land use rights grant contract, including those relating to the payment of land premiums, specified use of the land and the time for commencement and completion of the property development, the PRC government may issue a warning, may impose a penalty or may order us to forfeit the land. Specifically, under current PRC laws and regulations, if we fail to pay land premiums in accordance with the payment schedule set forth in the relevant land use rights grant contract, the relevant PRC land bureau may issue a warning notice to us, impose late payment penalties or even require us to forfeit the related land to the PRC government. The late payment penalties are usually calculated based on the overdue days for the land premium payments. Furthermore, if we fail to commence development within one year after the commencement date stipulated in the land use rights grant contract, the relevant PRC land bureau may issue a warning notice to us and impose an idle land fee on the land of up to 20% of the land premium. If we fail to commence development within two years, the land will be subject to forfeiture to the PRC government, unless the delay in development is caused by government actions or force majeure. Even if the commencement of the land development is compliant with the land use rights grant contract, if the developed GFA on the land is less than one-third of the total GFA of the project or the total capital invested is less than one-fourth of the total investment of the project and the suspension of the development of the land continues for more than one year without government approval, the land will also be treated as idle land and be subject to penalty or forfeiture. We and Jiantou Xinyuan, an entity in which we currently hold a 45% interest, have made late payments of land premiums in the past for which we and Jiantou Xinyuan were imposed penalties. Although we and Jiantou Xinyuan were imposed penalties for these late payments, neither we nor Jiantou Xinyuan have been required to forfeit land. In 2009, Jiantou Xinyuan recorded US$7.5 million in penalty charges and we absorbed our 45% share of the charge. If the final penalties paid by Jiantou Xinyuan exceed the amount previously recorded, our share of income from Jiantou Xinyuan could be further adversely affected as the property is developed and sold.

We cannot assure you that circumstances leading to significant delays in our own land premium payments or development schedules or forfeiture of land will not arise in the future. If we pay a substantial penalty, we may not be able to meet pre-set investment targeted returns for a given project and our financial conditions could be adversely affected. If we forfeit land, we will not only lose the opportunity to develop the property projects on such land, but may also lose a significant portion of the investment in such land, including land premium deposits and the development costs incurred.

 

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Any non-compliant GFA of our uncompleted and future property developments will be subject to governmental approval and additional payments.

The local government authorities inspect property developments after their completion and issue the completion acceptance certificates if the developments are in compliance with the relevant laws and regulations. If the total constructed GFA of a property development exceeds the GFA originally authorized in the relevant land grant contracts or construction permit, or if the completed property contains built-up areas that do not conform with the plan authorized by the construction permit, the property developer may be required to pay additional amounts or take corrective actions with respect to such non-compliant GFA before a completion acceptance certificate can be issued to the property development.

We have obtained completion acceptance certificates for all of our completed properties as of December 31, 2009. However, we cannot be certain that local government authorities will not find the total constructed GFA upon completion of our existing projects under development or any future property developments to exceed the relevant authorized GFA. Any such non-compliance could lead to additional payments or penalty, which would adversely affect our financial condition. We have not incurred any such payments or penalties since the founding of the company.

We may not be able to continue obtaining qualification certificates, which will adversely affect our business.

Real estate developers in the PRC must obtain a formal qualification certificate in order to carry on a property development business in the PRC. According to the PRC regulations on qualification of property developers issued in 2000, a newly established property developer must first apply for a temporary qualification certificate with a one-year validity, which can be renewed for not more than two years. If, however, the newly established property developer fails to commence a property development project within the one-year period during which the temporary qualification certificate is in effect, it will not be allowed to renew its temporary qualification certificate. All qualification certificates are subject to renewal on an annual basis. Under government regulations, developers must fulfill all statutory requirements before they may obtain or renew their qualification certificates. In accordance with the provisions of the rules on the administration of qualifications, the real estate developer qualifications are classified into four classes and the approval system for each class is tiered. The approval for Class I Qualification is subject to examination by the construction authority under the State Council, that is, the central government, and the procedure for approval of developers for Class II Qualification or lower qualifications is administered by the construction authorities at the provincial-level of government. A real estate developer may only engage in the development and sale of real estate within the scope of its qualification certificate. For instance, a Class I developer is not restricted to the scale of real estate projects to be developed and may undertake real estate development projects anywhere in the country, while a Class II or below developer may undertake projects with construction area of less than 250,000 square meters per project. See “Item 4. Information on the Company—B. Business Overview—Regulation—Regulations on Qualifications of Developer.”

There can be no assurance that some of our project companies that are in the process of applying for proper qualification certificates will be able to obtain such certificates timely to commence their planned real estate projects development on schedule. There can be no further assurance that we and our project companies will continue to be able to extend or renew the qualification certificates or be able to successfully upgrade the current qualification class to a higher qualification. If we or our project companies are unable to obtain or renew qualification certificates, the PRC government will refuse to issue pre-sale and other permits necessary for the conduct of the property development business, and our results of operations, financial condition and cash flows will be adversely affected. In addition, if any of our project companies engages in the development and sale of real estate outside the scope of its qualification certificate, it may be ordered to rectify such conduct within a prescribed period, imposed with a fine of up to RMB100,000, or even have its qualification certificate and business license suspended.

Our failure to assist our customers in applying for property ownership certificates in a timely manner may lead to compensatory liabilities to our customers.

We are required to meet various requirements within 90 days after delivery of property, or such other period contracted with our customers, in order for our customers to apply for their property ownership certificates, including passing various governmental clearances, formalities and procedures. Under our sales contract, we are liable for any delay in the submission of the required documents as a result of our failure to meet such requirements, and are required to compensate our customers for delays. In the case of serious delays on one or more property projects, we may be required to pay significant compensation to our customers and our reputation may be adversely affected.

We could face possible regulatory sanctions for the lack of environmental impact assessments, or EIAs, for some of our projects in Zhengzhou, Henan Province.

Under PRC environmental protection laws and regulations, a construction entity must conduct an EIA and submit an EIA report for a construction project to the competent administrative department of environmental protection for their examination and approval prior to the commencement of construction. Upon the completion of construction of the project, the construction entity must also seek environmental inspection of the construction project by the same administrative department of environmental protection and obtain its permission before the project can be put into use. A construction entity starting construction without approval of the EIA report may be ordered to comply with the foregoing formalities within a prescribed time limit, and the failure to do so may result in an order of suspension of construction work and a fine of up to RMB200,000 for the project in question. In addition, if a particular construction project fails to pass the environmental inspection and is denied permission to use approval, the project may fail to pass the completion acceptance inspection and may fail to obtain the completion acceptance certificate from the relevant administrative department of construction. Such failures may restrict both our ability to use proceeds from the pre-sales of the project even after the completion of construction and that of purchasers of such project from obtaining the title certificate for units they purchased on the project.

Certain of our projects in Zhengzhou, Henan Province that did not conduct the EIA nor prepare and submit an EIA report for approval prior to commencement of construction nor did seek environmental inspection to obtain permission to use approvals. In the past, we were able to obtain the required completion acceptance certificates and title certificates from the competent administrative department of construction in Zhengzhou even for projects that failed to comply with EIA requirements prior to the commencement of construction and failed to obtain permission to commence use from the environmental protection authority. However, we note that the PRC government has put greater emphasis on environmental protection during recent years and that the local environmental authorities have in fact strengthened the implementation and enforcement of EIA-related regulations since early last year. Therefore, we cannot assure you that projects that did not conduct an EIA will not be assessed any sanctions described above in the future or that we will not experience any delay or difficulty in obtaining completion acceptance certificates and/or title certificates. Such sanctions or delay or difficulty may materially adversely affect our business operations and financial condition.

We may become involved in legal and other proceedings from time to time and may suffer significant liabilities or other losses as a result.

We have in the past, and may in future, become involved in disputes with various parties relating to the acquisition of land use rights, the development and sale of our properties or other aspects of our business and operations. These disputes may lead to legal or other proceedings and may result in substantial costs and diversion of resources and management’s attention. Disputes and legal and other proceedings may require substantial time and expense to resolve, which could divert valuable resources, such as management time and working capital, delay our planned projects and increase our costs. Third parties that are found liable to us may not have the resources to compensate us for our incurred costs and damages. We could also be required to pay significant costs and damages if we do not prevail in any such disputes or proceedings. In addition, we may have disagreements with regulatory bodies in the course of our operations, which may subject us to administrative proceedings and unfavorable decrees that result in pecuniary liabilities and cause delays to our property developments.

 

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We are subject to potential environmental liability.

We are subject to a variety of laws and regulations concerning the protection of health and the environment. The particular environmental laws and regulations that apply to any given development site vary significantly according to the site’s location and environmental condition, the present and former uses of the site and the nature of the adjoining properties. Environmental laws and conditions may result in delays, may cause us to incur substantial compliance and other costs and can prohibit or severely restrict project development activity in environmentally-sensitive regions or areas. Although the environmental investigations conducted by local environmental authorities have not revealed any environmental liability that we believe would have a material adverse effect on our business, financial condition or results of operations to date, it is possible that these investigations did not reveal all environmental liabilities and that there are material environmental liabilities of which we are unaware. We cannot assure you that future environmental investigations will not reveal material environmental liability. Also, we cannot assure you that the PRC government will not change the existing laws and regulations or impose additional or stricter laws or regulations, the compliance of which may cause us to incur significant capital expenditure. See “Item 4. Information on the Company—B. Business Overview—Environmental Matters.”

If we fail to maintain an effective system of internal controls over financial reporting, we may not be able to accurately report our financial results or prevent fraud.

We are subject to reporting obligations under U.S. securities laws. The Securities and Exchange Commission, or the SEC, as required by Section 404 of the Sarbanes-Oxley Act of 2002, or the Sarbanes-Oxley Act, adopted rules requiring most public companies to include a management report on such company’s internal controls over financial reporting in its annual report, which contains management’s assessment of the effectiveness of the company’s internal controls over financial reporting. In addition, an independent registered public accounting firm must attest to and report on the effectiveness of the company’s internal controls over financial reporting. Our management may conclude that our internal controls over our financial reporting are not effective. Moreover, even if our management concludes that our internal controls over financial reporting is effective, our independent registered public accounting firm may still issue a report that is qualified or adverse if it believes that the design or implementation of our internal controls is not effective, or if it interprets the relevant requirements differently from us.

Prior to 2007, we were a private company with limited accounting personnel and other resources with which to address our internal controls and procedures. We have been improving our internal control over financial reporting. During 2007 and 2008, we identified a material weakness in our internal control over financial reporting related to lack of sufficient qualified financial reporting and accounting personnel to fulfill U.S. GAAP closing and reporting requirements. In 2008, we experienced high turnover of senior level finance and accounting staff members, including the Chief Financial Officer. For 2008, we identified a material weakness relating to our not having sufficient experienced personnel with the requisite technical skills and working knowledge of the application of U.S. GAAP relating to revenue recognition under percentage of completion, deferred income taxes, the financial statement close and reporting process and the evaluation of debt covenants relating to long-term debt. Based on the identified control risk, we have taken measures to reduce staff turnover in the accounting and finance department and provide additional training and cross-training to our existing personnel, including areas of new and emerging accounting standards and tax. If we fail to maintain the adequacy of our internal controls, we may not be able to conclude that we have effective internal control over financial reporting. Moreover, effective internal control over financial reporting are necessary for us to produce reliable financial reports and are important to help prevent fraud. As a result, our failure to maintain effective internal control over financial reporting could result in the loss of investor confidence in the reliability of our financial statements, which in turn could harm our business and negatively impact the trading price of our ADSs. Furthermore, we have incurred and expect to continue to incur considerable costs and devote significant management time and efforts and other resources to comply with Section 404 of the Sarbanes-Oxley Act.

Risks Relating to the Residential Property Industry in China

The PRC government has recently introduced certain policy and regulatory measures to control the rapid increase in housing prices and cool down the real estate market and may adopt further measures in the future.

Along with the economic growth in China, investments in the property sectors have increased significantly in the past few years. Since the second half of 2009, the PRC real estate market has experienced strong recovery from the financial crisis and housing prices rose rapidly in certain cities. In response to concerns over the scale of the increase in property investments, the PRC government has implemented measures and introduced policies to curtail property development and promote the healthy development of the real estate industry in China.

 

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On January 7, 2010, the general office of the PRC State Council issued a circular to all ministries and provincial-level local governments. Such circular aimed to control the rapid increase in housing prices and cool down the real estate market in China. It reiterated that the purchasers of a second residential property for their households must make down payments of no less than 40% of the purchasing price and real estate developers must commence the sale within the mandated period as set forth in the pre-sale approvals and at the publicly announced prices. The circular also requested the local government to increase the effective supply of low-income housing and ordinary commodity housing and instructed the PBOC and the China Bank Regulatory Commission to tighten the supervision of the bank lending to the real estate sector and mortgage financing. On February 25, 2010, the PBOC increased the reserve requirement ratio for commercial banks by 0.5% to 16.5%. It is possible that the government agencies may adopt further measures (e.g., raising interest rates) to implement the policies outlined in this circular. Further, in order to implement the requirements set out in the State Council’s circular, the Ministry of Land and Resources, or the MLR, issued a notice on March 8, 2010 in relation to increasing the supply of, and strengthening the supervision over, land for real estate development purposes. MLR’s notice stipulated that the floor price of a parcel of land must not be lower than 70% of the benchmark land price set for the area in which the parcel is located, and that real estate developers participating in land auctions must pay a deposit equivalent to 20% of the land parcel’s floor price.

The PRC government’s policy and regulatory measures on the PRC real estate sector could limit our access to required financing and other capital resources, adversely affect the property purchasers’ ability to obtain mortgage financing or significantly increase the cost of mortgage financing, reduce market demand for our properties and increase our operating costs. We cannot be certain that the PRC government will not issue additional and more stringent regulations or measures, which could substantially reduce pre-sales of our properties and cash flow from operations and substantially increase our financing needs, which would in turn materially and adversely affect our business, financial condition, results of operation and prospects.

Measures implemented by the PRC government on the property development industry remain in force and further restrictive measures may be adopted in the future.

Most of the restrictive regulations and measures implemented by the PRC government to curtail property development prior to the ongoing financial crisis remain in force. We believe the following regulations and policies, among others, significantly affect the property industry in China.

In July 2006, the Ministry of Housing and Urban-Rural Development, or the MOHURD (formerly known as the Ministry of Construction), the National Development and Reform Commission, or the NDRC, the PBOC, the State Administration for Industry and Commerce, or the SAIC, and the SAFE issued Opinions on Regulating the Entry and Administration of Foreign Investment in the Real Estate Market, which impose significant requirements on foreign investment in the PRC real estate sector. For instance, these opinions set forth requirements of registered capital of a foreign invested real estate enterprise as well as thresholds for a foreign invested real estate enterprise to borrow domestic or overseas loans. In addition, since June 2007, a foreign invested real estate enterprise approved by local authorities is required to file such approvals with the Ministry of Commerce, or the MOFCOM. As of July 1, 2008, the MOFCOM delegated its provincial branches to review the filing records in relation to foreign invested real estate enterprise’s establishment, capital increase, equity transfer, merger and acquisition, etc. Although this may accelerate the filing process, it does not eliminate the uncertainties surrounding filing as the material requirements for the filing process remain unchanged. We cannot assure you that any foreign invested real estate enterprise that we establish, or whose registered capital we increase after June 2007, will be able to complete the filing with the MOFCOM or its provincial branches.

On October 31, 2007, the MOFCOM and the NDRC jointly issued the Catalogue of Industries for Guiding Foreign Investment, which took effect on December 1, 2007, restricting the construction and operation of high-end residential and commercial properties by Sino-foreign and other foreign investment entities. In addition, the development and construction of ordinary residential properties was removed from the “encouraged” category of investment, but continue to be a permitted type of investment.

On July 10, 2007, the SAFE issued the Notice on Publicity of the List of the 1st Group of Foreign-Invested Real Estate Projects filed with the MOFCOM. This notice may strictly limit our capacity to raise funds offshore for the purpose of funding our PRC subsidiaries by means of increasing their registered capital or extending shareholders’ loans.

The PRC government’s restrictive regulations and measures could increase our operating costs in adapting to these regulations and measures, limit our access to capital resources or even restrict our business operations. We cannot be certain that the PRC government will not issue additional and more stringent regulations or measures, which could further adversely affect our business and prospects.

We are heavily dependent on the performance of the residential property market in China, which is at a relatively early development stage.

The residential property industry in the PRC is still in a relatively early stage of development. Although demand for residential property in the PRC has been growing rapidly in recent years, such growth is often coupled with volatility in market conditions and fluctuation in property prices. It is extremely difficult to predict how much and when demand will develop, as many social, political, economic, legal and other factors, most of which are beyond our control, may affect the development of the market. The level of uncertainty is increased by the limited availability of accurate financial and market information as well as the overall low level of transparency in the PRC, especially in Tier II cities which have lagged in progress in these aspects when compared to Tier I cities.

 

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We face intense competition from other real estate developers.

The property industry in the PRC is highly competitive. In the Tier II cities we focus on, local and regional property developers are our major competitors, and an increasing number of large state-owned and private national property developers have started entering these markets. Many of our competitors, especially the state-owned and private national property developers, are well capitalized and have greater financial, marketing and other resources than we have. Some also have larger land banks, greater economies of scale, broader name recognition, a longer track record and more established relationships in certain markets. In addition, the PRC government’s recent measures designed to reduce land supply further increased competition for land among property developers.

Competition among property developers may result in increased costs for the acquisition of land for development, increased costs for raw materials, shortages of skilled contractors, oversupply of properties, decrease in property prices in certain parts of the PRC, a slowdown in the rate at which new property developments will be approved and/or reviewed by the relevant government authorities and an increase in administrative costs for hiring or retaining qualified personnel, any of which may adversely affect our business and financial condition. Furthermore, property developers that are better capitalized than we are may be more competitive in acquiring land through the auction process. If we cannot respond to changes in market conditions as promptly and effectively as our competitors, or effectively compete for land acquisition through the auction systems and acquire other factors of production, our business and financial condition will be adversely affected.

In addition, risk of property over-supply is increasing in parts of China, where property investment, trading and speculation have become overly active. We are exposed to the risk that in the event of actual or perceived over-supply, property prices may fall drastically, and our revenue and profitability will be adversely affected.

Our sales will be affected if mortgage financing becomes more costly or otherwise becomes less attractive.

Substantially all purchasers of our residential properties rely on mortgages to fund their purchases. An increase in interest rates may significantly increase the cost of mortgage financing, thus affecting the affordability of residential properties. In order to promote the healthy development of Chinese property market during the global financial and economic crisis experienced in the latter half of 2008, the PBOC issued the Circular on Further Decreasing the Loan Interest Rate for Non-Welfare Residential Property and Other Relevant Issues, or Circular 302, on October 22, 2008. This Circular provides that, as of October 27, 2008, the lowest applicable loan interest rate for non-welfare residential property is reduced to 70% of the benchmark interest rate and the lowest applicable down payment ratio is reduced to 20% of the total purchase price. Financial institutions must determine the applicable loan interest rate and down-payment ratio for non-welfare residential property according to the following factors: (i) whether the borrower is purchasing a property for the first time; (ii) whether the borrower is purchasing the property for his own use; (iii) whether the property purchased is an ordinary residential property; and (iv) risk factors including the borrower’s credit records and payment ability. However, some commercial banks have imposed certain restrictive conditions in their detailed measures implementing Circular 302, including the requirement that only borrowers who meet the restrictive conditions stated in the measures are entitled to receive the preferential interest rate. In addition, mortgagee banks may not lend to any individual borrower if the monthly repayment of the anticipated mortgage loan would exceed 50% of the individual borrower’s monthly income or if the total debt service of the individual borrower would exceed 55% of such individual’s monthly income. If the availability or attractiveness of mortgage financing is reduced or limited, many of our prospective customers may not be able to purchase our properties and, as a result, our business, liquidity and results of operations could be adversely affected.

In line with industry practice, we provide guarantees to PRC banks with respect to loans procured by the purchasers of our properties for the total amount of mortgage loans. Such guarantees expire upon the completion of the registration of the mortgage with the relevant mortgage registration authorities. If there are changes in laws, regulations, policies and practices that would prohibit property developers from providing guarantees to banks in respect of mortgages offered to property purchasers and as a result, banks would not accept any alternative guarantees by third parties, or if no third party is available or willing in the market to provide such guarantees, it may become more difficult for property purchasers to obtain mortgages from banks and other financial institutions during sales and pre-sales of its properties. Such difficulties in financing could result in a substantially lower rate of sale and pre-sale of our properties, which would adversely affect our cash flow, financial condition and results of operations. We are not aware of any impending changes in laws, regulations, policies or practices which will prohibit such practice in China. However, there can be no assurance that such changes in laws, regulations, policies or practices will not occur in China in the future.

Risks Relating to China

PRC economic, political and social conditions as well as government policies can affect our business.

The PRC economy differs from the economies of most developed countries in many aspects, including:

 

   

political structure;

 

   

degree of government involvement;

 

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degree of development;

 

   

level and control of capital reinvestment;

 

   

control of foreign exchange; and

 

   

allocation of resources.

The PRC economy has been transitioning from a centrally planned economy to a more market-oriented economy. For more than two decades, the PRC government has implemented economic reform measures emphasizing utilization of market forces in the development of the PRC economy. Although we believe these reforms will have a positive effect on China’s overall and long-term development, we cannot predict whether changes in the PRC economic, political and social conditions, laws, regulations and policies will have any adverse effect on our current or future business, financial condition or results of operations.

Changes in foreign exchange regulations may adversely affect our ability to transfer funds and subsequently impact the results of our operations.

We currently receive all of our revenues from operations in RMB. The PRC government regulates the conversion between RMB and foreign currencies. Over the years, the PRC government has significantly reduced its control over routine foreign exchange transactions under current accounts, including trade and service related foreign exchange transactions, payment of dividends and service of foreign debt. However, foreign exchange transactions by our PRC subsidiaries under capital accounts continue to be subject to significant foreign exchange controls and require the approval of, or registration with, PRC governmental authorities. There can be no assurance that these PRC laws and regulations on foreign investment will not cast uncertainties on our financing and operating plans in China. Under current foreign exchange regulations in China, subject to the relevant registration at the SAFE, we will be able to pay dividends in foreign currencies, without prior approval from the SAFE, by complying with certain procedural requirements. However, there can be no assurance that the current PRC foreign exchange policies regarding debt service and payment of dividends in foreign currencies will continue in the future. Changes in PRC foreign exchange policies might have a negative impact on our ability to service our foreign currency-denominated indebtedness and to distribute dividends to our shareholders in foreign currencies.

In addition, on August 29, 2008, the SAFE issued a notice with respect to the administration of RMB converted from foreign exchange capital contributions of a foreign invested enterprise. As a result, unless otherwise permitted by PRC laws or regulations, such converted amount can only be applied to activities within the approved business scope of the relevant foreign invested enterprise and cannot be used for domestic equity investment or acquisition. As restricted by the notice, we may not be able to use RMB converted from foreign exchange capital contributions to fund our PRC subsidiaries.

Fluctuations in the value of RMB will affect the amount of our non-RMB debt service in RMB terms and affect the value of, and dividends payable on, our ADSs in foreign currency terms.

The value of RMB depends, to a large extent, on China’s domestic and international economic, financial and political developments and government policies, as well as the currency’s supply and demand in the local and international markets. For over 10 years from 1994, the conversion of RMB into foreign currencies, including the U.S. dollar, was based on exchange rates set and published daily by the PBOC in light of the previous day’s inter-bank foreign exchange market rates in China and the then current exchange rates on the global financial markets. The official exchange rate for the conversion of RMB into the U.S. dollar was largely stable until July 2005. On July 21, 2005, the PBOC revalued RMB by reference to a basket of foreign currencies, including the U.S. dollar. As a result, the value of RMB appreciated by 2% on that day. Since then, the PRC central bank has allowed the official RMB exchange rate to float against a basket of foreign currencies. There can be no assurance that such exchange rate will not fluctuate widely against the U.S. dollar or any other foreign currency in the future. Fluctuation of the value of RMB will affect the amount of our non-RMB debt service in RMB terms since we have to convert RMB into non-RMB currencies to service our foreign debt, including our floating rate and convertible notes. Since our income and profits are denominated in RMB, any appreciation of RMB will also increase the value of, and any dividends payable on, our ADSs in foreign currency terms. Conversely, any depreciation of RMB will decrease the value of, and any dividends payable on, our ADSs in foreign currency terms.

Interpretation of PRC laws and regulations involves uncertainty.

Our core business is conducted within China and is governed by PRC laws and regulations. The PRC legal system is based on written statutes, and prior court decisions can only be used as a reference. Since 1979, the PRC government has promulgated laws and regulations in relation to economic matters such as foreign investment, corporate organization and governance, commerce, taxation and trade, with a view to developing a comprehensive system of commercial law, including laws relating to property ownership and development. However, due to the fact that these laws and regulations have not been fully developed, and because of the limited volume of published cases and the non-binding nature of prior court decisions, interpretation of PRC laws and regulations involves a degree of uncertainty. Some of these laws may be changed without being immediately published or may be amended with retroactive effect. Depending on the government agency or how an application or case is presented to such agency, we may receive less favorable interpretations of laws and regulations than our competitors, particularly if a competitor has long been established in the locality of, and has developed a relationship with, such agency. In addition, any litigation in China may be protracted and result in substantial costs and diversion of resources and management attention. All these uncertainties may cause difficulties in the enforcement of our land use rights, entitlements under its permits, and other statutory and contractual rights and interests.

 

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The PRC national and regional economies may be adversely affected by a recurrence of epidemic.

Certain areas of China, including the Tier II cities where we operate, are susceptible to epidemics such as Severe Acute Respiratory Syndrome, or SARS, avian or swine influenza. A recurrence of SARS, avian or swine influenza or any epidemic in these cities or other areas of China could result in material disruptions to our property developments, which in turn could materially and adversely affect our financial condition and results of operations.

PRC regulations relating to the establishment of offshore special purpose companies by PRC residents limit our ability to inject capital into our PRC subsidiaries, limit our PRC subsidiaries’ ability to distribute profits to us or otherwise adversely affect us.

The SAFE issued a public notice in October 2005, requiring PRC residents to register with the local SAFE branch before establishing or acquiring the control of any company outside of China for the purpose of financing that offshore company to acquire assets or equity interest in a PRC company. Once the special purpose vehicle has a major capital change event (including overseas equity or convertible bonds financing), the residents must conduct a registration relating to the change within 30 days of occurrence of the event. On May 29, 2007, the SAFE issued an additional notice, clarifying some outstanding issues and providing standard operating procedures for implementing the prior notice. According to the new notice, the SAFE sets up seven schedules that track registration requirements for offshore fundraising and roundtrip investments. Further, pursuant to the above notices, if our PRC resident shareholders fail to adhere to any of the registration requirements, or if they make any false representations to obtain the registration for roundtrip investments in onshore entities or special purpose vehicles, they may face fines and other legal sanctions. In addition, such actions may also impede our ability to contribute additional capital or extend loans to our PRC subsidiaries, impede our PRC subsidiaries’ ability to pay dividends or otherwise distribute profits to us, or otherwise adversely affect us. However, as a result of uncertainty concerning the reconciliation of these notices with other approval or registration requirements, it remains unclear how these notices, and any future legislation concerning offshore or cross-border transactions, will be interpreted, amended and implemented by the relevant government authorities. We attempt to comply, and attempt to ensure that our shareholders who are subject to these rules comply, with the relevant requirements. Since Mr. Yong Zhang, Chairman of our board of directors and Chief Executive Officer, and his spouse, Ms. Yuyan Yang, also a board member and Vice President, are PRC residents and our shareholders, each is subject to the SAFE registration requirements. Mr. Zhang and Ms. Yang have updated their registrations with the local SAFE branch. However, we cannot provide any assurances that Mr. Zhang, Ms. Yang, or any of our other shareholders who are PRC residents will comply with our request to make or obtain any applicable registrations or comply with other requirements required by these notices or other related rules for any future updates. The failure or inability of these PRC resident beneficial owners to comply with applicable SAFE registration requirements may subject us to the sanctions described above, including sanctions which may impede our ability to contribute the additional capital from our proceeds of any future offerings to our PRC subsidiaries, and our PRC subsidiaries ability to pay dividends or distribute profits to us.

We may face PRC regulatory risks relating to our equity incentive plan and long term incentive plan.

On March 28, 2007, the SAFE promulgated the Application Procedures of Foreign Exchange Administration for Domestic Individuals Participating in Employee Stock Holding Plan or Stock Option Plan of Overseas-Listed Company, or the Stock Option Rules. Under the Stock Option Rules, PRC residents who are granted stock options and other types of stock-based awards by an overseas publicly-listed company are required, through an agent of the overseas publicly-listed company, generally its PRC subsidiary or a financial institution, to obtain approval from the local SAFE branch. As a company listed on a stock exchange in the United States, we and our PRC directors, management, employees, consultants and employees of our equity investee who have been granted share options and other awards under our equity incentive plan and our long term incentive plan are subject to the Stock Option Rules. We filed our 2007 equity incentive plan and 2007 long term incentive plan with the local SAFE branch in December 2007. In addition, we are required to apply for the quota for purchasing foreign exchange with the local SAFE branch in respect of any cash exercise of options pursuant to the 2007 equity incentive plan and 2007 long term incentive plan and to continue to file the updated equity incentive plan and long term incentive plan with the local SAFE branch on a regular basis. If we, or any of these persons, fail to comply with the relevant rules or requirements, we may be subject to penalties, and may become subject to more stringent review and approval processes with respect to our foreign exchange activities, such as our PRC subsidiaries’ dividend payment to us or borrowing foreign currency loans, all of which may adversely affect our business and financial condition.

 

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Risks Related to Our ADSs

The market price for our ADSs may be volatile.

The market price for our ADSs may be volatile and subject to wide fluctuations in response to factors such as actual or anticipated fluctuations in our quarterly operating results, changes in financial estimates by securities research analysts, changes in the economic performance or market valuations of other real estate developers, announcements by us or our competitors of material acquisitions, strategic partnerships, joint ventures or capital commitments, fluctuations of exchange rates between RMB and the U.S. dollar, release of transfer restrictions on our outstanding shares or ADSs, and economic or political conditions in China. In addition, the performance, and fluctuation in market prices, of other companies with business operations located mainly in China that have listed their securities in the United States may affect the volatility in the price of and trading volumes of our ADSs. Furthermore, the securities market has from time to time experienced significant price and volume fluctuations that are not related to the operating performance of particular companies. These market fluctuations may also materially and adversely affect the market price of our ADSs.

You may experience dilution in the net tangible book value of ADSs.

Our IPO in December 2007 resulted in a dilution to purchasers at the offering of US$9.35 per ADS. You may experience further dilution with respect to your ADSs upon our issuance of common shares in connection with the exercise of outstanding options, warrants and further options we may grant from time to time, as well as with any conversion of our outstanding convertible notes.

We may raise additional capital through the sale of additional equity or debt securities, which could result in additional dilution to our shareholders, or impose upon us additional financial obligations.

We may require additional cash resources to finance our continued growth or other future developments, including any investments or acquisitions we may decide to pursue. The amount and timing of such additional financing needs will vary principally depending on the timing of our property developments, investments and/or acquisitions, and the amount of cash flow from our operations. If our resources are insufficient to satisfy our cash requirements, we may seek to sell additional equity or debt securities. The sale of additional equity securities, including additional warrants, could result in additional dilution to our shareholders. The incurrence of indebtedness would result in increased debt service obligations and could result in operating and financing covenants that would restrict our operations, including our ability to pay dividends or redeem stock. We cannot guarantee that financing will be available in amounts or on terms acceptable to us, if at all.

Substantial future sales or the perception of sales of our ADSs in the public market could cause the price of our ADSs to decline.

Sales of our ADSs or common shares in the public market, or the perception that these sales could occur, could cause the market price of our ADSs to decline. As of December 31, 2009, we had 151,688,262 common shares outstanding, including 91,888,260 common shares represented by 45,944,130 ADSs. All ADSs are freely transferable without restriction or additional registration under the Securities Act of 1933, as amended, or the Securities Act. The remaining common shares outstanding are available for sale, subject any volume and other restrictions as applicable under Rule 144 under the Securities Act. To the extent that common shares are sold into the market, the market price of our ADSs could decline.

In addition, certain holders of our common shares have the right to cause us to register the resale of a certain number of shares under the Securities Act. We have registered most of those shares for resale on a Form F-3 registration statement. We have registered under the Securities Act the sale of all common shares that are issuable upon exercise of stock options or other awards under our equity incentive plans. As a result, shares are freely tradable without restriction under the Securities Act, subject to any applicable lock-up agreements. Sales of those registered shares in the public market could cause the price of our ADSs to decline.

The interests of our major shareholders may not be aligned with the interests of our other shareholders.

As of December 31, 2009, Mr. Yong Zhang, Chairman of our board of directors and Chief Executive Officer, together with his spouse, Ms. Yuyan Yang, also a board member and Vice President, beneficially owned 39.7% of our outstanding share capital. Accordingly, they have substantial influence over our business, including decisions regarding mergers, consolidations and the sale of all or substantially all of our assets, election of directors and other significant corporate actions. In addition, our institutional shareholders, Blue Ridge China and Equity International, also have substantial ownership of our shares. As of December 31, 2009, Blue Ridge China owned 18.4% of our outstanding share capital and Equity International owned 12.2% of our outstanding share capital. This concentration of ownership by our major shareholders may result in actions being taken even if opposed by our other shareholders. In addition, it may discourage, delay or prevent a change in control of our company, which could deprive our shareholders of an opportunity to receive a premium for their shares as part of a sale of our company and might reduce the price of our ADSs.

 

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Compliance with rules and regulations applicable to companies publicly listed in the United States is costly and complex and any failure by us to comply with these requirements on an ongoing basis could negatively affect investor confidence in us and cause the market price of our ADSs to decrease.

In addition to Section 404, the Sarbanes-Oxley Act also mandates, among other things, that companies adopt corporate governance measures, imposes comprehensive reporting and disclosure requirements, sets strict independence and financial expertise standards for audit committee members, and imposes civil and criminal penalties for companies, their chief executive officers, chief financial officers and directors for securities law violations. For example, in response to the Sarbanes-Oxley Act, the NYSE has adopted additional comprehensive rules and regulations relating to corporate governance. These laws, rules and regulations have increased the scope, complexity and cost of our corporate governance and reporting and disclosure practices. Our current and future compliance efforts will continue to require significant management attention. In addition, our board members, chief executive officer and chief financial officer could face an increased risk of personal liability in connection with the performance of their duties. As a result, we may have difficulty attracting and retaining qualified board members and executive officers to fill critical positions within our company. Any failure by us to comply with these requirements on an ongoing basis could negatively affect investor confidence in us, cause the market price of our ADSs to decrease or even result in the delisting of our ADSs from the NYSE.

You may not have the same voting rights as the holders of our common shares and may not receive voting materials in time to be able to exercise your right to vote.

Holders of our ADSs will not be able to exercise voting rights attaching to the common shares evidenced by our ADSs on an individual basis. Holders of our ADSs will appoint the depositary or its nominee as their representative to exercise the voting rights attaching to the common shares represented by the ADSs. Holders of ADSs may not receive voting materials in time to instruct the depositary to vote, and it is possible that you, or persons who hold their ADSs through brokers, dealers or other third parties, will not have the opportunity to exercise a right to vote. As soon as practicable after the depositary receives from us a notice of a shareholders’ meeting, the depositary will distribute to registered holders of ADRs a notice stating (a) such information as is contained in such notice and any solicitation materials, (b) that each registered holder on the record date set for such purpose will, subject to any applicable provisions of Cayman Island law, be entitled to instruct the depositary as to the exercise of the voting rights and (c) the manner in which such instructions may be given, including instructions to give a discretionary proxy to a person designated by us. The depositary will not itself exercise any voting discretion in respect of any common shares nor will it provide any instructions with respect to the common shares represented by any ADSs for which voting instructions were not timely and properly received. There can be no guarantee that registered holders of ADRs will receive the notice described above with sufficient time to enable them to return any voting instructions to the depositary in a timely manner. To the extent you hold your ADSs through a bank, broker or other nominee, you will be relying upon such institutions with respect to voting matters.

You may not be able to participate in rights offerings and may experience dilution of your holdings as a result.

We may from time to time distribute rights to our shareholders, including rights to acquire our securities. Under the deposit agreement for the ADSs, the depositary will not offer those rights to ADS holders unless both the rights and the underlying securities to be distributed to ADS holders are either registered under the Securities Act or are exempt from registration under the Securities Act with respect to all holders of ADSs. We are under no obligation to file a registration statement with respect to any such rights or underlying securities or to endeavor to cause such a registration statement to be declared effective. In addition, we may not be able to take advantage of any exemptions from registration under the Securities Act. Accordingly, holders of our ADSs may be unable to participate in our rights offerings and may experience dilution in their holdings as a result.

You may be subject to limitations on transfer of your ADSs.

Your ADSs are transferable on the books of the depositary. However, the depositary may close its transfer books at any time or from time to time when it deems expedient in connection with the performance of its duties. In addition, the depositary may refuse to deliver, transfer or register transfers of ADSs generally when our books or the books of the depositary are closed, or at any time if we or the depositary deem it advisable to do so because of any requirement of law or of any government or governmental body, or under any provision of the deposit agreement, or for any other reason.

Certain judgments obtained against us by our shareholders may not be enforceable.

We are incorporated in the Cayman Islands, and conduct substantially all of our operations in China through our wholly owned subsidiaries and affiliated entities in China. All of our officers reside outside the United States and some or all of the assets of those persons are located outside of the United States. As a result, it may be difficult or impossible for you to bring an action against us or against these individuals in the Cayman Islands or in China in the event that you believe that your rights have been infringed under the securities laws or otherwise. Even if you are successful in bringing an action of this kind, the respective laws of the Cayman Islands and China may render you unable to enforce a judgment against our assets or the assets of our directors and officers. There is no statutory recognition in the Cayman Islands of judgments obtained in the United States, although the courts of the Cayman Islands will generally recognize and enforce a non-penal judgment of a foreign court of competent jurisdiction without retrial on the merits.

 

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We are a Cayman Islands company and, because judicial precedent regarding the rights of shareholders is more limited under Cayman Islands law than under U.S. law, you may have less protection of your shareholder rights than you would under U.S. law.

Our corporate affairs are governed by our memorandum and articles of association and by the Companies Law (2009 Revision) and common law of the Cayman Islands. The rights of shareholders to take legal action against our directors and us, actions by minority shareholders and the fiduciary responsibilities of our directors to us under Cayman Islands law are to a large extent governed by the common law of the Cayman Islands. The common law of the Cayman Islands is derived in part from comparatively limited judicial precedent in the Cayman Islands as well as from English common law, which has persuasive, but not binding, authority on a court in the Cayman Islands. The rights of our shareholders and the fiduciary responsibilities of our directors under Cayman Islands law are not as clearly established as they would be under statutes or judicial precedents in the United States. In particular, the Cayman Islands have a less developed body of securities laws as compared to the United States, and provide significantly less protection to investors. In addition, Cayman Islands companies may not have standing to initiate a shareholder derivative action before the federal courts of the United States.

The Companies Law introduced a new mechanism for mergers and acquisitions where the merged company or consolidated company will continue to be a Cayman Islands entity. Under this mechanism, dissenting shareholders have the right to be paid the fair value of their shares (which, if not agreed between the parties, will be determined by the Cayman Islands courts) if they follow the required procedures, subject to certain exceptions. However, these rights have never been tested before the Cayman Islands court and as a result, they may not be comparable to the appraisal rights that would ordinarily be available to dissenting shareholders of a U.S. company.

As a result of all of the above, our public shareholders may have more difficulty in protecting their interests through actions against our management, directors or major shareholders than would shareholders of a corporation incorporated in a jurisdiction in the United States.

You may experience difficulties in effecting service of legal process, enforcing foreign judgments or bringing original actions in China based on United States or other foreign laws against us or our management named in the annual report.

We conduct substantially all of our operations in China and all of our assets are located in China. In addition, most of our directors and senior executive officers reside within China. As a result, it may not be possible to affect service of process within the United States or elsewhere outside China upon our directors and senior executive officers, including with respect to matters arising under U.S. federal securities laws or applicable state securities laws. Moreover, our PRC counsel has advised us that the PRC does not have treaties with the United States or many other countries providing for the reciprocal recognition and enforcement of judgment of courts.

Our articles of association may contain anti-takeover provisions that could have a material adverse effect on the rights of holders of our common shares and ADSs.

Our amended and restated articles of association contain provisions limiting the ability of others to acquire control of our company or cause us to engage in change-of-control transactions. These provisions could have the effect of depriving our shareholders of an opportunity to sell their shares at a premium over prevailing market prices by discouraging third parties from seeking to obtain control of our company in a tender offer or similar transaction. For example, our board of directors has the authority, without further action by our shareholders, to issue preferred shares in one or more series and to fix their designations, powers, preferences, privileges and relative participating, optional or special rights and their qualifications, limitations or restrictions, including dividend rights, conversion rights, voting rights, terms of redemption and liquidation preferences, any or all of which may be greater than the rights associated with our common shares, in the form of ADS or otherwise. Preferred shares could be issued quickly with terms calculated to delay or prevent a change in control of our company or make removal of management more difficult. If our board of directors decides to issue preferred shares, the price of our ADSs may fall and the voting and other rights of the holders of our common shares and ADSs may be materially and adversely affected. As a result, the price of our ADSs may fall.

We may be classified as a passive foreign investment company, which could result in adverse U.S. federal income tax consequences to U.S. holders of our ADSs or common shares.

Based on the composition of our assets and income and the current expectations, we believe that we were not a “passive foreign investment company,” or PFIC, for U.S. federal income tax purposes for our taxable year ending December 31, 2009 and we do not expect to become a PFIC with respect to our current taxable year or the foreseeable future. However, the determination of our PFIC status is dependent upon the composition of our income and assets and, in addition, we must make a separate determination at the close of each taxable year as to whether we are a PFIC. Accordingly, we cannot assure you that we will not be a PFIC for our current taxable year ending December 31, 2010, or any future taxable year. A non-U.S. corporation will be considered a PFIC for any taxable year if either (1) at least 75% of its gross income is passive income or (2) at least 50% of the value of its assets is attributable to assets that produce or are held for the production of passive income. The market value of our assets will be determined based on the market price of our ADSs and common shares, which are likely to fluctuate. If we were treated as a PFIC for any taxable year during which a U.S. person held an ADS or a common share, certain adverse U.S. federal income tax consequences could apply to such U.S. person. See “Item 10. Additional Information—E. Taxation—U.S. Federal Income Taxation—Passive Foreign Investment Company.”

 

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We may be classified as a controlled foreign corporation, which will result in application of special rules to certain of our U.S. holders.

Given our current ownership, there is a possibility that we may be a controlled foreign corporation, or CFC, which is a factual determination dependent on the circumstances existing on the relevant date. If we were treated as a CFC for any taxable year during which a U.S. 10% shareholder held ADSs or common shares, certain adverse U.S. federal income tax consequences could apply to such U.S. 10% shareholder. See “Item 10. Additional Information—E. Taxation—U.S. Federal Income Taxation—Controlled Foreign Corporation.”

 

ITEM 4. INFORMATION ON THE COMPANY

A. History and Development of the Company

We are a Cayman Islands holding company and conduct substantially all of our business through our operating subsidiaries in China. We were founded by Yong Zhang, our Chairman and Chief Executive Officer, and commenced operations in 1997 in Zhengzhou, the provincial capital of Henan Province. Since 2006, we have expanded into certain Tier II cities in China which we strategically selected based on a set of criteria. Our selection criteria includes population and urbanization growth rate, general economic condition and growth rate, disposable income and purchasing power of resident consumers, anticipated demand for private residential properties, availability of future land supply and land prices and governmental urban planning and development policies. We have established operations in seven Tier II cities in China, comprised of Chengdu in Sichuan Province, Hefei in Anhui Province, Jinan in Shandong Province, Suzhou, Kunshan and Xuzhou in Jiangsu Province and Zhengzhou in Henan Province.

Our company was incorporated in the Cayman Islands on March 26, 2007. Our company operates under Cayman Islands Companies Laws (2009 Revision). Our registered address is located at the offices of Maples Corporate Services Limited, P.O. Box 309, Ugland House, Grand Cayman, KY1-1104 Cayman Islands. Our principal executive offices are located at 27/F, China Central Place, Tower II, 79 Jianguo Road, Chaoyang District, Beijing 100025, People’s Republic of China. Our telephone number at this address is (86) 10 8588-9200 and our fax number is (86) 10 8588-9300.

For a discussion of our capital expenditures for the last three fiscal years, see “Item 5. Operating and Financial Review and Prospects – A. Operating Results – Operating Results – Capital Expenditures.”

Shareholder inquiries should be directed to us at the address and telephone number of our principal executive offices set forth above. Our website is www.xyre.com. The information contained on our website does not form part of this annual report. Our agent for service of process in the United States is CT Corporation System located at 111 Eighth Avenue, New York, New York 10011.

B. Business Overview

We are a residential real estate developer that focuses on Tier II cities in China. Our standardized and scalable model emphasizes rapid asset turnover, efficient capital management and strict cost control.

We focus on developing large scale quality residential projects, which typically consist of multiple residential buildings that include multi-layer apartment buildings, sub-high-rise apartment buildings or high-rise apartment buildings. Several of our projects include auxiliary services and amenities such as retail outlets, leisure and health facilities, kindergartens and schools. We also develop small scale residential properties. Our developments aim at providing middle-income consumers with a comfortable and convenient community life. In addition, we provide property management services for our developments and other real estate-related services to our customers. We acquire development sites primarily through public auctions of government land. This acquisition method allows us to obtain unencumbered land use rights to unoccupied land without the need for additional demolition, re-settlement or protracted legal processes to obtain title. As a result, we are able to commence construction relatively quickly after we acquire a site for development.

We have expanded our business and operations significantly during the past three years. The number of projects we had under construction increased from five projects with a total GFA of 584,011 square meters as of December 31, 2006 to five projects with a total GFA 1,389,332 square meters as of December 31, 2009. We have seven additional projects with a total GFA of 1,498,389 square meters under planning as of December 31, 2009. As of December 31, 2009, we have completed nineteen projects with a total GFA of approximately 1,591,132 square meters and comprising a total of 16,404 units, more than 99.6% of which have been sold. For each of the three years ended December 31, 2007, 2008 and 2009, our revenues were US$309.7 million, US$356.6 million and US$449.0 million, respectively, representing a compound annual growth rate, or CAGR, of 20.4%. Our net income/(loss) for each of those three years US$45.7 million, US$(23.6) million and US$42.4 million, respectively.

 

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We intend to continue our expansion in selected Tier II cities as suitable opportunities arise. The following map illustrates the geographic locations of our current operations and selected potential target Tier II cities for expansion in the future:

LOGO

 

City Information (1):

                

Population (millions, as of Dec 31,

   12.7      7.4      6.6      5.0      6.3      1.6      8.7      46.7

Real GDP Growth (2008)

   12.1   12.2   13.0   17.2   12.5   15.0   13.5   —  

Per Capital Disposable Income for urban households (2008, RMB in

   16.9      15.7      20 8      15.6      23.9      24.8      17.0      —  

Residential Real Estate Investment (2008, RMB in billions)

   91.3      33.8      27.4      44.0      71.8      12.0      13.1      281.3
Our Property Projects (as of December 31, 2009)

Projects under construction

   1      1      1      —        1      1      —        5

Projects under planning

   1      4      1      —        —        —        1      7

Completed projects

   —        14      2      1      2      —        —        19

Total number of projects

   2      19      4      1      3      1      1      31

Total GFA (m2)

   450,374      1,849,160      961,916      145,455      482,555      497,076      92,317      4,478,853

 

Sources of city information    Current Presence ¡ Potential target tier II cities
(1) 2008 National Economic and Social Development Statistical Bulletin of various cities   

• The map is for illustrative purposes only

•• Data of City Information for Suzhou includes the data for Kunshan

 

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Our Strengths

Under the current circumstances, we believe the following strengths allow us to compete effectively in the PRC real estate development industry.

Well Positioned to Capture Attractive Growth Opportunities in Tier II Cities. Increases in consumer disposable income and urbanization rates have resulted in the emergence of a growing middle-income consumer market, driving demand for affordable and quality housing in many cities across China. Since 1997, we have been building large communities of modern, mid-sized residential properties for this market segment and have accumulated substantial knowledge and experience about the residential preferences and demands of these customers. We believe demand for product types and consumption trends are similar across the selected Tier II cities we enter into and believe that we can leverage our experience to capture the growth opportunities in these markets. We typically acquire land through the government auction system which provides us ready access to undeveloped land, enabling us to expand rapidly into other Tier II cities. We believe our land acquisition method positions us well to capitalize on increasing demand and growth opportunities in our target markets.

Standardized and Scalable Business Model. Our business model focuses on a standardized property development process designed for accelerating asset turnover. We segment the process into well-defined stages and closely monitor costs and development schedules through each stage. These stages include (i) identifying land, (ii) pre-planning and budgeting, (iii) land acquisition, (iv) detailed project design, (v) construction management, (vi) sales and (vii) after-sale service. We commence pre-planning and budgeting prior to land acquisition, which enables us to acquire land at costs that meet our pre-set investment targeted returns and to quickly begin the development process upon acquisition. We typically acquire land through a transparent government auction system providing us with unencumbered land use rights to unoccupied land. Our enterprise resource planning enables us to collect and analyze information on a real-time basis throughout the entire property development process, optimizing decision making, outsourcing and development cycle scheduling. We utilize our customer relationship management system to track customer profiles and sales to forecast future individual preferences and market demand. We believe that these standardized practices and methodologies, together with a systematic approach to the development process, can be replicated in strategically selected Tier II cities, allowing us to effectively and rapidly enter into new geographic markets and develop new projects as attractive opportunities arise. Since 2006, we have expanded from one to a total of seven Tier II cities in China, and from December 31, 2005 to December 31, 2009, our total GFA for projects under construction has grown 159.3%.

Proven Ability to Provide Large Scale Quality Housing for Middle-Income Consumers. We have a clear focus on emerging middle-income consumers in China’s Tier II cities. We provide standardized mid-sized units, typically ranging from 50 square meters to 100 square meters in size, at affordable prices for this market. Our residential units feature modern designs and offer comfortable and convenient community lifestyles. We have developed a portfolio of architectural plans and designs, which typically comprise 1,000 to 5,000 units and include facilities such as clubhouses, retail shops and schools. We have a proven track record of building large-scale quality residential communities that appeal to middle-income customers, as demonstrated by the sale of more than 99.6% of the units in completed projects and revenue growth at a CAGR of 64.1% from 2005 to 2009.

Rapid Asset Turnover. Our standardized processes that emphasize rapid asset turnover allow us to efficiently use capital and generate attractive returns on our investments. We typically acquire land that is ready for development through the government auction system. We do not tie up capital in idle land banks but instead begin development relatively quickly after land acquisition. We use working capital efficiently by actively managing and coordinating receivables and expenditures across various projects. We can complete a project consisting of multi-layered buildings of six stories or below in 13 to 17 months after acquiring land. We typically begin pre-sales for a project within two to four months after we commence construction. Historically, our pre-sales activities have allowed us to generate cash flows relatively early in the development cycle and to fund a significant portion of the capital required for existing projects, reducing financing needs and other associated costs. Our long-term relationships established with third-party contractors allow us to efficiently conduct selection processes and closely manage and supervise construction progress to avoid unexpected delays and cost overruns. We believe that the velocity of our development cycle and our ability to efficiently manage capital and maintain strict cost control at each stage of the development cycle enable us to generate attractive returns on our projects.

Experienced Management Team Supported by Trained and Motivated Workforce. Our senior managers have on average over 10 years of experience in the PRC real estate industry and considerable strategic planning and business management expertise. Our Chairman and founder, Mr. Yong Zhang, has more than 20 years of experience in developing residential housing in China. Mr. Zhang was selected in 2004 as one of the Top 10 Rising Entrepreneurs in China’s Real Estate Industry by the China International Real Estate & Archi-tech Fair, or the CIHAF. Ms. Yuyan Yang , our Vice President and co-founder and Mr. Zhang’s spouse, has more than 10 years of experience in the real estate industry. In February 2009, Mr. Thomas Gurnee, formerly an independent director on our audit committee, was named our Chief Financial Officer. Mr. Gurnee brings in depth knowledge of finance and over 34 years of experience acting in executive and directorship roles in several public companies. Mr. Liming Ma, our Executive Vice President, joined our company in 2009. Mr. Ma has prior management experience at a number of leading real estate companies in China. We emphasize the training and motivation of our management and workforce. To promote effective recruitment, retention and advancement, we provide management with training and incentive programs that include subsidizing management’s pursuit of post-secondary degrees and programs. Currently, some of our managers are undertaking part-time post-secondary degrees and over 50 managers have completed or are at various stages of undertaking one year part-time business administration programs at top universities in China. Our workforce receives on-going training in their areas of specialization at our head office.

 

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Relationships with Our Institutional Shareholders. In 2006, Blue Ridge China and Equity International invested in our company. Blue Ridge China is a China-focused private equity fund and Equity International is a privately-held investment company specializing in real estate investments outside the United States, founded and led by Samuel Zell and Gary Garrabrant. Equity International’s portfolio companies include Gafisa in Brazil, a publicly listed company in the United States. Equity International is affiliated with Equity Group Investments, LLC, a privately-held investment company founded by Samuel Zell, which together with its affiliates, has created some of the largest publicly-traded real estate companies in the United States. Both of these shareholders (through their designees on the board of directors) are active in major board-level decisions and contribute their expertise in corporate governance best practices, financial management and accessing global capital. Each of Blue Ridge China and Equity International has appointed one director to our board. Since the IPO in December 2007, although Blue Ridge China and Equity International no longer have any contractual rights to appoint directors to our board however, their designated directors (Yue (Justin) Tang and Christopher J. Fiegen) are and will continue to be directors of our company until their resignation or removal.

Our Strategies

Our goal is to become the leading residential property developer focused on China’s Tier II cities by implementing the following strategies:

Continue Expansion in Selected Tier II Cities. We believe that Tier II cities present development opportunities that are well suited for our scalable business model of rapid asset turnover. Many Tier II cities offer a large supply of potential development sites that meet the criteria of our internal pre-set targeted returns. Furthermore, Tier II cities currently tend to be in an early stage of market maturity and have fewer large national developers. We believe that the fragmented market and relative abundance of land supply in Tier II cities, as compared to Tier I cities, offer opportunities for us to generate attractive margins and believe that our experience in and strategic focus on Tier II cities afford us the potential to emerge as a leading developer in these markets. Since 2006, we have rapidly expanded from one to seven Tier II cities: Jinan, Suzhou, Kunshan, Zhengzhou, Chengdu, Hefei and, as a result of a property acquisition in late 2009, Xuzhou. With the recovery of the real estate market during the later part of 2009, we made a total of five land acquisitions, three in Zhengzhou, one in Jinan and the property in Xuzhou.

Conservative Financial Policy. Given that in the second half of 2008 and the first quarter of 2009, the residential real estate market in China has experienced soft demand followed in the second, third and fourth quarters of 2009 by a sharp recovery, we have developed a more conservative approach in order to cope with increased volatility. During most of 2008 and 2009, we focused our efforts and resources on the completion of existing projects and reduction of operating expenses and did not acquire properties. As the real estate market improved during 2009, we made five land acquisitions late in the year.

Capitalize on Growth of Middle-Income Population. The growing middle-income consumer market in China presents an attractive opportunity to continue our business expansion. We will target this market by continuing to provide quality mid-sized modern residential units in large community developments for middle-income consumers. Our strategy is also consistent with the housing policy direction of relevant PRC governmental authorities in the context of rising incomes and rapid urbanization. The MOHURD and other PRC governmental authorities released policies in 2006 to promote the development of more low-priced and mid-priced housing and to limit the amount of resources, including land supply, devoted to the luxury housing market. We believe that our strategy and business model to target the middle-income market provide us with a competitive advantage in China’s current regulatory environment.

Focus on Efficient Land Acquisition. We constantly seek and assess land acquisition opportunities in selected Tier II cities through the governmental land auction system. To achieve our land acquisition targets, we have established a centralized and efficient system to research land acquisition opportunities. We monitor, plan and budget development costs for potential development sites and, if the development opportunity meets our pre-set investment target, bid for the site through the auction process. We believe that beginning with efficient land acquisitions and following through with well-executed development will allow us to expand successfully and provide sustainable growth to our business.

Maintain Strict Cost Control. We plan to continue to closely monitor our capital and cash positions and carefully manage our land use rights costs, construction costs and operating expenses. We believe that by adhering to prudent cost management we will be able to more efficiently use our working capital, which will help to maintain our profit margins. When selecting a property project for development, we will continue to follow our established internal evaluation process, including utilizing the analysis and input of our institutional shareholders and choosing third-party contractors through a tender process open only to bids which meet our budgeted costs, thus allowing us to meet our investment return criteria. We will also actively manage our sales and pre-sales to generate cash flows for our ongoing capital requirements.

 

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Strengthen our “Xinyuan” Brand. We intend to continue promoting “Xinyuan” brand in selected Tier II cities by delivering quality products and attentive real estate-related services to our customers. We believe, based on surveys we conducted with our customers, that over half of our property purchasers were referred to us by existing unit owners. We therefore believe that we can most effectively enhance our brand name by continuing to focus on providing quality products and after-sales support to customers to maintain their trust and loyalty and promote referrals to us. At the same time, we will continue to actively promote the “Xinyuan” brand through marketing initiatives in our targeted markets, such as increasing the level of advertising activities.

Our Markets

We currently operate in seven markets—Chengdu in Sichuan Province, Hefei in Anhui Province, Jinan in Shandong Province, Suzhou, Kunshan and Xuzhou in Jiangsu Province, and Zhengzhou in Henan Province.

The following table sets forth the numbers of our projects and the total GFA in each location indicated as of December 31, 2009.

 

     Chengdu    Hefei    Jinan    Kunshan    Suzhou    Zhengzhou    Xuzhou    Total

Properties under construction

   1    —      1    1    1    1    —      5

Properties under planning

   1    —      1    —      —      4    1    7

Completed projects

   —      1    2    —      2    14    —      19

Total number of projects

   2    1    4    1    3    19    1    31

Total GFA (m2)

   450,374    145,455    961,916    497,076    482,555    1,849,160    92,317    4,478,853

For a discussion of revenues from each segment in each of 2007, 2008 and 2009, see “Item 5. Operating and Financial Review and Prospects – A. Operating Results - Discussion of Segment Operations.”

In addition, Zhengzhou Jiantou Xinyuan Real Estate Co. Ltd., or Jiantou Xinyuan, a property development company founded in 2005 in which we currently own a 45% interest and which operates exclusively in Zhengzhou, has initiated six projects totaling 759,997 square meters, with one property under construction, one property under planning, and four completed projects. On September 25, 2009, we entered into an agreement to acquire the remaining 55% equity interest in Jiantou Xinyuan. The completion of such equity acquisition is subject to regulatory approvals from the relevant PRC authorities. For a discussion of the proposed acquisition, see “Item 4. Information on the Company—B. Business Overview—Jiantou Xinyuan’s Projects.”

We intend to seek attractive opportunities to expand into additional Tier II cities, which we will select based on certain macroeconomic criteria, including economic growth, per capita disposable income, population and urbanization rate as well as availability of suitable land supply and local residential property market conditions.

Our Property Projects

Overview

We offer the following three main types of real estate property products:

 

   

multi-layer apartment buildings, which are typically six stories or less and normally require nine to 12 months to construct after we obtain the related construction permit;

 

   

sub-high-rise apartment buildings, which are typically seven to 11 stories and normally require 12 to 18 months to construct after we obtain the related construction permit; and

 

   

high-rise apartment buildings, which are typically 12 to 33 stories and normally require 18 to 24 months to construct after we obtain the related construction permit.

Our projects are in one of the following three stages:

 

   

completed projects, comprising projects the construction of which has been completed;

 

   

properties under construction, comprising properties for which the construction permits have been obtained; and

 

   

properties under planning, comprising properties for which we have entered into land grant contracts and are in the process of obtaining the required permits to begin construction.

 

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Properties under Construction and Properties under Planning

The following table sets forth each of our properties currently under construction or planning as of December 31, 2009:

 

Project Name

   Location   

Type of
Products(1)

   Construction
Commencement
Date
   Pre-sale
Commencement
Date(2)
   Total
Site Area

(m2)
   Total
GFA

(m2)
   Total
Number
of
Units(4)
   Number
of Units
Sold
   GFA
Sold

Properties under construction

Jinan International City Garden

   Jinan    H/S    09/2007    11/2007    93,928    264,416    4,672    4,580    261,907

Suzhou International City Garden(3)

   Suzhou    H    02/2008    05/2008    119,089    205,161    2,436    846    69,822

Kunshan International City Garden

   Kunshan    M/H    07/2008    09/2008    200,008    497,076    5,103    2,520    226,569

Zhengzhou Xinyuan Colorful Garden

   Zhengzhou    M/H    03/2008    04/2008    74,462    191,786    2,233    1,776    144,850

Chengdu Xinyuan Splendid I

   Chengdu    H    11/2007    09/2008    34,007    230,893    4,069    1,967    134,080

Subtotal

               521,494    1,389,332    18,513    11,689    837,228

Properties under planning

Chengdu Xinyuan Splendid II

   Chengdu    H       —      30,497    219,481    2,782    —      —  

Zhengzhou Longhai Road Project

   Zhengzhou    M/H       —      60,556    255,147    2,562    —      —  

Zhengzhou Century East A

   Zhengzhou    M/H    —      —      22,418    78,422    TBD    —      —  

Zhengzhou Century East B

   Zhengzhou    M/H    —      —      51,372    179,723    TBD    —      —  

Zhengzhou Royal Palace

   Zhengzhou    M/H    —      —      45,716    137,081    TBD    —      —  

Xuzhou Xinyuan Colorful Garden

   Xuzhou    M/H    —      —      46,777    92,317    838    —      —  

Jinan Xinyuan Splendid

   Jinan    M/H    —      —      200,180    536,218    TBD    —      —  
                                    

Subtotal

               457,516    1,498,389    6,182      
                                    

Total

               979,010    2,887,721    24,695    11,689    837,228
                                    

 

(1) “M” refers to multi-layer buildings, “H” refers to high-rise buildings and “S” refers to sub-high-rise buildings.
(2) Pre-sale commencement dates refer to dates on which we began or expect to begin pre-sale activities after receiving the relevant pre-sale permits.
(3) Suzhou International City Garden was previously being developed under the name Suzhou Xinyuan Splendid.
(4) “TBD” refers to “to be determined.”

Properties under Construction

Jinan, Shandong Province

Jinan International City Garden. Jinan International City Garden is located on South Industrial Road of Hitech Industry Park in Jinan. Jinan International City Garden covers a site area of 93,928 square meters and has a total GFA of 264,416 square meters, of which 203,617 square meters are for high-rise buildings, 40,749 square meters are for sub-high-rise buildings, 9,672 square meters are for retail stores, and 10,378 square meters are for basements. We acquired the site in August 2007, commenced construction of this project in September 2007, and delivered it at January 2010. This project consists of 4,672 units. We started pre-sales in November 2007 and, as of December 31, 2009, we had sold 4,580 units with a total GFA of 261,907 square meters.

Suzhou, Jiangsu Province

Suzhou International City Garden. Suzhou International City Garden is located on Mayun Road of Hitech District in Suzhou. It covers a site area of 119,089 square meters, and is expected to have a total GFA of 205,161 square meters, 204,157 square meters of which are for high-rise buildings and 1,004 square meters are for retail stores. We acquired the site in September 2007, commenced construction of this project in February 2008, and expect to deliver it in 2011. This project, when completed, will consist of 2,436 units. We started pre-sales in May 2008 and, as of December 31, 2009, we had sold 846 units with a total GFA of 69,822 square meters.

 

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Kunshan, Jiangsu Province

Kunshan International City Garden. Kunshan International City Garden is located on Lucheng Road in Kunshan of Jiangsu Province. This project covers a site area of 200,008 square meters and has a total GFA of 497,076 square meters, of which 5,965 square meters are for multi-layer buildings, 481,228 square meters are for high-rise buildings and 9,883 square meters are for retail stores. We acquired the site in December 2007, commenced construction of this project in July 2008, and expect to deliver it in 2012. This project, when completed, will consist of 5,103 units. We started pre-sales in September 2008, and as of December 31, 2009, we had sold 2,520 units with a total GFA of 226,569 square meters.

Zhengzhou, Henan Province

Zhengzhou Xinyuan Colorful Garden. Zhengzhou Xinyuan Colorful Garden is located on Hezuo Road of Erqi District in Zhengzhou. It covers a site area of 74,462 square meters and has a total GFA of 191,786 square meters, of which 48,638 square meters are for multi-layer buildings, 139,564 square meters are for high-rise buildings and 3,584 square meters are for retail stores. We acquired this site in February 2008, commenced construction of this project in March 2008 and started to deliver it in December 2009. This project, when completed, will consist of 2,233 units. We started pre-sales in April 2008, and as of December 31, 2009, we had sold 1,776 units with a total GFA of 144,850 square meters.

Chengdu, Sichuan Province

Chengdu Xinyuan Splendid Phase I. Chengdu Xinyuan Splendid Phase I is located on Donghong Road of Jinjiang District in Chengdu. This project covers a site area of 34,007 square meters, and has a total GFA of 230,893 square meters, consisting of 9 high-rise buildings. We acquired the site in June 2007, commenced construction of this project in November 2007, and expect to deliver it in 2011. This project, when completed, will consist of 4,069 units. We started pre-sales activities in September 2008, and as of December 31, 2009, we had sold 1,967 units with a total GFA of 134,080 square meters.

Properties under Planning

Chengdu, Sichuan Province

Chengdu Xinyuan Splendid Phase II. Chengdu Xinyuan Splendid Phase II is located on Donghong Road of Jinjiang District in Chengdu, and is currently under planning. We acquired this site in June 2007 and commenced construction in October 2009. This project will cover an aggregate site area of 30,497 square meters, and is expected to have a total GFA of 219,481 square meters and consist of 2,782 residential units upon completion.

Zhengzhou, Henan Province

Zhengzhou Longhai Road Project. Zhengzhou Longhai Road Project is located on Longhai Road of Erqi District in Zhengzhou, and is currently under planning. It will cover a site area of 60,556 square meters and is expected to have a total GFA of 255,147 square meters. We acquired the site in September 2004 and commenced construction in January 2010. This project is expected to consist of residential 2,562 units when completed.

Zhengzhou Century East A. Zhengzhou Century East A is located on south to Yongping Road and west to Kangping Road in New-East-Zheng District in Zhengzhou, and is currently under planning. It will cover a site area of 22,418 square meters and is expected to have a total GFA of 78,422 square meters. We acquired the site in September 2009 and expect to commence construction in 2010.

Zhengzhou Century East B. Zhengzhou Century East B is located on west to Dongfeng road and north to Anping road in New-East-Zheng District in Zhengzhou, and is currently under planning. It will cover a site area of 51,372 square meters and is expected to have a total GFA of 179,723 square meters. We acquired the site in October 2009 and expect to commence construction in 2010.

Zhengzhou Royal Palace. Zhengzhou Century Royal Place is located on South to Nongke Road and East to Wenbo Road in Zhengzhou, and is currently under planning. It will cover a site area of 45,716 square meters and is expected to have a total GFA of 137,081 square meters. We acquired the site in December 2009 and expect to commence construction in 2010.

Xuzhou, Jiangsu Province

Xuzhou Xinyuan Colorful Garden. Xuzhou Xinyuan Colorful Garden is located on North of Quanshan District in Xuzhou, and is currently under planning. It will cover a site area of 46,777 square meters and is expected to have a total GFA of 92,317 square meters. We acquired the site in October 2009 and expect to commence construction in 2010. This project is expected to consist of residential 838 units when completed.

 

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Jinan, Shandong Province

Jinan Xinyuan Splendid. Jinan Xinyuan Splendid is located on west to Lishan road, south to Xiaoqinghe road in Jinan, and is currently under planning. It will cover a site area of 200,180 square meters and is expected to have a total GFA of 536,218 square meters. We acquired the site in October 2009 and expect to commence construction in 2010.

Completed Projects

The following table sets forth each of our completed projects as of December 31, 2009.

 

Project Name

   Location    Type of
Products
   Completion
Date
   Total
Site Area

(m2)
   Total GFA
(m2)
   Total
Number
of Units
   Number
of Units
Sold
   GFA
Sold

Zhengzhou Longhai Star Garden

   Zhengzhou    M/H/S    12/2000    11,719    39,975    239    210    34,924

Zhengzhou Xinyuan Splendid:

                       

Zhengzhou Xinyuan Splendid 1A

   Zhengzhou    M/S    07/2002    35,444    62,623    484    483    62,623

Zhengzhou Xinyuan Splendid 1B

   Zhengzhou    M    04/2004    21,800    43,673    333    333    43,673

Zhengzhou Xinyuan Splendid 2A

   Zhengzhou    M    04/2003    23,460    39,996    271    271    39,996

Zhengzhou Xinyuan Splendid 2B

   Zhengzhou    M    06/2004    19,295    27,041    86    86    27,041

Zhengzhou Xinyuan Splendid 2C

   Zhengzhou    S    04/2004    9,968    21,748    132    132    21,748

Zhengzhou Xinyuan Splendid 3A3B3C

   Zhengzhou    M/S    08/2005    51,014    114,774    792    792    114,774

Zhengzhou Xinyuan Splendid Haojinge

   Zhengzhou    H    11/2004    8,298    31,089    166    166    31,089

Zhengzhou Xinyuan Splendid City Homestead

   Zhengzhou    M    08/2005    23,606    45,378    369    369    45,378

Zhengzhou Xinyuan Splendid subtotal

            192,885    386,322    2,633    2,632    386,322

Zhengzhou City Manor

   Zhengzhou    M    03/2006    63,089    118,716    1,633    1,633    118,716

Zhengzhou City Family

   Zhengzhou    M    12/2006    21,380    39,226    720    720    39,226

Zhengzhou Central Garden—East

   Zhengzhou    M/H/S    09/2007    60,849    165,206    1,624    1,624    165,206

Zhengzhou Central Garden—West

   Zhengzhou    M/H/S    09/2007    79,464    190,384    1,796    1,796    190,384

Jinan City Family

   Jinan    M    11/2207    47,411    61,065    785    784    61,033

Suzhou Lake Splendid

   Suzhou    M/H/S    01/2009    130,945    196,920    2,315    2,307    196,060

Hefei Wangjiang Garden

   Hefei    M/H    04/2009    51,939    145,455    1,649    1,649    145,455

Suzhou Colorful Garden

   Suzhou    M/H    04/2009    41,365    80,474    967    942    78,984

Jinan Elegant Scenery

   Jinan    H/S    06/2009    61,502    100,217    1,127    1,126    100,181

Zhengzhou Commercial Plaza

   Zhengzhou    H    06/2009    8,410    67,172    916    912    66,130

Total

            770,958    1,591,132    16,404    16,335    1,582,621

Zhengzhou Central Garden (East and West). Zhengzhou Central Garden is located on Jinshui Road of Zhengdong District in Zhengzhou, near the central business district of Zhengzhou. The projects cover an aggregate area of 140,313 square meters and have an aggregate GFA of 355,590 square meters, of which 97,627 square meters are for multi layer buildings, 62,570 square meters are for sub-high-rise buildings, 181,789 square meters are for high-rise buildings and 13,604 square meters are for retail stores. The size of the units ranges from studios of approximately 39 square meters to luxury duplex units of approximately 175 square meters. We acquired the site in March 2005, commenced construction of Zhengzhou Central Garden (East) in November 2005, started pre-sales in December 2005 and delivered it in September 2007. We commenced construction of Zhengzhou Central Garden (West) in December 2005, started pre-sales in January 2006 and delivered it in September 2007. All of the 3,420 saleable units of the projects have been sold.

 

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Jinan City Family. Jinan City Family is located on Zhangzhuang Road of Huaiyin District in Jinan. Jinan City Family covers a site area of 47,411 square meters and has a total GFA of 61,065 square meters, of which 60,256 square meters are for multi-layer buildings and 809 square meters are for retail stores. We acquired the site in August 2006, commenced construction of this project in October 2006 and delivered it in November 2007. As of December 31, 2009, we had sold 784 units out of 785 saleable units.

Suzhou Lake Splendid. Suzhou Lake Splendid is located on Tongda Road of Wuzhong District in Suzhou. Suzhou Lake Splendid covers a site area of 130,945 square meters and has a total GFA of 196,920 square meters, of which 98,704 square meters are for multi-layer buildings, 58,449 square meters are for sub-high-rise buildings, 35,800 square meters are for high-rise buildings and 3,967 square meters are for retail stores. We acquired the site in January 2007, commenced construction of this project in March 2007, and delivered it in January 2009. As of December 31, 2009, we had sold 2,307 units out of 2,315 saleable units.

Hefei Wangjiang Garden. Hefei Wangjiang Garden is located at Wangjiang Road of Baohe District in Hefei. Hefei Wangjiang Garden covers a site area of 51,939 square meters and has a total GFA of 145,455 square meters, of which 9,436 square meters are for multi-layer buildings, 135,157 square meters are for high-rise buildings and 859 square meters are for retail stores. We acquired the site in February 2007, commenced construction of this project in May 2007 and delivered it in April 2009. As of December 31, 2009, all of the 1,649 saleable units were sold.

Suzhou Colorful Garden. Suzhou Colorful Garden is located on Xihuan Road of Jinchang District in Suzhou. This project covers a site area of 41,365 square meters and has a total GFA of 80,474 square meters, which consists of 33,231 square meters of multi-layer buildings, 45,801 square meters of high-rise buildings and 1,442 square meters of retail stores. We acquired the site in January 2007, commenced construction of this project in June 2007 and delivered it in April 2009. As of December 31, 2009, we had sold 942 units out of 967 saleable units.

Jinan Elegant Scenery. Jinan Elegant Scenery is located on Autoplant Road East of Tianqiao District in Jinan. Jinan Elegant Scenery covers a site area of 61,502 square meters and has a total GFA of 100,217 square meters, of which 78,862 square meters are for sub-high-rise buildings, 15,763 square meters are for high-rise buildings, 5,120 square meters are for retail stores and 472 square meters are for basements. We acquired the site in December 2006, commenced construction of this project in December 2006 and delivered it in June 2009. As of December 31, 2009, we had sold 1,126 units out of 1,127 saleable units.

Zhengzhou Commercial Plaza. Zhengzhou Commercial Plaza is located on Jingsan Road of Jinshui District in Zhengzhou. Zhengzhou Commercial Plaza covers a site area of 8,410 square meters and has a total GFA of 67,172 square meters. This project consists of two high-rise buildings. One building with a total GFA of 27,367 square meters is purely for residential use. The other with a total GFA of 39,806 square meters is for both residential and commercial use. We acquired this site in 2004, commenced construction of this project in November 2006 and delivered it in June 2009. As of December 31, 2009, we had sold 912 units out of 916 saleable units.

Cancelled Projects

Zhengzhou Xinyuan Huating. Zhengzhou Xinyuan Huating is located on Funiu Road of Zhongyuan District in Zhengzhou. This project was cancelled in the fourth quarter of 2008 due to failure to resolve inconsistent plot ratios provided by different government agencies. 73.8% of the total paid up land premium of US$15,963,565 was refunded in the first quarter of 2009; a full recovery of the land premium paid in 2007 and 2008 is expected.

Jiantou Xinyuan’s Projects

As of December 31, 2009, Jiantou Xinyuan completed four projects, one project was under construction and one project was under planning. In addition, Jiantou Xinyuan owns a 52% interest in a company that has one completed project. The six projects are all located in Zhengzhou, with a total GFA of 759,997 square meters. The following table sets forth detailed information for each project.

 

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Project Name

   Location    Type of
Products
   Construction
Commencement
Date
   Pre-sale
Commencement
Date
   Total Site
Area

(m2)
   Total
GFA

(m2)
   Total
Units
   Number of
Units
Sold
   GFA
Sold

Properties under construction

Zhengzhou Yipin Xiangshan Phase I

   Zhengzhou    M/S    04/2008    12/2009    57,289    93,944    979    562    39,318

Properties under planning

Zhengzhou Yipin Xiangshan Phase II

   Zhengzhou    M/S    —      —      81,145    194,177    —      —      —  

Completed Projects

Zhengzhou International City Garden Phase I

   Zhengzhou    M    03/2006    08/2007    64,370    107,439    1,560    1,560    —  

Zhengzhou International Plaza (1)

   Zhengzhou    H    03/2007    01/2009    10,095    41,115    505    505    —  

Zhengzhou City Mansion

   Zhengzhou    M/S    03/2007    05/2009    21,516    42,703    788    771    1,857

Zhengzhou International City Garden Phase II

   Zhengzhou    H    07/2007    08/2009    96,240    280,619    3,693    3,675    13,307
                                    

Total

               330,655    759,997    7,525    7,073    54,482
                                    

 

(1) Jiantou Xinyuan owns a 52% interest in the project company developing Zhengzhou International Plaza. The remaining 48% interest in that project company is owned by an independent third party.

We hold a 45% equity interest in Jiantou Xinyuan, with 50% held by Zhengzhou General Construction Investment Company and the remaining 5% held by Zhengzhou Jiantou Project Consulting Co., Ltd. Under the joint venture contract, we and the other partners agree to share the profits according to our respective equity interests in Jiantou Xinyuan. We and the other partners also extend loans to Jiantou Xinyuan at an interest rate comparable to bank lending rates for Jiantou Xinyuan’s property development operations. On September 25, 2009, we, through our indirect wholly owned subsidiary Henan Xinyuan, entered into an Equity Transfer and Profit Distribution Agreement, or ETA, with Zhengzhou General Construction Investment Co., Ltd. and Zhengzhou Jiantou Engineering Co., Ltd., or, collectively, the Sellers, to purchase from the Sellers their 55% equity interest in Jiantou Xinyuan, or the 55% Equity. The purchase price for the 55% Equity is US$4.2 million. As part of the transaction, Jiantou Xinyuan has made distributions of US$26.7 million to the Sellers and has declared distributions of US$21.8 million to Henan Xinyuan.

Pursuant to the ETA, the aggregate purchase price for the 55% Equity is approximately US$4.2 million in cash. As the Sellers are state-owned enterprises, our proposed acquisition of the 55% Equity is deemed a transfer of state-owned assets. Under PRC laws and regulations governing transfers of state-owned assets, state-owned assets, including state-owned equity interests, are required to be sold or disposed through a public listing and auction process, unless a proposed sale or disposition has been exempted by the relevant authority. Under the ETA, the Sellers are responsible for obtaining any governmental approvals necessary for the transfer, including, if available, an exemption from the public listing and auction process. The Sellers have not obtained the exemption from the Zhengzhou municipal administration of state-owned assets, or Zhengzhou SASAC, for our acquisition of the 55% Equity. Accordingly, we anticipate that the Sellers will be required to complete their sale of the 55% Equity through the public listing and auction process. Due to the mandatory procedures and the uncertainties involved in the listing and auction process as well as the governmental approvals required prior to the commencement of such process, we cannot predict the exact timing that would be required to complete the process or assure you that we will actually be selected as the winning bidder for the 55% Equity in the listing and auction process. Any closing of the proposed acquisition of the 55% Equity pursuant to the ETA will be subject to customary closing conditions, including, in the absence of an exemption of the public listing and auction process, our being selected as the successful bidder in the public listing and auction process.

Zhengzhou Yipin Xiangshan Phase I. Zhengzhou Yipin Xiangshan Phase I is located on Yingcai street of Huiji District in Zhengzhou. This project covers a site area of 57,289 square meters, and has a total GFA of 93,944 square meters, of which 26,855 square meters are for multi-layer buildings, 61,603 square meters are for sub-high-rise buildings and 5,486 square meters are for retail stores. Jiantou Xinyuan acquired the site in December 2007, commenced construction of this project in April 2008, and started delivery in December 2009. This project, when completed, will consist of 979 units. Jiantou Xinyuan started pre-sales activities in July 2008, and as of December 31, 2009, 562 units had been sold.

 

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Zhengzhou Yipin Xiangshan Phase II. Zhengzhou Yipin Xiangshan Phase II is located on Yingcai street of Huiji District in Zhengzhou. Jiantou Xinyuan acquired the site in April 2008. Commencement of construction is not yet scheduled. This project will cover a site area of 81,145 square meters, have a total GFA of 194,177 square meters.

Zhengzhou International City Garden (Phase I). Zhengzhou International City Garden (Phase I) is located on Mianfang Road of Erqi District in Zhengzhou. This project covers a site area of 64,370 square meters and has a total GFA of 107,439 square meters. It contains 23 multi-layer buildings. Jiantou Xinyuan acquired the site in December 2005, commenced construction of this project in March 2006 and delivered it in January 2007. Pre-sales started in April 2006 and, as of December 31, 2009, all 1,560 saleable units had been sold.

Zhengzhou International Plaza(Phase I). Zhengzhou International Plaza is located on Jianshe Road of Zhongyuan District in Zhengzhou. This project covers a site area of 10,095 square meters and is expected to have a total GFA of 41,115 square meters. It comprised of 31,377 square meters of high-rise buildings and 9,738 square meters of retail stores. Jiantou Xinyuan acquired the site in November 2006, commenced construction in March 2007 and delivered it in January 2009. Jiantou Xinyuan started pre-sales in July 2007 and, as of December 31 2009, all 505 saleable units had been sold.

Zhengzhou City Mansion. Zhengzhou City Mansion is located on Tongbai Road of Zhongyuan District in Zhengzhou. It covers a site area of 21,516 square meters and has a total GFA of 42,703 square meters, of which 12,280 square meters consist of multi-layer buildings, 18,248 square meters consist of sub-high-rise buildings, and 12,175 square meters consist of retail stores. Jiantou Xinyuan acquired the site in November 2006, commenced construction in March 2007 and delivered it in May 2009. Jiantou Xinyuan started pre-sales for this project in May 2007 and, as of December 31, 2009, 771 saleable units had been sold.

Zhengzhou International City Garden (Phase II). Zhengzhou International City Garden (Phase II) is located on Mianfang Road of Erqi District in Zhengzhou. It covers a site area of 96,240 square meters and has a total GFA of 280,619 square meters, containing 17 high-rise buildings of 257,939 square meters and 22,680 square meters of retail stores. Jiantou Xinyuan acquired the site in December 2005, commenced construction in July 2007 and started delivery in August 2009. This project, when completed, will have 3,693 units. Pre-sales started in February 2008 and, as of December 31, 2009, 3,675 saleable units had been sold with a total GFA of 280,619.

Our Property Development Operations

We have a systematic and standardized process to project development, which we implement through several well-defined phases. A significant portion of our process is dedicated to land acquisition, which is segmented into three stages: (i) opportunity identification, (ii) initial planning and budgeting and (iii) land acquisition. The following diagram sets forth the key stages of our property development process.

LOGO

Opportunity Identification

The first stage of our development process involves the identification of new opportunities for forthcoming land auctions in our selected Tier II cities around China. Our Land Development Department prepares a strategic plan that specifies our future project development plans and land acquisition requirements. They also conduct in-depth demographic and market research regarding our selected Tier II cities. We have formulated a set of criteria in selecting suitable Tier II cities to expand our operations based on certain indicators, including, among others:

 

   

population and urbanization growth rate;

 

   

general economic condition and growth rate;

 

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disposable income and purchasing power of resident consumers;

 

   

anticipated demand for private residential properties;

 

   

availability of future land supply and land prices;

 

   

governmental urban planning and development policies; and

 

   

overall competitive landscape.

Once a Tier II city has been identified as meeting our selection criteria, we research for forthcoming land auctions in the identified city and conduct preliminary analysis on whether a given auction opportunity will meet our project development plans, land acquisition requirements and pre-set investment return criteria. We also conduct in-depth demographic and market research regarding the specific region in which the land site is located.

Initial Planning and Budgeting

Once a forthcoming land auction has been identified, our Land Development Department will conduct a feasibility study based on our collected data as well as preliminary design and pre-planning of the proposed development project on the land site. We will also budget costs and financial requirements for the proposed project to identify whether the land site is suitable for our requirements.

The key factors we consider in land site selection are:

 

   

site area and suitability;

 

   

location within the city;

 

   

neighboring environment and amenities;

 

   

existing or planned infrastructure;

 

   

announced government planning for the vicinity; and

 

   

projected cost, investment and financial return ratios.

We evaluate projects through a rigorous planning and approval process. We consider detailed input from each of our Land Development Department, Budget-Planning-Design Department, Operations Department and Financial Department. The proposed project, once vetted and approved by various departments, will be submitted to our Chief Financial Officer and Chief Executive Officer and, thereafter, to a project committee established by our board of directors, for approval.

The flow of initial planning includes, among other things, strategic planning, market investigation and analysis, feasibility study, preliminary design, cost and profit projection and investment approval. In particular, our initial planning includes the engagement of external local design firms to draw up preliminary designs for our proposed projects. In addition, before making any decision to bid for land, we project the financial and cost control metrics for the proposed projects based on studies of market statistics and other relevant information, and select only those projects that satisfy pre-determined benchmarks.

Land Acquisition

Once we receive approval for a proposed project, we will proceed to bid for the land site. Although we acquire land for development primarily through the governmental auction process, if opportunities arise, we will also consider obtaining land use rights from third parties through negotiation, acquisition of entities, co-development or other joint venture arrangements.

As of December 31, 2009, we had a total GFA of 1,389,332 square meters for property projects under construction and a total GFA of 1,498,389 square meters for property projects under planning. We continually seek attractive opportunities to acquire development sites which meet our selection criteria.

Project Planning and Design

Our project planning and design process includes concept and architectural design, construction and engineering design, budgeting, financial analysis and projections as well as arranging for financing. We believe careful planning is essential to control costs, quality and timing of our projects.

We outsource our design work to reputable third-party design firms. Our planning and development team, with 75 employees as of December 31, 2009, works closely with project managers as well as our external designers and architects to ensure that our designs comply with PRC laws and regulations, and meet our design and other project objectives. Our senior management is also actively involved in the whole process, especially in the master planning and architectural design of our projects. We use our enterprise resource planning systems to conduct preliminary planning and scheduling for each stage of the development project, including planning our outsourcing requirements for the project construction stage.

 

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We seek to create a comfortable and convenient middle-class lifestyle concept in our projects by incorporating certain design features, such as landscaped environments. In determining the architectural designs of our projects, we consider the proposed type of products to be developed as well as the surrounding environment and neighborhood.

In selecting external design firms, we consider, among other things, their reputation for reliability and quality, their track record with us, the design proposed and the price quoted. Design firms can participate in the tender process by our invitation only. Our planning and design team monitors the progress and quality of the design firms to ensure that they meet our requirements.

We also begin arranging financing for a project at this stage. We typically finance our property developments through a combination of internal funds, pre-sale proceeds and bank loans. The loans are negotiated with the local branches of national commercial banks. A substantial majority of our bank loans are secured by our assets, including the land to be developed.

Project Construction and Management

We outsource substantially all of our construction work to independent construction companies which are selected through our invitation to tender bids for the project. We conduct a small portion of our construction work on our own, including fixture installation and gardening and landscaping. We provide landscaping and intercom systems installation services through our subsidiaries, Zhengzhou Mingyuan Landscape Engineering Co., Ltd. and Zhengzhou Xinyuan Computer Network Engineering Co., Ltd. We generally hire more than one contractor for each of our projects, with each contractor responsible for a designated portion of the project on a “turnkey” basis. We have established a selection procedure in order to ensure compliance with our quality and workmanship standards. We take into account the construction companies’ professional qualifications, reputation, track record, past cooperation with our project companies and financial condition and resources when inviting candidates to bid. We also review the qualifications and performance of our construction contractors on an annual basis. We closely supervise and manage the entire project construction process, utilizing our enterprise resource planning systems to monitor and analyze information regarding the process on a real-time basis. We collect information throughout the development cycle on the entire project, including information from our third-party contractors, to avoid unanticipated delays and cost overruns.

Our construction contracts typically provide for fixed or capped payments, subject to adjustments for some types of excess, such as design changes during construction or changes in government-suggested steel prices. The contractors are typically responsible for procuring the necessary raw materials, as well as providing engineering and construction services. We procure certain ancillary fixtures for installation, such as elevators, windows and entrance doors. For our purchases of such fixtures, we use a centralized procurement process to help increase our negotiating power and lower our unit costs. Our major suppliers are suppliers of power distribution boxes, elevators, plastic-steel windows, doors and heat sinks. We maintain good relationships with our suppliers and have not encountered any significant supply shortages or disruptions in the past.

Pre-Sales, Sales and Marketing

Like other developers, we pre-sell properties prior to the completion of their construction. Under PRC pre-sales regulations, property developers must satisfy specific conditions before they can pre-sell their properties under construction. These mandatory conditions include:

 

   

the land premium must have been paid in full;

 

   

the land use rights certificate, the construction site planning permit, the construction work planning permit and the construction permit must have been obtained;

 

   

at least 25% of the total project development cost must have been incurred;

 

   

the progress and the expected completion and delivery date of the construction must be fixed;

 

   

the pre-sale permit must have been obtained; and

 

   

certain milestones in the construction processes specified by the local government authorities must have been completed.

These mandatory conditions are designed to require a certain level of capital expenditure and substantial progress in project construction before the commencement of pre-sales. Generally, the local governments also require developers and property purchasers to use standard pre-sale contracts prepared under the auspices of the government. Developers are required to file all pre-sale contracts with local land bureaus and real estate administrations after entering into such contracts.

As of December 31, 2009, we maintain a marketing and sales force for our development projects with 60 personnel specializing in marketing and sales. We use outside sales agencies for all of our projects.

Our marketing and sales teams work closely with each other and with our external sales agents to survey the demographics for a particular project area to determine the appropriate advertising, promotion, and selling plans for that project. We develop customer awareness through our marketing and promotion efforts and through referrals from satisfied customers. A sales team at each project is responsible for following through on the entire sales process including setting monthly sales targets, controlling prices, implementing special promotions, monitoring external sales agency performance, and processing customer feedback.

 

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We utilize our customer relationship management system to track customer profiles and sales to forecast future individual requirements and general demand for our products. This allows us to have real-time information on the status of individual customer transactions and the availability of product types for each project, and to anticipate the product preferences of current and future customers.

We use various advertising media to market our property developments, including newspapers, magazines, television, radio, e-marketing and outdoor billboards. We also participate in real estate exhibitions to enhance our brand name and promote our property developments.

Most of our customers purchase our properties using mortgage financing. Under current PRC law, the minimum down payment is 30% of the total purchase price for the purchase of the first self-use residential unit with total GFA of 90 square meters or more on all existing units and those yet to be completed, and a down payment of 20% on the first residential units for self use with total GFA of under 90 square meters. The loan-to-value of the mortgage loan is also subject to change according to the economic policies of the central and local governments and banks in China.

A typical sales transaction in which a portion of the purchase price is financed by a mortgage loan consists of three steps. First, the customer pays a deposit to us. Within seven days after paying the deposit, the customer will sign a purchase contract with us and make down payment to us in cash. After making the down payment, the customer arranges for a mortgage loan for the balance of the purchase price. Once the loan is approved, the mortgage loan proceeds are paid to us directly by the bank. Finally, we deliver the property to the customer. Legal title, as evidenced by a property ownership certificate issued by local land and construction bureaus, may not pass for a period of six to twelve months following delivery and acceptance.

As is customary in the property industry in China, we provide guarantees to mortgagee banks in respect of the mortgage loans provided to the purchasers of our properties up until completion of the registration of the mortgage with the relevant mortgage registration authorities. Guarantees for mortgages on residential properties are typically discharged when the individual property ownership certificates are issued. In our experience, the issuance of the individual property ownership certificates typically takes six to twelve months, so our mortgage guarantees typically remain outstanding for up to twelve months after we deliver the underlying property.

If a purchaser defaults under the loan while our guarantee is in effect, and we repay all debt owed by the purchaser to the mortgagee bank, the mortgagee bank must assign its rights under the loan to us. We are entitled to full recourse to the property after the registration of the mortgage. In line with what we believe is industry practice, we do not conduct independent credit checks on our customers but rely on the credit checks conducted by the mortgagee banks. As of December 31, 2007, 2008 and 2009, we guaranteed mortgage loans in the aggregate outstanding amounts US$209.6 million, US$384.0 million and US$509.2 million, respectively.

After-sale Services and Delivery

We assist customers in arranging for and providing information relating to financing. We also assist our customers in various title registration procedures relating to their properties, and we have set up an ownership certificate team to assist purchasers to obtain their property ownership certificates. We offer various communication channels to customers to provide their feedback about our products or services. We also cooperate with property management companies that manage our properties and ancillary facilities, such as schools and clubhouses, to handle customer feedback.

We endeavor to deliver the units to our customers on a timely basis. We closely monitor the progress of construction of our property projects and conduct pre-delivery property inspections to ensure timely delivery. The time frame for delivery is set out in the sale and purchase agreements entered into with our customers, and we are subject to penalty payments to the purchasers for any delay in delivery caused by us. Once a property development has been completed, has passed the requisite government inspections and is ready for delivery, we will notify our customers and hand over keys and possession of the properties.

To ensure quality property management, we provide property management services to purchasers until they have become statutorily entitled to elect their own property management companies. As of the date of this annual report, owners of all of our developments who have become statutorily entitled to elect their property management companies have continued to choose us to manage their properties.

Our property management services include security, landscaping, building management and management of public facilities and equipment, and additional services, such as cultural activities, housekeeping and repair. We are currently managing approximately 3,000,000 square meters, comprising more than 30,000 residential units.

 

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Our Leased Properties and Real Estate Related Services

Ancillary to our property development operations, we also lease certain properties, including an elementary school, a basement, three clubhouses, five kindergartens and parking facilities. The rental income of our lease operations represented 0.1%, 0.1% and 0.1%, respectively, of our revenues for the years ended December 31, 2007, 2008 and 2009.

We also provide property management services and other real estate related services such as landscaping and installing intercom systems, through three of our subsidiaries, Henan Xinyuan Property Management Co., Ltd., Zhengzhou Mingyuan Landscape Engineering Co., Ltd. and Zhengzhou Xinyuan Computer Network Engineering Co., Ltd. Prior to 2009, we also provided real estate agency services through our subsidiary, Henan Xinyuan Real Estate Agency Co., Ltd., which we liquidated at the beginning of 2009. For the years ended December 31, 2007, 2008 and 2009, revenues from our real estate related services represented 1.2%, 1.1% and 1.6% of our total revenues for those periods, respectively.

Quality Control

We emphasize quality control to ensure that our buildings and residential units meet our standards and provide high quality service. We select only experienced design and construction companies. We provide customers with warranties covering the building structure and certain fittings and facilities of our property developments in accordance with the relevant regulations. To ensure construction quality, our construction contracts contain quality warranties and penalty provisions for poor work quality. In the event of delay or poor work quality, the contractor may be required to pay pre-agreed damages under our construction contracts. Our construction contracts do not allow our contractors to subcontract or transfer their contractual arrangements with us to third parties. We typically withhold 5% of the agreed construction fees for two to five years after completion of the construction as a deposit to guarantee quality, which provides us assurance for our contractors’ work quality.

Our contractors are also subject to our quality control procedures, including examination of materials and supplies, on-site inspection and production of progress reports. We require our contractors to comply with relevant PRC laws and regulations, as well as our own standards and specifications. Despite the “turnkey” nature of the construction contracts, we closely monitor the construction work for quality, timing and cost control reasons. Our project construction management team consists of 108 employees as of December 31, 2009, all of whom are professionally qualified civil engineers or surveyors and are responsible for supervising and managing the construction costs, construction schedule and quality of the construction work. We set up a profile for each and every unit constructed and monitor the quality of such unit throughout its construction period until its delivery. We also employ independent surveyors to supervise the construction progress. In addition, the construction of real estate projects is regularly inspected and supervised by PRC governmental authorities.

Competition

The real estate industry in China is highly competitive. In the Tier II cities we focus on, the markets are relatively more fragmented than Tier I cities. We compete primarily with local and regional property developers, but an increasing number of large national property developers have also started to enter these markets. Competitive factors include the geographical location of the projects, the types of products offered, brand recognition, price, design and quality. See “Item 3. Key Information—D. Risk Factors—Risk Relating to the Residential Property Industry in China—We face intense competition from other real estate developers.” In the Tier II cities in which we operate, our major competitors include China Overseas Property Ltd., China Vanke Co., Ltd., Sunshine 100, China Resources Land Limited, Henan Zhengshang Real Estate Co., Ltd., Henan New Greatwall Real Estate Co., Ltd. and Longhu Real Estate Co., Ltd.

Intellectual Property Rights

We rely on a combination of trademarks, service marks, domain name registrations, copyright protection and contractual restrictions to establish and protect our brand name and logos, marketing designs and internet domain names.

We have registered the trademark of “ LOGO ” and the associated logo for the real estate related service in the PRC. We have also applied the same trademark for other goods and services directly or indirectly related to our business operations, to strengthen the protection of our trademark and brand. All these trademark applications are pending examination and approval. We have also registered the Internet domain name “www.xyre.com” and other related domain names.

In the PRC, the registration and protection of a company’s corporate name is regional and limited to its related industry. Although we have registered our corporate name “Xinyuan” in the provinces where we operate, we cannot prevent others from registering the same corporate name in other provinces or in other industries. If a company first registers “Xinyuan” as its corporate name in a province other than Henan Province, Shandong Province, Jiangsu Province, Anhui Province and Sichuan Provinces or in another industry, we will have to adopt another corporate name if we plan to enter that market or industry.

 

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Insurance

We do not maintain insurance policies for properties that we have delivered to our customers, nor do we maintain insurance coverage against potential losses or damages with respect to our properties before their delivery to customers. In addition, our contractors typically do not maintain insurance coverage on our properties under construction. We believe that third-party contractors should bear liabilities from tortuous acts or other personal injuries on our project sites, and we do not maintain insurance coverage against such liabilities. There are certain types of losses, such as losses from natural disasters, terrorist attacks, construction delays and business interruptions, for which insurance is either not available or not available at a reasonable cost. We believe our practice is consistent with the customary industry practice in China.

Environmental Matters

As a developer of property in the PRC, we are subject to various environmental laws and regulations set by the PRC national, provincial and municipal governments. These include regulations on air pollution, noise emissions, as well as water and waste discharge. We in the past have never been required to pay any penalties associated with the breach of any such laws and regulations. Compliance with existing environmental laws and regulations has not had a material adverse effect on our financial condition and results of operations, and we do not believe it will have such an impact in the future.

Our projects are normally required to undergo an environmental impact assessment by government-appointed third parties, and a report of such assessment needs to be submitted to the relevant environmental authorities in order to obtain their approval before commencing construction. Upon completion of each project, the relevant environmental authorities inspect the site to ensure the applicable environmental standards have been complied with, and the resulting report is presented together with other specified documents to the relevant construction administration authorities for their approval and record. Approval from the environmental authorities of such report is required before we can deliver our completed work to our customers. In the past, we have not experienced any difficulties in obtaining those approvals for commencement of construction and delivery of completed projects. However, we cannot assure you that we will not experience any difficulties in the future. See “Item 4. Information on the Company—B. Business Overview—Regulation—Regulations on Environmental Protection in Construction Projects.”

Employees

As of December 31, 2009, we had 482 full time employees. The following table sets forth the number of our full time employees categorized by function as of the period indicated:

 

     As of
December 31,
2007
   As of
December 31,
2008
   As of
December 31,
2009

Management

   19    20    18

Finance

   69    78    70

Planning and development

   90    99    75

Project construction management

   155    161    108

Sales and marketing

   171    132    60

Property management

   32    57    53

Administrative and human resources

   89    90    90

Legal and audit

   8    8    8

Total

   633    645    482

During the year ended December 31, 2009, our subsidiary, Henan Xinyuan Property Management Co., Ltd., also hired approximately 1,213 temporary employees, most of whom provided security and housekeeping services relating to property management.

As required by PRC regulations, we participate in various employee benefit plans that are organized by municipal and provincial governments, including housing funds, pension, medical and unemployment benefit plans. We are required under PRC law to make contributions to the employee benefit plans at specified percentages of the salaries, bonuses and certain allowances of our employees, up to a maximum amount specified by the respective local government authorities where we operate our businesses from time to time. Members of the retirement plan are entitled to a pension equal to a fixed proportion of the salary prevailing at the member’s retirement date. The total amount of contributions we made to employee benefit plans for the years ended December 31, 2007, 2008 and 2009 was US$1,476,405, US$2,062,315 and US$935,791, respectively.

On August 11, 2007, we granted share options awards for an aggregate of 6,802,495 common shares to our directors, employees, consultants and employees of our equity investee. On November 5, 2007, we granted options for an aggregate of 2,441,844 common shares to our directors, management, key employees and employees of our equity investee. On July 1, 2008, we granted share option awards for an aggregate of 360,000 common shares to our employees. On March 31, 2009, we granted a share option award of 500,000 common shares to one employee. In August 2009, we granted a share option award of 100,000 common shares to one employee.

 

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We have entered into non-competition agreements with our management and key personnel, which prohibit them from engaging in any activities that compete with our business during, and for one or two years after, the period of their employment with our company. We have also entered into confidentiality agreements with all of our employees.

We offer training programs for our employees, third-party contractors and outsourced employees. We sponsor senior managers for executive MBA programs and other senior employees for part-time non-degree MBA courses at top universities in China. We also invite industry experts to give lectures to our employees and provide training to our third-party contractors.

We have not been subjected to any strikes or other labor disturbances that have interfered with our operations, and we believe that we have a good relationship with our employees. Our employees are not covered by any collective bargaining agreement.

Regulation

The PRC government regulates the real estate industry. This section summarizes the principal PRC regulations relating to our business.

We operate our business in China under a legal regime consisting of the National People’s Congress, State Council, which is the highest authority of the executive branch of the PRC central government, and several ministries and agencies under its authority, including the MOHURD, MLR, the MOFCOM, the NDRC, the SAIC, and the SAFE, and their respective authorized local counterparts.

Regulations on Land

The Law of the PRC on Land Administration, promulgated on June 25, 1986 and amended on August 28, 2004 by the Standing Committee of National People’s Congress, distinguishes between the ownership of land and the right to use land. All land in the PRC is either state-owned or collectively-owned, depending on location. Generally, land in urban areas within a city or town is state-owned, and all land in the rural areas of a city or town and all rural land, unless otherwise specified by law, are collectively-owned.

Although all land in the PRC is owned by the governments or by the collectives, private individuals and businesses are permitted to hold, lease and develop land for a specified term without ever owning the land, the duration of which depends on the use purpose of the land. These rights to use land are termed land use rights.

Under the Interim Regulations of the PRC on Grant and Transfer of the Right to Use State-owned Land in Urban Areas, promulgated on and effective as of May 19, 1990 by the State Council, enterprises, companies and other organizations who intend to hold, lease and develop the land, or Land Users, pay a premium to the government as consideration for the grant of the land use rights on terms of use prescribed by the government, and a Land User may transfer, lease and mortgage or otherwise commercially exploit the land use rights within such terms of use. The land administration authority enters into a contract with the Land User for grant of the land use rights. The Land User pays the grant premium as stipulated in the grant contract. After paying the grant premium in full, the Land User registers with the land administration authority and obtains a land use rights certificate. The certificate evidences the acquisition of the land use rights.

The Regulations on the Grant of State-Owned Construction Land Use Rights through Competitive Bidding, Auction and Listing-for-Sale (formerly known as the Regulation on the Grant of State-Owned Land Use Rights through Competitive Bidding, Auction and Listing-for-Sale ), promulgated by the MLR on May 9, 2002 and amended on September 21, 2007, provides that the land for industrial use (except for mining), commercial use, tourism, entertainment and commodity housing development is granted by way of competitive bidding, public auction or listing-for-sale. The land use rights are granted to the bidder with the highest bid/tender in accordance with the terms and conditions of the bid/tender, or to the bidder who can best fulfill the comprehensive evaluation standards of the bid. The successful bidder/tender will then enter into a grant contract with the local land administration authority. Only after the successful bidder/tender has paid the land premium in full under the land grant contract, can the successful bidder/tender apply for the land registration and obtain the land use right certificate.

Under the Urgent Notice of Further Strengthening the Administration of the Land, issued by the MLR on May 30, 2006, the land administration authority is required to rigidly implement the model contract of the state-owned land use rights grant contract and model contract of the state-owned land use rights grant supplementary agreement (for trial implementation) jointly promulgated by the MLR and the SAIC. The requirements of planning, construction and land use, such as the restriction of the dwelling size, plot ratio and the time limit for commencement and completion, should be ascertained and are generally agreed to in the land use rights grant contract.

 

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The Property Law of the PRC, promulgated on March 16, 2007 and effective as of October 1, 2007, further clarified land use rights in the PRC with the following rules:

 

   

the land use rights for residence will be automatically renewed upon expiry;

 

   

the car parks and garages within the building area planned for vehicle parks must be used to meet the needs of the owners who live in the building first;

 

   

the construction of buildings must abide by relevant laws and regulations with regard to the construction planning and may not affect the ventilation of or lighting to the neighboring buildings; and

 

   

where the land use rights for construction use are transferred, exchanged, used as a capital contribution, donated to others or mortgaged, an application for modification registration must be filed with the registration department.

Pursuant to the Notice on Further Strengthening the Administration of the Costs and Revenues Associated with Land Grant, jointly issued by the Ministry of Finance, the MLR, the PBOC, the Ministry of Supervision and the National Audit Office on November 18, 2009, all payments for land use rights paid for through installments must be made in full within 1 year. In certain circumstances the payment term may be extended to two years upon the approval of the competent authorities. In addition, the initial installment payment may not be less than 50% of the overall amount owed for the land use rights.

Local Regulations on Land

The Measures for Implementation of Land Administration Law of Henan Province, promulgated on September 24, 1999 and amended on November 26, 2004, provides that the entities obtaining state-owned land use rights by means of grant and other means of valuable consideration may use the land only after paying the required consideration, such as the grant premium, and other relevant fees.

The Land Administration Regulations of Jiangsu Province, promulgated on October 17, 2000 and amended on April 16, 2004, provides that the grant premium of state-owned land use rights must not be less than the lowest price fixed by the provincial government. The specific procedures and measures concerning the grant, bid invitation, auction and grant of state-owned land use rights are subject to the regulations of the provincial people’s government.

The Measures on the Grant of State-Owned Land Use Rights through Competitive Bidding, Auction and Listing-for-Sale of Jiangsu Province, promulgated on May 19, 2003 and effective as of July 1, 2003, provides that the land price for grant of state-owned land use rights by means of competitive bidding, auction and listing-for-sale will be fixed by the local land authority after an institution qualified for land valuation has carried out the valuation according to the technical guidelines issued by the central and provincial governments.

The Measures of Anhui Province for Implementation of the Land Administration Law, promulgated on December 20, 1987 and amended on June 26, 2004, provides that the grant, capital contribution, transfer and mortgage of state-owned land use rights involving land price valuation will be evaluated by an institution qualified for land valuation and report to the relevant land administration for filing.

Regulations on Establishment of a Real Estate Development Enterprise

Pursuant to the Law of the PRC on Administration of Urban Real Estate, or Urban Real Estate Law, promulgated by the Standing Committee of the National People’s Congress on July 5, 1994 and amended on August 30, 2007, a developer is defined as “an enterprise which engages in the development and sale of real estate for the purposes of making profits.”

Under the Regulations on Administration of Development of Urban Real Estate, or Development Regulation, promulgated by the State Council on and effective as of July 20, 1998, a real estate development enterprise must satisfy the following requirements:

 

   

has a registered capital of not less than RMB1 million; and

 

   

has four or more full time professional real estate/construction technicians and two or more full time accounting officers, each of whom must hold the relevant qualifications.

The Development Regulations also allow people’s governments of the provinces, autonomous regions and/or municipalities directly under the central government to impose more stringent requirements regarding the registered capital and qualifications of professional personnel of a real estate development enterprise according to the local circumstances.

To establish a real estate development enterprise, the developer is required to apply for registration with the department of administration of industry and commerce. The developer must also report its establishment to the real estate administration authority in the location of the registration authority within 30 days upon receipt of its business license.

 

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Xinyuan (China) Real Estate, Ltd., Henan Xinyuan Real Estate Co., Ltd., Suzhou Xinyuan Real Estate Development Co., Ltd., Henan Wanzhong Real Estate Co., Ltd., Shandong Xinyuan Real Estate Co., Ltd., Qingdao Xinyuan Real Estate Co., Ltd., Anhui Xinyuan Real Estate Co., Ltd., Xinyuan Real Estate (Chengdu) Co., Ltd., Zhengzhou Jiantou Xinyuan Real Estate Co., Ltd., Beijing Xinyuan Wanzhong Real Estate Co., Ltd., Kunshan Xinyuan Real Estate Co., Ltd., Henan Jiye Real Estate Co., Ltd. and Xuzhou Xinyuan Real Estate Co., Ltd. are registered as real estate development enterprises.

Local Regulations on Establishment of a Real Estate Development Enterprise

Under the Regulations on Administration of Development of Urban Real Estate of Henan Province promulgated on May 31, 2002 by the Standing Committee of Henan People’s Congress and amended on January 24, 2005, a real estate development enterprise must satisfy the following requirements:

 

   

has a registered capital of not less than RMB2 million; and

 

   

has five or more full time professional real estate/construction technicians and two or more full time accounting officers, each of whom must hold the required qualifications.

Regulations on Foreign Invested Real Estate Enterprise

Industrial Restriction

Under the Catalogue of Industries for Guiding Foreign Investment, promulgated on October 31, 2007 jointly by the MOFCOM and the NDRC and effective as of December 1, 2007, the development of a whole land lot which is to be operated only by sino-foreign equity joint ventures or co-operative joint ventures, the construction and operation of high-end hotels, villas, premium office buildings, international conference centers and large-scale scheme parks, and the real estate intermediary services and second transaction market fall within the category under which foreign investment is restricted. The construction and operation of golf courses falls within the category under which foreign investment is forbidden. The development and construction of ordinary residential properties was removed from the “encouraged” category of investments and, together with other types of real estate-related business, is not specifically mentioned in the catalogue. We have been advised by our PRC counsel that this means that they continue to be permitted by the MOFCOM and the NDRC.

Xinyuan (China) Real Estate, Ltd. is a wholly foreign owned enterprise and targets the development of ordinary residential properties in which foreign investment is permitted.

Circular No. 171

Considering the increasing foreign investment in the real estate industry in recent years, the MOHURD, the MOFCOM, the NDRC, the PBOC, the SAIC, and the SAFE jointly promulgated the Opinions on Regulating the Entry and Administration of Foreign Investment in the Real Estate Market, or Circular No. 171, on July 11, 2006, which may impact foreign investment in the real estate industry in the following areas:

 

   

Circular No. 171 requires a foreign invested real estate enterprise, or FIREE, with total investments equating to or exceeding US$10 million to have a registered capital consisting of no less than 50% of its total amount of investment. FIREEs with total investments below US$10 million must have a registered capital in amounts pursuant to and consistent with existing regulations.

The ratio of registered capital and total investment of Xinyuan (China) Real Estate, Ltd. meets such requirement.

 

   

Upon payment of the land use rights grant premium, the FIREE can apply to the land administration authority for a land use rights certificate. Upon obtaining the land use rights certificate, an FIREE may then obtain a recertification of its existing Foreign Invested Enterprises Approval Certificate, or FIEAC, and the Business License, with the same validity period as that of such land use rights certificate; following which, the FIREE may apply to the tax administration for tax registration purposes.

The valid terms on the FIEAC and Business License of Xinyuan (China) Real Estate, Ltd. are 10 years.

 

   

When a foreign investor merges with a domestic real estate enterprise, or acquires an FIREE’s equity or project, the investor is required to submit a guarantee which ensures the compliance with the provisions of the land use rights grant contract, construction site planning permit and construction work planning permit, and the land use rights certificate, and the modification certification issued by the construction authorities, and the tax payments certification issued by the relevant tax authorities.

 

   

foreign investors which merge with domestic real estate development enterprises by share transfers or other methods, or which acquire the equity of a PRC party in joint venture enterprises, must allocate their employees appropriately, deal with bank debts and settle the lump sum payment of the transfer price through self-owned funds. However, a foreign investor with an unfavorable record may not be allowed to conduct any of the aforesaid activities.

 

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FIREEs which have not paid up their registered capital fully, or have failed to obtain a land use rights certificate, or which have under 35% of the total capital required for the project, will not be allowed to obtain a loan in or outside China, and foreign exchange administration departments will not approve any settlement of foreign loans by such enterprises.

 

   

any sino or foreign investors in an FIREE may not guarantee fixed profit returns or provide other arrangements to the same effect for any party in any form.

Circular No. 50

On May 23, 2007, the MOFCOM and the SAFE issued the Notice on Further Strengthening and Standardizing the Approval and Administration of Foreign Direct Investments in Real Estate Enterprises, or Circular No. 50, which will have a significant impact on foreign investments in the PRC real estate sector. Some of the key developments in this area are as follows:

 

   

the local governments/authorities that approve FIREE establishments are now required to file such approvals with the MOFCOM;

 

   

prior to establishing a FIREE, foreign investors are required to obtain land use rights or the ownership of a real estate project, or the investor should have entered into an indicative land grant contract or indicative project purchase agreement with the land administrative department, developer of the land or owner of the property;

 

   

the practice of allowing foreign investors taking over local project companies by way of roundtrip investment is strictly controlled; and

 

   

a foreign invested enterprise that intends to engage in real estate development, or an existing FIREE which intends to undertake a new real estate development project, must first apply to the relevant authorities for such business scope and scale expansion in accordance with laws and regulations on foreign investments.

Circular No. 130

On July 10, 2007, the SAFE promulgated the Notice on Publicity of the List of the 1st Group of Foreign Invested Real Estate Projects Filed with the MOFCOM , which is a strict embodiment and application of Circular No. 50, under which some notices will have a significant impact on offshore financings of FIREEs. Some of the key developments in this area are as follows:

 

   

an FIREE which has obtained an FIEAC (including new establishment and registered capital increase) and filed with the MOFCOM after June 1, 2007 may not incur foreign debt or convert loans in foreign currency into RMB; and

 

   

an FIREE which obtains an FIEAC after June 1, 2007 but fails to file with the MOFCOM after June 1, 2007, may not conduct a foreign exchange registration nor a foreign exchange conversion of its registered capital.

Circular No. 23

Under the Circular on Properly Conducting Filing for the Record for Foreign Investment in the Real Property Sector, or Circular No. 23, promulgated by the MOFCOM on June 18, 2008 and effective as of July 1, 2008, the MOFCOM delegated to its provincial branches the review of filing records in relation to FIREE’s establishment, capital increase, equity transfer, merger and acquisition, etc. Under Circular No. 23, the local branches of the MOFCOM submit all the application documents that were previously required to be filed with the MOFCOM to the aforesaid provincial branches of the MOFCOM for review. Within five days of receipt of the MOFCOM’s request, the provincial branches of the MOFCOM that have reviewed such filings must submit all of the aforementioned materials to the MOFCOM.

Notwithstanding the above, Circular No. 23 does not de-regulate the Chinese real estate market. The previous material requirements for granting approval under Circular No. 171 and Circular No. 50 still apply.

Regulations on Qualifications of Developer

Under the Rules on the Administration of Qualifications of Real Estate Developers promulgated on March 29, 2000 by the MOHURD and effective as of March 29, 2000, a developer must apply for registration of its qualifications. An enterprise may not engage in the development and sale of real estate without a qualification classification certificate for real estate development.

In accordance with the above rules, developers are classified into four classes: class I, class II, class III and class IV. A developer that passes the qualification examination will be issued a qualification certificate of the relevant class by the relevant construction authority.

 

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A developer of any qualification classification may only engage in the development and sale of real estate within its approved scope of business and may not engage in business of another classification. A class I developer is not restricted as to the scale of the real estate projects to be developed and may undertake real estate development projects anywhere in the country. A developer of class II or lower may only undertake projects with a gross area of less than 250,000 square meters and the specific scope of business must be as confirmed by the local construction authority.

Under the Development Regulations, real estate administration authorities examine all applications for the registration of the qualifications of a developer when it reports its establishment, by considering its assets, professional personnel and business results. A developer may only undertake real estate development projects in compliance with the approved qualification registration.

After a newly established developer reports its establishment to the real estate administration authority, the latter will issue a temporary Qualification Certificate to the eligible developer within 30 days of its receipt of the above report. The developer must apply for the qualification classification by the real estate administration authority within one month before expiry of the temporary Qualification Certificate.

Local Regulations on Qualifications of Developer

The Regulations on Administration of Development of Urban Real Estate of Henan Province provides the following:

 

   

a class I developer is not restricted as to the scale of the real estate development projects it may undertake and may undertake real estate development projects anywhere in the PRC;

 

   

a class II developer may undertake projects with a gross area of less than 250,000 square meters;

 

   

a class III developer may undertake projects with a gross area of less than 100,000 square meters;

 

   

a class IV developer may undertake projects with a gross area of less than 30,000 square meters; and

 

   

a developer with temporary qualification may undertake relevant projects in accordance with its certificate.

The Rules on the Administration of Qualifications of Real Estate Developers of Shandong Province promulgated on March 8, 2005 provides the following:

 

   

a class I developer is not restricted as to the scale of the real estate development projects it may undertake and may undertake real estate development projects anywhere in the PRC;

 

   

a class II developer may undertake projects with a gross area of less than 250,000 square meters anywhere in the province;

 

   

a class III developer may undertake projects with a gross area of less than 150,000 square meters anywhere in the province;

 

   

a class IV developer may undertake projects with a gross area of less than 100,000 square meters in the city where it is located; and

 

   

a developer with temporary qualification may undertake relevant projects complying with its actual conditions such as registered capital and personnel in the city where it is located.

Henan Xinyuan Real Estate Co., Ltd. is classified as a class I developer. Xinyuan (China) Real Estate, Ltd. is classified as a class II developer. Shandong Xinyuan Real Estate Co., Ltd. and Xinyuan Real Estate (Chengdu) Co., Ltd. are classified as class III developers. The following companies i.e., Suzhou Xinyuan Real Estate Development Co., Ltd., Anhui Xinyuan Real Estate Co., Ltd., Kunshan Xinyuan Real Estate Co., Ltd. and Xuzhou Xinyuan Real Estate Co., Ltd., either hold a valid temporary qualification or are applying for a formal qualification or extension of the expired temporary qualification. In addition, Henan Jiye Real Estate Co., Ltd., a newly established company, is currently applying for a temporary qualification for the first time.

Regulations on Development of a Real Estate Project

Commencement of a Real Estate Project and the Idle Land

Under the Urban Real Estate Law, those who have obtained the land use rights through grant must develop the land in accordance with the terms of use and within the period of commencement prescribed in the contract for the land use rights grant.

According to the Measures on Disposing Idle Land promulgated by the MLR and enforced on effective as of April 28, 1999, with regards to the land for a real estate project which is obtained by grant and is within the scope of city planning, if the construction work has not been commenced within one year upon the commencement date as set forth in the land use rights grant contract, a surcharge on idle land equivalent to less than 20% of the grant premium may be levied; if the construction work has not been commenced within two years, the land can be confiscated without any compensation, unless the delay is caused by force majeure, or the acts of government or acts of other relevant departments under the government, or by indispensable preliminary work.

 

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Planning of a Real Estate Project

The Law of the PRC on Urban and Rural Planning, promulgated by the National People’s Congress on October 28, 2007 and effective as of January 1, 2008, replacing the previous City Planning Law of the PRC, provides that a developer who has obtained land use rights by grant must, after obtaining approval for a construction project and signing a land use rights grant contract, apply to the city planning authority for the Permit for Construction Site Planning

It further provides that a developer who has a proposed construction project within the planning area of a city or town must, after obtaining a Permit for Construction Site Planning, prepare the necessary planning and design work, and submit the detailed planning and design report, together with the land use rights certificate, to the city planning authority or the town government designated by the provincial government, and apply for the Permit for Construction Work Planning.

Relocation

Under Regulations of Administration on City Housing Demolition promulgated by the State Council on June 13, 2001 and effective as of November 1, 2001, upon obtaining approvals for a construction project, a permit for construction site planning, state-owned land use rights and a verification of deposit to compensate parties that are affected by the relocation payable by the developer by a bank, a developer may apply to the local real estate administration authorities where the real estate is located for a permit for housing demolition and removal.

Upon granting a demolition and removal permit, the real estate administration department must issue a demolition and removal notice to the inhabitants of the area.

Construction of a Real Estate Project

According to the Measures for the Administration of Construction Permits for Construction Projects promulgated by the MOHURD on October 15, 1999 and amended and effective as of July 4, 2001, after obtaining the Permit for Construction Work Planning, a developer must apply for a Construction Permit from the relevant construction authority.

Completion of a Real Estate Project

According to the Development Regulations and the Interim Provisions on the Acceptance Examination Upon the Completion of Construction Work and Municipal Infrastructure promulgated on June 30, 2000 by the MOHURD and effective as of June 30, 2000, and the Interim Measures for Reporting Details Regarding Acceptance Examination Upon Completion of Construction Work and Municipal Infrastructure promulgated on April 7, 2000 by the MOHURD and effective as of April 7, 2000, a real estate project must comply with the relevant laws and other regulations, requirements on construction quality, safety standards and technical guidance on survey, design and construction work, as well as provisions of the relevant construction contract. After the completion of works for a project, the developer must apply for an acceptance examination to the construction authority and must also report details of the acceptance examination to the construction authority. A real estate development project may only be delivered after passing the acceptance examination.

Regulations on Sale of Commodity Properties

Under the Measures for Administration of Sale of Commodity Properties promulgated by the MOHURD on April 2001, the sale of commodity properties can include both pre-completion and post-completion sales.

Pre-completion Sales

In accordance with the Measures for the Administration of Pre-completion Sale of Commodity Properties, or Pre-completion Sale Measure, promulgated in November 1994 by the MOHURD and amended on July 20, 2004, a developer intending to sell a commodity building before its construction work’s completion must attend to the necessary pre-completion sale registration with the real estate administration authority of the relevant city or county to obtain a Permit for Pre-completion Sale of Commodity Properties.

Commodity properties may only be sold before completion if:

 

   

the grant land premium has been paid in full for the grant of the land use rights involved and a land use rights certificate has been obtained;

 

   

a permit for construction work planning and a construction permit have been obtained;

 

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the funds invested in the development of the commodity properties put up for pre-completion sale represent 25% or more of the total investment in the project and the progress of works and the completion and delivery dates have been ascertained; and

 

   

the pre-completion sale has been registered and a permit for pre-completion sale of commodity properties has been obtained.

The Regulations on Administration of Development of Urban Real Estate of Henan Province also provides that commodity properties may only be sold before completion provided that half or more of the project has been completed and the construction schedule and delivery date has been specified in addition to compliance with the requirements under the Pre-completion Sale Measures.

The Regulations on Administration of Transfer of Urban Real Estate of Jiangsu Province promulgated on February 5, 2002 and amended on August 20, 2004 also provides that commodity properties may only be sold before completion in accordance with the requirements under the Pre-completion Sale Measures.

The Regulations on Administration on Urban Real Estate Transaction of Anhui Province, promulgated on May 29, 2000 and effective as of December 1, 2000, provides that the development enterprises which have obtained a permit for pre-completion sale of commodity properties must file with the real estate administrative authority of the relevant city or county pre-sale contracts entered into with customers.

Management of Proceeds from Pre-sales of Properties

The Pre-completion Sale Measures also provide that the proceeds obtained by a real estate developer from the advance sale of commodity properties must be used for the construction of the relevant projects. The specific measures for the supervision of proceeds from the pre-sale of commodity properties are formulated by the real estate administration authorities.

Under the Implementing Regulations on Supervision of Proceeds from Pre-sales of Commodity Properties of Jinan City, promulgated by Jinan Committee of Construction on September 26, 2005 and effective as of October 26, 2005, the proceeds from pre-sales of properties must be used in the construction of pre-sale projects, including the purchase of construction materials and equipments, remittance of construction fees and taxes payable, and should not be used for other purposes.

In accordance with the Implementing Opinions on Strengthening the Management of Pre-sale of Urban Commodity Properties, promulgated by the People’s Government of Sichuan Province on March 23, 2000, the proceeds from pre-sales of properties must be deposited in a special bank account opened by the developers, may only be used for the relevant construction work and may not be used for other purposes. The relevant banks monitor the use of the proceeds of pre-sales and ensure that the proceeds are used in the designated way.

Pursuant to the Regulations on Supervision of Proceeds from the Pre-sales of Commodity Properties in Zhengzhou, promulgated by the Zhengzhou People’s Government on November 20, 2009 and effective as of December 20, 2009, the proceeds from the pre-sales of properties must be used for the construction of the same, which includes the purchase of construction materials and equipment, remittance of fees for construction and taxes payable.

Post-completion Sales

In accordance with the Measures for Administration of Sale of Commodity Properties promulgated by the MOHURD on April 4, 2001, commodity properties may be put up for post-completion sale only when the following preconditions for such sale have been satisfied:

 

   

the developer offering to sell the post-completion properties has a valid business license and a qualification classification certificate;

 

   

the developer has obtained a land use rights certificate or other approval documents of land use;

 

   

the developer has the relevant permit for construction project planning and the permit for construction;

 

   

the commodity properties have been completed, inspected and accepted as qualified;

 

   

the relocation of the original residents has been settled;

 

   

the supplementary and essential facilities for supplying water, electricity, heating, gas, communication, etc. have been made ready for use, and other supplementary facilities and public facilities have been made ready for use, or the schedule of construction and delivery date of such facilities have been specified; and

 

   

the property management plan has been completed.

 

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Prior to a post-completion sale of a commodity property, a real estate developer is required to submit the Real Estate Development Project Manual and other documents showing that the preconditions for a post-completion sale have been fulfilled to the real estate development authority.

Regulations on Property Ownership Certificates

Under the Sale Measures, the developers must submit the documents relating to the application for property ownership certificates to the local real estate administration authorities within 60 days after the delivery of the property to customers. The developers are required to assist customers in applying for amendments in the procedures for land use rights and registration procedures for property ownership.

In accordance with the Pre-completion Sale Measures, the purchasers must apply for property ownership certificates to the local real estate administration authorities within 90 days after the delivery of pre-sale property to purchasers. The developers are required to assist and provide the purchasers with necessary verifying documents. Where the purchasers fail to obtain the property ownership certificates within 90 days thereafter due to the developer’s fault, unless otherwise provided between the developers and the purchasers, the developers will be liable for the breach of contract.

Regulations on Transfer, Mortgage and Lease

Transfer

According to the Urban Real Estate Law and the Provisions on Administration of Transfer of Urban Real Estate promulgated on August 7, 1995 by the MOHURD and amended on August 15, 2001, a real estate owner may sell, bequeath or otherwise legally transfer real estate to another person or legal entity. When transferring a building, the ownership of the building and the land use rights to the site on which the building is situated are transferred as well.

The parties to a transfer must enter into a real estate transfer contract in writing and register the transfer with the real estate administration authority having jurisdiction over the location of the real estate within 90 days of the execution of the transfer contract.

Where the land use rights were originally obtained by grant, the real property may only be transferred if:

 

   

the grant premium has been paid in full for the grant of the land use rights as provided by the grant contract and a land use rights certificate has been obtained; and

 

   

the development has been carried out according to the grant contract: in the case of a project for which buildings are developed, development representing more than 25% of the total investment has been completed; in the case of a whole land lot development project, construction works have been carried out as planned, water supply, sewerage, electricity supply, heat supply, access roads, telecommunications and other infrastructure or utilities have been made available, and the site has been leveled and made ready for industrial or other construction purposes.

Mortgages of Real Estate

Under the Urban Real Estate Law and the Security Law of the PRC promulgated by the Standing Committee of the National People’s Congress on June 30, 1995 and effective as of October 1, 1995, and the Measures on the Administration of Mortgage of Buildings in Urban Areas promulgated by the MOHURD in May 1997 and amended on August 15, 2001, when a mortgage is created on the ownership of a building on state-owned land legally obtained, a mortgage will be simultaneously created on the land use rights of the land on which the building is erected. Land use rights occupied by the properties will also be mortgaged at the same time. The mortgager and the mortgagee sign a mortgage contract in writing. Within 30 days after a real estate mortgage contract has been signed, the parties to the mortgage must register the mortgage with the real estate administration authority in the city where the real estate is situated. A real estate mortgage contract will become effective on the date of registration of the mortgage. If a mortgage is created on the property placed on pre-sale or which is still undergoing construction, the registration authority will, when registering the mortgage, record such details on the mortgage contract. If the construction of the property is completed during the term of a mortgage, the parties involved will have to re-register the mortgage after the issuance of the relevant certificates evidencing the rights and ownership to the real estate.

Lease

Under the Urban Real Estate Law and the Measures for Administration of Leases of Buildings in Urban Areas promulgated by the MOHURD on April 28, 1995 and effective as of June 1, 1995, the parties to a lease of a building are required to enter into a lease contract in writing. When a lease contract is signed, amended or terminated, the parties must register the details with the real estate administration authority in which the building is situated.

 

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Regulations on Real Estate Financing

Under the Notice of the People’s Bank of China on Regulating Home Financing Business promulgated by the PBOC on June 19, 2001, all banks must comply with the following requirements prior to granting residential property loans, individual home mortgage loans and individual commercial flat loans:

 

   

Housing development loans from banks may only be granted to real estate development enterprises with approved development qualifications and high credit ratings. Such loans will be offered to residential projects with good market potential. The borrowing enterprise must provide capital of no less than 30% of the total investment required of the project, and the project itself must have been issued with a land use rights certificate, a permit for construction site planning, a permit for construction work planning and a construction permit.

 

   

In respect of the grant of individual commercial flat loans, the mortgage ratio for such application may not exceed 60%, with a maximum loan period of 10 years and on the condition that the subject commercial properties have already been completed.

The Circular on Further Strengthening the Management of Loans for Property Business, promulgated on June 5, 2003 by the PBOC, specifies that commercial banks may not grant loans to property developers for the purposes of paying for the land premium.

The Guidance on Risk Management of Property Loans of Commercial Banks, issued by China Banking Regulatory Commission on September 2, 2004, provides that any developer applying for real estate development loans must have at least 35% of the capital funds required for the development.

The Opinion of MOHURD and Other Departments on Adjusting the Housing Supply Structure and Stabilizing the Property Prices, issued on May 24, 2006 by the State Council, provides that:

 

   

to tighten the control of advancing loan facilities, commercial banks are not allowed to advance their loan facilities to developers who do not have the required 35% or more of the total capital for the construction projects. The commercial banks should be prudent in granting loan facilities and/or revolving credit facilities in any form to the developers who have a large number of idle land parcels and unsold commodity properties. Banks may not accept mortgages of commodity properties remaining unsold for more than three years;

 

   

from June 1, 2006 onward, purchasers are required to pay a minimum of 30% of the purchase price as down payment for self-use purposes. However, if purchasers purchase apartments with a floor area of less than 90 square meters for self-use, the existing requirement of 20% of the purchase price as down payment remains unchanged.

The Circular on Strengthening the Management of Commercial Real Estate Credit Facilities, issued on September 27, 2007 by the PBOC and China Banking Regulatory Commission, as supplemented on December 5, 2007, provides that:

 

   

the minimum down payment for any purchase of first self-use residential property with a unit GFA of less than 90 square meters is 20% of the purchase price of the property. The minimum down payment for any purchase of first self-use residential property with a unit GFA of 90 square meters or more is 30% of the purchase price of the property.

 

   

the minimum down payment for any purchase of second or subsequent residential property is 40% of the purchase price, if the purchaser had obtained a bank loan for the purchase of his or her first property, and the interest rate for bank loans of such purchase shall not be less than 110% of the PBOC benchmark rate of the same period and category. For further purchases of properties, there would be upward adjustments on the minimum down payment and interest rate for bank loan.

 

   

the minimum down payment for any purchase of a commercial property is 50% of the purchase price, and the interest rate for bank loans of such purchase may not be less than 110% of the PBOC benchmark rate, for a term of no more than 10 years.

 

   

if a family member (including the purchaser and his / her spouse and their children under 18) has financed the purchase of a residential property with bank loans from banks, any member of the family that purchases another residential property will be regarded as a second-time property purchaser.

 

   

commercial banks are allowed to set forth specific implementing rules for themselves in accordance with the provisions of this circular.

On October 22, 2008, the PBOC issued the Circular on Further Decreasing the Loan Interest Rate for Non-Welfare Residential Property and Other Relevant Issues. This provides that, as of October 27, 2008, the lowest applicable loan interest rate for non-welfare residential property is reduced to 70% of the benchmark interest rate and the lowest applicable down payment ratio for such property is reduced to 20% of the total purchase price. Financial institutions must determine the applicable loan interest rate and down payment ratio for non-welfare residential property in accordance with the following factors: (i) whether the borrower is purchasing a property for the first time; (ii) whether the borrower is purchasing the property for his own use; (iii) whether the property purchased is an ordinary residential property; and (iv) risk factors including the borrower’s credit records and payment ability.

 

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On October 22, 2008, the Ministry of Finance and the State Administration for Taxation jointly issued the Circular on the Adjustment of Property Transaction Tax. This provides that, from November 1, 2008:

 

   

the deed tax imposed on individuals who are purchasing ordinary residential properties for the first time will be decreased to 1% of the purchase price, provided that the unit GFA of the property is no more than 90 square meters;

 

   

individuals who are purchasing or selling ordinary residential properties will be exempt from stamp tax; and

 

   

individuals who are selling ordinary residential properties will be exempt from land appreciation tax.

On December 20, 2008, the General Office of the State Council issued Several Opinions on Promoting the Sound Development of the Real Estate Market, or Opinions No. 131, which took effect on the same date. In order to boost real estate sales, Opinions No. 131 provides preferential support in relation to loan interest and down payment ratios for certain residents purchasing a second property for the purpose of improving their living conditions. Under Opinions No. 131, when purchasing a second property to improve their living conditions, residents who have already purchased, with mortgages, an “ordinary property for self-use” that is smaller than the average size in their locality, may enjoy the preferential loan interest and down payment ratio available to first-time purchasers of residential property.

The Circular on Amending the Business Tax Policy for Individuals Transferring Property, issued on December 22, 2009 by the Ministry of Finance and the State Administration for Taxation, provides that:

 

   

from January 1, 2010, individuals who sell non-ordinary residential properties that they had bought in the past five years will be liable for business tax;

 

   

individuals who sell non-ordinary residential properties they had bought five or more years ago or sell ordinary houses they had bought in the past five years will be liable for business tax on the revenue from the sale, minus the original purchase price; and

 

   

individuals who sell ordinary residential properties they had bought five or more years ago will be exempt from business tax.

On January 7, 2010, the General Office of the State Council issued the Notice on Promoting the Sound Development of the Real Estate Market, which took effect on the same date. This notice stipulates that the purchasers of a second residential property for their households must make down payment of no less than 40% of the purchasing price and real estate developers must commence the sale within the mandated period as set forth in the pre-sale approvals and at the publicly announced prices.

The Circular of the State Council on Adjusting the Proportions of Capital Funds in Fixed Asset Investment Projects, issued on May 25, 2009, provides that:

 

   

in respect of welfare property and ordinary non-welfare residential property development projects, the minimum proportion of capital funds is 20% of the total investment required for such projects and for any other property development projects the minimum proportion of capital funds is 30%;

 

   

prior to construction, financing institutions will thoroughly examine and assess the capital funds held by developers, the possible outcome of the investment, and the potential risks of the loan and then determine the grant and loan amount with reference to the aforesaid minimum proportions of capital funds.

Regulations on Housing Supply and Improving the Healthy Development of the Real Estate Market

The Opinion of the MOHURD and Other Departments on Adjusting the Housing Supply Structure and Stabilizing Property Prices provides the following:

 

   

as of June 1, 2006, at least 70% of approved areas for property development must be used for the development of apartments measuring less than 90 square meters;

 

   

commercial banks must not grant loans to any developer whose total investment capital contributed is less than 35% and must not accept any premises that have been left vacant for more than three years as security;

 

   

land that has been left idle for two years or more will be repossessed by the government without any compensation payment to the developer. Also, land will be treated as being left idle if construction has been halted for more than one year and the total area developed is less than one-third of the whole project area or the capital invested is less than a quarter of the total investment;

 

   

there will be no supply of land for villas and other equivalent real estate development projects, while land allocation for low-density, large housing developments will remain tight; and

 

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no planning permit, construction permit or premises pre-sale permit is to be issued for projects that do not comply with the abovementioned requirements, in particular composite structure projects that exceed planning requirements.

The Notice on Increasing the Supply of, and Strengthening the Supervision over, Land for Real Estate Development Purposes issued on March 8, 2010 by the MLR, provides that:

 

   

the floor price of a parcel of land must not be lower than 70% of the benchmark land price set for the area in which the parcel is located;

 

   

real estate developers participating in land auctions must pay a deposit equivalent to 20% of the land parcel’s floor price; and

 

   

real estate developers must report to the competent land authorities when they commence and complete the construction of each project, and the land authorities will conduct inspections according to the corresponding land grant contract.

This notice also reiterated the policy that the initial installment payment made by real estate developers for a parcel of land must not be less than 50% of the overall amount owed for the land use rights.

Regulations on Environmental Protection in Construction Projects

Under the Regulations on the Administration of Environmental Protection in Construction Projects, or Environmental Regulations, promulgated by the State Council on November 29, 1998 and effective as of the same date, each construction project is subject to an environmental impact assessment by the relevant authorities.

According to the Environmental Regulations, a developer is required to submit an environmental impact report, or an environmental impact report form, or an environmental impact registration form (as the case may be) to the relevant environmental protection administration for approval during the project’s feasibility analysis stage. In the meantime, if any ancillary environmental protection facilities are necessary in the construction project, such facilities are required to be designed, constructed and used in conjunction with the main project. After completion of the project, the developers are required to apply to the relevant environmental protection administrations for final acceptance examination in respect of any ancillary environmental protection facilities. Construction projects are approved for use after passing the said acceptance examination.

The Environmental Impact Assessment Law, promulgated by the National People’s Congress on October 28, 2002 and effective as of September 1, 2003, provides that if the environmental impact assessment documents of a construction project have not been examined by the relevant environmental protection administrations or are not approved after examination, the authority in charge of examination and approval of the project may not approve construction on the project, and the construction work unit may not commence work.

On July 6, 2006, the State Environmental Protection Administration issued its Circular on Strengthening the Environmental Protection Examination and Approval and Strictly Controlling New Construction Project, which provides for stringent examination and approval procedures for various real estate development projects. It also stipulates that no approvals may be issued for new residential projects or extensions in industry development zones, areas impacted by industrial enterprises or areas where such development poses potential harm to residents’ health.

Regulations on Property Management

The Property Management Rules, amended by the State Council on August 26, 2007 and effective as of October 1, 2007, provide that property owners have the right to appoint and dismiss property service enterprises (formerly known as property management enterprises). The rules also establish a regulatory system for property service enterprises, which encompasses the following regulations:

 

   

the Measures for the Administration of Qualifications of Property Service Enterprises (formerly known as the Measures for the Administration of Qualifications of Property Management Enterprises) amended by the MOHURD and effective as of November 26, 2007, provide that property service enterprises must apply to the local branch of the MOHURD and undertake a qualification examination to obtain a Property Service Qualification Certificate. A property service enterprise must pass the Property Service Qualification (formerly known as the Property Management Qualification), or PSQ examination, in order to engage in property management. Property service enterprises are classified as Class I, II or III. Different classes of service enterprises have different establishment requirements and may manage different types of premises.

 

   

the Provisional Measures on the Administration of Initial Property Management Bid-inviting and Bidding, promulgated on June 26, 2003 by the MOHURD, provide that prior to the selection of the Property Owners’ Committee, or the POC, the property developer will select a property management enterprise to provide property management services.

 

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the NDRC and the MOHURD jointly promulgated the Rules on Property Management Service Fees on November 13, 2003, which provide that property management fees will be determined by mutual consent between the POC and the property management enterprise, and set forth in writing in the property management service contract.

Henan Xinyuan Property Management Co., Ltd. is a Class I property management company.

Regulations on Urban Landscaping Services

The Regulations Regarding Urban Landscape promulgated on June 22, 1992 by the State Council and the Measures on Administration of Qualifications of Urban Landscaping Enterprises promulgated on July 4, 1995 provide the following:

 

   

any enterprise that wishes to provide landscaping services must apply to the MOHURD’s local branch for an urban landscaping qualification, or ULQ, certificate; and

 

   

if a landscaping enterprise wishes to provide landscaping service outside the province where it is registered, it must establish branches in such locales and submit its original ULQ certificate for filing with the MOHURD’s respective local branch.

Local Regulations on Urban Landscaping Services

On August 7, 2006, the Construction Bureau of Henan promulgated the Implementation Measures on the Administration of Qualifications of Urban Landscaping Enterprise in Henan. These measures require a newly-established landscaping enterprise to apply to the local construction administration for a temporary Class III qualification. The requirements for a temporary Class III qualification are the same as for a Class III qualification (except no requirement for experience). A temporary Class III qualification is valid for two years, after which, the local construction administration authority will issue a Class III qualification if the enterprise successfully passes an examination. Otherwise, the local construction administration authority will extend the temporary qualification term or withdraw the temporary Class III qualification. A ULQ certificate is subject to an annual inspection by the local construction administration authorities.

Zhengzhou Mingyuan Landscape Engineering Co., Ltd. is a Class III urban landscaping service company. Its qualification will expire in May 2013.

C. Organizational Structure

The following diagram illustrates our corporate structure as of March 2010.

LOGO

 

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(1) The other shareholders of Zhengzhou Jiantou Xinyuan Real Estate Co., Ltd. are Zhengzhou General Construction Investment Company (50%) and Zhengzhou Jiantou Project Consulting Co., Ltd. (5%).

D. Property, plant and equipment

Our headquarters are located in Beijing China, where we lease approximately 2,390 square meters of office space. We also lease a total of approximately 5,400 square meters of office space in other cities where our subsidiaries are located, which includes approximately 300 square meters in Chengdu, Sichuan Province, 144 square meters in Hefei, Anhui Province, 1,044 square meters in Jinan, Shandong Province, 562 square meters in Suzhou, Jiangsu Province, 1,270 square meters in Kunshan, Jiangsu Province, 581 square meters in Xuzhou, Jiansu Province and 1,497 square meters in Zhengzhou, Henan Province.

 

ITEM 4A. UNRESOLVED STAFF COMMENTS

None.

 

ITEM 5. OPERATING AND FINANCIAL REVIEW AND PROSPECTS

You should read the following discussion and analysis of our financial condition and results of operations in conjunction with our consolidated financial statements and the related notes included elsewhere in this annual report on Form 20-F. This discussion may contain forward-looking statements based upon current expectations that involve risks and uncertainties. Our actual results may differ materially from those anticipated in these forward-looking statements as a result of various factors, including those set forth under “Item 3. Key Information—D. Risk Factors” or in other parts of this annual report on Form 20-F.

A. Operating Results

Overview

Since our inception in 1997, we have completed nineteen projects with total GFA of 1,591,132 square meters. Since 2006, we have expanded our operations outside of Zhengzhou and we are currently developing and planning projects in seven Tier II cities. As of December 31, 2009, we had twelve projects in six cities with estimated total GFA of 2,887,172 square meters under construction and planning, of which five projects with estimated total GFA of 1,389,332 square meters were under construction. From September to December 2009, we acquired five parcels of land with an aggregate site area of 366,000 square meters and an aggregate estimated buildable GFA of 1,024,000 square meters, which are included in the projects under planning as of December 31, 2009.

Our revenue, derived primarily from sales of residential real estate, has increased from US$309.7 million in 2007 to US$356.6 million in 2008 and to US$449.0 million in 2009. Our net income/(loss) was US$45.7 million, US$(23.6) million, and US$42.4 million, respectively, for the same periods. We acquire land primarily through auctions of government land. This acquisition method allows us to obtain unoccupied land with unencumbered land use rights, which in turn enables us to save the time and expenses associated with protracted legal processes to obtain title, demolition and re-settlement and to commence construction quickly.

As a public company, we are subject to the rules and regulations of the United States securities laws and the NYSE relating to, among other things, corporate governance and internal controls. As such, we have recruited the appropriate amount of experienced management, accounting and other personnel. We have also incurred expenses to improve our enterprise resource management system and internal controls.

The most significant factors that directly or indirectly affect our financial performance and results of operations are:

 

   

Economic growth and demand for residential property in China;

 

   

PRC government policies and regulations, including tax guidelines and lending policies for the real estate sector;

 

   

Location, number and type of our property developments;

 

   

Availability and cost of financing;

 

   

Acquisition of quality land use rights in target markets;

 

   

Changes in the price of raw materials and labor costs; and

 

   

Our execution capability to support business expansion.

 

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We hold a 45% interest in a joint venture company, Jiantou Xinyuan, which as of December 31, 2009 had completed four projects with total GFA of 471,876 square meters. One additional project is under construction with an estimated total GFA of 93,944 square meters. One project is under planning with estimated total GFA of 194,117 square meters. All of Jiantou Xinyuan’s projects are located in Zhengzhou in Henan Province.

As discussed above, on September 25, 2009, we, through our indirectly wholly owned subsidiary, Henan Xinyuan, entered into an Equity Transfer and Profit Distribution Agreement, or ETA, with Zhengzhou General Construction Investment Company and Zhengzhou Jiantou Project Consulting Co., Ltd., or collectively, the Sellers, to acquire their 55% equity interest in Jiantou Xinyuan. As the Sellers are state-owned enterprises, our proposed acquisition of the 55% Equity is deemed as a transfer of state-owned assets. For a discussion of the pending transaction, see “Item 4. Information on the Company—B. Business Overview—Jiantou Xinyuan’s Projects.”

Principal Factors Affecting Our Results of Operations

Economic growth and demand for residential property in China

Our business and results of operations are significantly affected by trends and developments in the PRC economy, including disposable income levels, urbanization rate, population growth, and availability of project and consumer financing, which affect demand for residential properties in China. During the past decade, China has experienced significant economic growth, which has created a favorable operating environment for us in the Tier II cities where we operate. As of December 30, 2009, 99.6% of the units in our completed projects have been sold. Although we experienced less demand during the fourth quarter of 2008 and the first quarter of 2009 due to the impact of the global financial crisis, we expect continuing economic growth in China, rising disposable income levels and population growth in Tier II cities to support demand for residential properties over the next few years.

PRC government policies and regulations

Our business and results of operations are significantly affected by PRC government policies and regulations, particularly those that relate to land sales and development, project and consumer financing, property sales and transfers, property taxation and residential property prices.

Since 2004, due to concerns that investment in the PRC property market may become excessive, the PRC government introduced a series of measures to curb speculative investments in the property market, regulate real estate project lending and promote the development of more low-and mid-priced housing. These policies have included, among others, clarification of the measurement and enforcement of land appreciation tax, or LAT, 40% minimum down payment for any purchase of second or subsequent residential property, the increase of the loan interest rate for such purchases to no less than 110% of the benchmark interest rate, the tightening of money supply and the lifting of bank lending rates.

However, due to the financial crisis beginning in late 2008, the PRC government introduced a stimulus package, which included the reduction of deed taxes for first-time purchasers of ordinary residential property of less than 90 square meters, the waiver of stamp duty fees for individuals who are purchasing or selling ordinary residential properties, and the exemption of LAT for individuals who are selling ordinary residential properties, among other benefits.

In late 2009, the PRC real estate market recovered and housing prices rose rapidly in certain cities. In connection with this, the general office of PRC State Council issued a circular on January 7, 2010 which aimed to control the rapid increase in housing prices and cool down of the real estate market. Among other matters, the circular reiterated that purchasers of a second residential property for their households must make down payments of no less than 40% of the purchasing price, and that real estate developers who have received approval to sell property must commence the sale within the mandated period at the price they have publicly announced. The circular also requested local governments to increase the effective supply of low income housing and ordinary commodity housing and instructed the PBOC and the China Banking Regulatory Commission to tighten the supervision of bank lending to the real estate sector. On January 18, 2010, the PBOC decided to tighten the credit supply by increasing the reserve requirement ratio for commercial banks by 0.5%, which was the first increase since June 2008.

We believe it is in the PRC government’s interest to stabilize the market, and the urbanization process and the continuous increase of disposable income will continue to support the long-term growth of China’s real estate market, so we expect that the government will maintain policies that will foster long-term healthy growth and curb potential bubbles in the market. However, there can be no assurance that the PRC government will not adopt further measures in the near future that may adversely affect our business and financial performance.

 

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Moreover, a substantial portion of our customers depend on mortgage financing to purchase our properties. Although government policies have generally fostered the growth of private home ownership, regulations have been adopted in recent years to tighten and then loosen mortgage lending rules. For example, the minimum down payment required for residential properties of 90 square meters or more was increased from 20% to 30% of the purchase price in 2006. In September 2007, the minimum down payment for any second or subsequent purchase of residential property was increased to 40% of the purchase price where the purchaser had obtained a bank loan to finance the purchase of his or her first property. Moreover, the interest rate for bank loans of such purchase may not be less than 110% of the People’s Bank of China, or PBOC, benchmark rate of the same term and category. Effective as of December 20, 2008, when purchasing a second property to improve their living conditions, residents who have already purchased, with mortgages, an “ordinary property for self-use” that is smaller than the average size for their locality are entitled to the preferential loan interest rate and down payment ratio available to first-time purchasers of residential property. The down payment ratio, the loan interest rate and the size of mortgage financing are important factors that affect our results of operations.

The PRC government will also from time to time introduce sales tax incentives or disincentives to either stimulate or dampen demand. For example, the required holding period for avoidance of tax on capital gains on sale of real estate was extended in December 2009 from 2 years to 5 years in an effort to reduce alleged speculation.

Number, type and location of our property developments

The amount of revenue we record in any given period is affected by a number of factors, including the number, type and location of properties we have under construction and their stage of completion, whether the completed units have been sold and the realized selling prices for such units. The average selling prices of our projects vary depending on the types and sizes of the units sold and on the location of the projects. As the overall development moves closer to completion, the sales prices tend to increase because a more established residential community is offered to purchasers. The type of property development affects the estimated construction period of the project, which largely determines the revenue recognition method we apply. Revenue recognized in any period under the full accrual method depends on the number, aggregate GFA and average selling prices of units completed and sold during the period. Revenue recognized in any period under the percentage of completion method depends on contracted sales of units in the relevant project and the completion progress of a project (measured by the ratio of cost incurred to total estimated cost). As the completion and sales of our projects are not spread evenly over time, our results of operations may differ significantly from period to period.

Availability and cost of financing

Like other property developers, we require substantial capital investment for the acquisition of land use rights and the construction of our projects. Our ability to secure financing for such purposes affects the number of projects we are able to develop at any time. In the wake of the global financial and economic crisis, the PBOC reduced the reserve requirement ratio imposed on banks several times in late 2008 from 17.5% to 15.5%. However after maintaining the reserve requirement at 15.5% for approximately 12 months, the PBOC announced that the reserve requirement was increased to 16% starting January 2010, thus impacting the total amount of bank loans available to the real estate industry. These changes in the availability of bank loans may affect our ability to obtain sufficient funding from banks to finance our business expansion.

The cost of our financing also affects our operating results. We typically obtain bank borrowings for up to 65% of the cost of our land use rights to fund project development after we receive the required permits. Interest rates on our commercial bank borrowings vary and are linked to benchmark lending rates published by the PBOC. The PBOC decreased the benchmark lending rate five times in 2008 but has not changed it since December 23, 2008. In 2007, we issued US$75 million principal amount of floating rate notes, which bear interest at a variable rate based on LIBOR plus 6.8% per annum, and US$25 million principal amount of convertible notes, which bear interest at 2% per annum. We expect our interest costs to fluctuate in future periods as a result of changes in interest rates and our outstanding borrowing.

Acquisition of land use rights in target markets

Our business model depends to a large extent on our ability to acquire land use rights for development sites and proceed quickly with construction to shorten our development cycle. As a consequence, we are frequently surveying the market for attractive development opportunities in our target Tier II cities. Under current regulations and market practice, land use rights for residential development purposes may be acquired from local governments through a competitive auction or other bidding process, in which the minimum reserve price is determined based on the appraised value. Land use rights may also be acquired in the secondary markets. Land use rights prices vary significantly from city to city.

Government land auctions are a transparent and competitive process for bringing development land to market, allowing the developer to acquire clean title and the ability to proceed immediately with development. However, as competition for development sites in Tier II cities increases, the auction mechanism tends to lead to higher prices. In 2007, 2008 and 2009, land use rights costs, including auction price and taxes, constituted 47.1%, 44.9% and 42.5%, respectively, of our cost of revenue. We have noted that land use rights costs stabilized in the Tier II cities where we have operations due to softness in the market during the fourth quarter of 2008 and the first quarter of 2009. However, in late 2009, land use rights costs started to increase again due to the recovery of the real estate market in China and sudden rise in housing prices in certain cities. The land cost of the five parcels of land acquired from September to December 2009 is expected to account for 43.5% of total project costs.

 

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Increases in the price of raw materials and labor costs

We outsource the design and construction of our property developments to third-party service providers. Our third-party contractors are responsible for providing labor and procuring a majority of the raw materials used in our project developments. Our construction contracts typically provide for fixed or capped payments, but the payments are subject to changes in certain cases, such as changes in government-suggested steel prices. Any increase in labor costs or other costs which may result in adjustments in payments under our construction contracts could result in an increase in our construction costs. In addition, the increase in the price of raw materials, such as cement, concrete blocks and bricks, in the long run could be passed on to us by our contractors, which could increase our construction costs. Any input cost increase could reduce our earnings to the extent we are unable to pass these increased costs to our customers.

Our execution capability to support business expansion

Since 2006, we have been expanding our residential property development operations from Zhengzhou in Henan Province into other Tier II cities, including Chengdu in Sichuan Province, Hefei in Anhui Province, Jinan in Shandong Province, and Suzhou and Kunshan in Jiangsu Province. In the fourth quarter of 2009, we acquired land in Xuzhou in Jiangsu Province and plan to expand into additional Tier II cities as suitable opportunities arise. The development of real estate projects outside Zhengzhou will impose significant demand on our management and other operational resources. Moreover, we will face additional competition and will need to establish brand recognition and market acceptance for our developments in these new markets. Each of these Tier II cities has its own market conditions, customer requirements and local regulations related to the real estate industry. The success of our business expansion depends on our ability to develop, market, and deliver quality development projects on time. The progress and costs of a development project can be adversely affected by many factors, such as delays in obtaining necessary licenses, permits or approvals from relevant government authorities, failure by local contractors to comply with our designs, specifications or standards, and disputes with our third-party contractors. For instance, we are not permitted to commence pre-sales until we have reached certain milestones in the construction progress for a project. Thus, any significant delay in construction could restrict our ability to pre-sell our properties, which could extend the recovery period for our investments. This, in turn, could have an adverse effect on our cash flow, investment returns and financial position.

Operating Results

Revenues

Our revenues are derived mainly from the development and sale of real estate. In addition, we generate a small percentage of revenue from leasing ancillary facilities and residential units in certain of our residential developments, as well as from the provision of related services, including property management and real estate agency services.

 

     Year Ended December 31,
     2007    2008    2009
     US$    %    US$    %    US$    %
     (US$ in thousands, except for percentages)

Real estate sales

   305,668    98.7    352,181    98.8    441,338    98.3

Real estate leasing

   339    0.1    379    0.1    320    0.1

Other revenue

   3,718    1.2    4,072    1.1    7,326    1.6

Total revenues

   309,725    100.0    356,632    100.0    448,984    100.0

Real Estate Sales

Real estate sales represent revenues from the sales of residential properties we develop. Throughout this annual report, real estate sales are stated net of sales tax levied on the relevant contracted sales value. Sales tax is a one-time tariff which consists of a business tax at the rate of 5%, an urban construction tax at the rate of 0.35% and an education surcharge at the rate of 0.15%. Total sales tax amounted to US$18.0 million, US$21.3 million and US$25.8 million, for 2007, 2008 and 2009, respectively.

When we developed smaller projects in the past, we recognized most of our projects under the full accrual method. In 2006, we recognized revenues from two projects, Zhengzhou Central Garden-East and Zhengzhou Central Garden-West, under the percentage of completion method. In 2007, we recognized revenues from six additional projects, Suzhou Lake Splendid, Jinan Elegant Scenery, Zhengzhou Commercial Plaza, Suzhou Colorful Garden, Hefei Wangjiang Garden and Shandong International City Garden, under the percentage of completion method. In the year ended December 31, 2008, we recognized revenue from four additional projects, Henan Colorful Garden, Suzhou International City Garden, Chengdu Xinyuan Splendid Phase I, and Kunshan International City Garden, under the percentage of completion method. The full accrual method was applied to the remainder of our projects. In the year ended December 31, 2009, we recognized all our real estate sales revenues under the percentage of completion method.

 

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Real Estate Leasing

Real estate leasing revenues represent the income from the rental of ancillary facilities, including kindergarten, elementary school, clubhouse and parking facilities, in a number of our developments. We also lease a small number of residential units owned by us.

Other Revenue

Other revenue consists primarily of fees received for our property management services, landscaping and computer network engineering and other real estate-related services that we provide to residents and purchasers of our residential units.

Cost of Revenues

The following table sets forth a breakdown of our cost of revenues for the period indicated.

 

     Year Ended December 31,
     2007    2008    2009
     US$    %    US$    %    US$    %
     (US$ in thousands, except for percentages)

Cost of real estate sales

                 

Land use rights costs

   97,946    47.1    160,297    44.9    153,004    42.5

Construction costs

   107,264    51.5    136,999    38.4    198,432    55.2

Impairment charges

   —         55,004    15.4    —      —  
                             

Total cost of real estate sales

   205,210    98.6    352,300    98.7    351,436    97.7

Cost of real estate leasing

   655    0.3    583    0.2    598    0.2

Other costs

   2,270    1.1    4,098    1.1    7,705    2.1
                             

Total costs of revenues

   208,135    100.0    356,981    100.0    359,739    100.0

Cost of Real Estate Sales

Cost of real estate sales consist primarily of land use rights costs and construction costs. Impairment charges, if any, are also recorded under cost of real estate sales. Cost of real estate sales are capitalized and allocated to development projects using the specific identification method. When the full accrual method of revenue recognition is applied, costs are recorded based on the ratio of the sales value of the relevant units completed and sold to the estimated total project sales value, multiplied by the estimated total project costs. When the percentage of completion method of revenue recognition is applied, capitalized costs are released to our statement of operations based on the completion progress of a project.

Land use rights cost. Land use rights costs include the amount we pay to acquire land use rights for our property development sites, plus taxes. We acquire our development sites mainly by competitive bidding at public auctions of government land. Our land use rights costs for different projects vary according to the size and location of the site and the minimum reserve price for the site, all of which are influenced by government policies, as well as prevailing market conditions. Our land use rights costs have increased in the past few years due to several factors including geographic expansion into certain higher priced markets, generally rising prices in each of our served markets, and increased competition from a growing number of bidders at government land auctions.

Construction costs. We outsource the construction of all of our projects to third party contractors, whom we select through a competitive tender process. Our construction contracts provide for fixed or capped payments which cover substantially all labor, materials, fittings and equipment costs, subject to adjustments for certain prescribed contingencies, such as design changes during the construction process or changes in government-suggested steel prices. Our construction costs consist primarily of the payments to our third-party contractors, which are paid over the construction period based on specified milestones. In addition, we directly purchase and supply a limited range of fittings and equipment, including elevators, window frames and door frames. Our construction costs also include capitalized interest costs in the amount of US$11.2 million, US$32.2 million and US$34.8 million for 2007, 2008 and 2009, respectively.

 

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Future losses and impairment charges. When the profitability of a project deteriorates due to a slow down in the sales pace or some other factors, this indicates that there may be a possible future loss on delivery and potential impairment in the recoverability of the assets. Accordingly, the assets of such project are reviewed for future losses and impairment by comparing the estimated future undiscounted cash flows for the project to the carrying value of such project. If the estimated future undiscounted cash flows are less than the asset’s carrying value, such deficit will be charged as a future loss. Then the assets will be written down to its estimated fair value. We determine estimated fair value primarily by discounting the estimated future cash flows relating to the asset. In estimating the cash flows for a project, we use various factors including (a) the expected pace at which the planned number of units will be sold, based on competitive market conditions, historical trends in sales pace, actual average selling prices, sales of similar product offerings and any other long or short-term economic conditions which may impact the market in which the project is located; (b) the estimated net sales prices expected to be attained based on the current market conditions and historical price trends, as well as any estimated increases in future sales prices based upon the projected rate of unit sales, estimated time gap between presale and expected delivery, the impact of government policies, the local and regional competitive environment, and certain external factors such as the opening of a subway line, school or factory; and (c) the expected costs to be expended in the future, including, but not limited to, home construction, construction overheads, sales and marketing, sales taxes and interest costs.

Our determination of fair value requires discounting the estimated cash flow at a rate commensurate with the inherent risk associated with the assets and related estimated cash flow. The discount rate used in determining each project’s fair value depends on the stage of development, location and other specific factors that increase or decrease the risk associated with the estimated cash flows. In accordance with our accounting policies, we review each of our projects for impairments on a quarterly basis. Based on our testing at the end of 2008, we recognized an impairment of US $55 million on the Suzhou International City Garden project in the fourth quarter of 2008. See also “—Critical Accounting Policies” for our policy on impairment of long-lived assets.

As of December 31, 2009, we tested all of our active projects, consisting of projects under construction or planning, for impairment. Our testing indicated that the undiscounted cash flows of all of our projects exceeded their related carrying value, and accordingly, none of the projects were considered impaired.

Cost of Real Estate Leasing

Our cost of real estate leasing consists primarily of depreciation expenses and maintenance expenses associated with the leased properties. Depreciation is computed using the straight-line method over the estimated useful lives of the assets. Estimated useful lives of our properties held for lease are generally 20 years.

Other Costs

Other costs represent costs incurred in connection with the property management services, real estate agency services and other property related services that we provide to residents and purchasers of our developments.

Selling and Distribution Expenses

Our selling and distribution expenses include:

 

   

advertising and promotion expenses, such as print advertisement costs, billboard and other display advertising costs, and costs associated with our showrooms and illustrative units;

 

   

staff costs, which consist primarily of salaries and sales commissions of 0.45% of contracted sales of our sales personnel;

 

   

for 2009, agency commissions of approximately 1.2% of contracted sales on outsourced project sales; and

 

   

other related expenses.

As of December 31, 2009, we employed 60 full-time sales and marketing personnel. We expect our selling and marketing expenses to increase in the near future as we increase our sales efforts, launch more projects and target new markets to expand our operations.

General and Administrative Expenses

General and administrative expenses principally include:

 

   

staff salaries and benefits, quarterly and annual bonuses, and stock-based compensation;

 

   

travelling and entertainment expenses;

 

   

professional fees, such as audit and legal fees; and

 

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other expenses.

Interest Income

Interest income represents interest earned on our bank balances.

Interest Expenses

Interest expenses include (i) interest paid on our bank borrowings and other indebtedness, including our floating rate notes and convertible notes issued in April 2007, (ii) amortization of warrants and debt issuance cost, (iii) accretion of discount from embedded derivatives and (iv) change in fair value of embedded derivatives, all net of amounts capitalized to construction costs. The floating rate notes bear interest at the adjustable annual rate of six-month LIBOR plus 6.8%, while the convertible notes bear interest at the fixed annual rate of 2%. The rates of interest payable on our floating rate notes are variable. Interest rates on our bank borrowings, all of which are granted by PRC commercial banks and denominated in RMB, are typically variable and linked to benchmark rates published by the PBOC. Our weighted average interest rate on short-term bank loans as of December 31, 2009 was 5.46%. As of December 31, 2009, the PBOC benchmark rate for a one-year loan was 5.31% per annum and those for loans of more than one year ranged from 5.40% to 5.94% per annum.

Share of Income in Equity Investee

Share of income in equity investee represents profit associated with our 45% equity interest in Jiantou Xinyuan. Under the relevant joint venture agreement, we share the profit or loss of Jiantou Xinyuan according to our equity interest percentage. As of December 31, 2009, Jiantou Xinyuan had completed four projects, had one project under construction and had one project under planning. Our share of income from Jiantou Xinyuan for 2007, 2008 and 2009 was US$8.7 million, US$9.8 million and US$4.4 million, respectively.

Change in Fair Value of Derivative Liabilities

We have issued warrants to Series A preference shareholders and floating rate note holders, which are accounted for as derivative liabilities. The warrants issued to the holders of our floating rate notes entitle such holders to purchase our common shares at 80% of the initial public offering price per common share in December 2007, or US$5.60 per share.

Under US GAAP, we are required to recognize the fair value of the outstanding warrants as a liability on our balance sheet. We determine the fair value of the warrants on a quarterly basis using the Black-Scholes valuation method with increases/decreases in value resulting in a charge/credit to “change in fair value of derivative liabilities”.

During the year ended December 31, 2009, the valuation of the warrants and associated liabilities decreased by US$169,736, from US$170,000 to US$264, which was recorded as a change in the fair value of derivative liabilities in our 2009 results. The decrease mainly resulted from the shorter time to expiration.

Income Taxes

The following table sets forth the components of income taxes for the periods indicated.

 

     Year Ended December 31,  
     2007    2008    2009  
     US$    %    US$    %    US$     %  
     (in thousands, except for percentages)  

Corporate income tax

   5,827    19.6    4,290    40.0    23,740      119.8   

Land appreciation tax

   5,736    19.3    4,912    45.8    2,186      11.0   

Tax uncertainty benefit

   8,711    29.3    —      —      —        —     

Deferred tax expense

   9,441    31.8    1,528    14.2    (6,101   (30.8

Income taxes

   29,715    100.0    10,730    100.0    19,825      100.0   

For an explanation of deferred tax expense, see Notes 2(t) and 12 of the consolidated financial statements included elsewhere in this annual report on Form 20-F. For a discussion of corporate income tax and land appreciation tax, see below.

 

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Corporate Income Tax and Tax Uncertainty Benefit

Cayman Islands

We are incorporated in the Cayman Islands. Under the current law of the Cayman Islands, we are not subject to income or capital gains tax. In addition, dividend payments are not subject to withholding tax in the Cayman Islands.

People’s Republic of China

In general, enterprises in the PRC are subject to income tax at a statutory rate of 25%. In 2007, 2008 and 2009, in accordance with local provisional tax regulations in Henan province, the local tax authority in Zhengzhou determined that the taxable income of our PRC subsidiaries in Henan province should be deemed at 12% or 14% of their total cash receipts from sales of residential units. Total cash receipts include cash receipts proceeds from pre-sales of our properties that are recorded as customer deposits, which partly comprise mortgage loan proceeds received in our account from mortgage lending banks. The Zhengzhou local tax authority has provisionally confirmed that it applied the same levy method to our PRC subsidiaries located in Henan province for the year ended December 31, 2009. For our subsidiaries located in Shandong, Jiangsu, Anhui and Sichuan provinces, income tax is levied at the statutory rate of 25% on income as reported in the statutory financial statements after appropriate tax adjustments for the year ended December 31, 2009.

The Zhengzhou and other local tax authorities are entitled to re-examine taxes paid in prior years under the levy method described above; however, they have not indicated whether they will do so. We have made full provision for the corporate income tax, or CIT, payable by our PRC subsidiaries based on the statutory income tax rate of 25%, after appropriate adjustments to our taxable income used in the calculation. The difference between tax payable on our actual taxable income and tax levied on the deemed taxable income basis has been treated as an unrecognized tax uncertainty benefit under Financial Accounting Standards Board Interpretation No. 48, “Accounting for Uncertainty in Income Taxes—an interpretation of FASB Statement No. 109,” as codified in ASC 740-10 “ Income Tax” (“ASC 740-10”), which has a balance of US$12.8 million as of December 31, 2009. The increase related to current year tax positions arises primarily from foreign exchange movements. We believe this treatment is appropriate due to the possibility of reinterpretation of the application of the tax regulations by higher tax authorities in the PRC, as the local authorities have indicated that they will apply the regulation in the same manner in 2009.

Land Appreciation Tax

Under PRC laws and regulations, our PRC subsidiaries engaging in property development are subject to LAT, which is levied by the local tax authorities upon the “appreciation value” as defined in the relevant tax laws. All taxable gains from the sale or transfer of land use rights, buildings and related facilities in China are subject to LAT at progressive rates that range from 30% to 60%. Certain exemptions are allowed for sales of ordinary residential properties if the appreciation value does not exceed a threshold specified in the relevant tax laws. Gains from sales of commercial properties are not eligible for this exemption. Whether a property qualifies for the ordinary residential property exemption is determined by the local government taking into consideration the property’s plot ratio, aggregate GFA and sales price.

We have recorded a provision for LAT on all projects completed since the date of incorporation. We have accrued all LAT payable on our property sales and transfers in accordance with the progressive rates specified in relevant tax laws, less amounts previously paid under the levy method applied by relevant local tax authorities.

Share-based compensation expense

We adopted our 2007 equity incentive plan for our directors, management, employees and consultants and for employees of our equity investee in August 2007. On August 11, 2007, we granted share options awards for an aggregate of 6,802,495 common shares at a weighted average exercise price of US$1.08. These options have various vesting periods ranging from 10 to 60 months, and will vest only if the holder is still a director or an employee or an affiliate of our company at the time of the relevant vesting. These awards commenced vesting in December 2008 and will expire no later than August 10, 2017.

In November 2007, we adopted our 2007 long term incentive plan for our directors, management and key employees of both our company and our equity investee under which we are authorized to grant options, restricted shares, restricted stock units, stock appreciation rights and other stock-based awards for the purchase of up to 10 million common shares at prevailing market prices. On November 5, 2007, we granted options for an aggregate of 2,441,844 common shares at an exercise price of US$7 per share, representing the per-common share equivalent of the IPO price of the ADSs, taking into account the ADS to common share conversion ratio. These options have commenced vesting and have vesting periods of up to 36 months, and will expire no later than November 5, 2017.

In July 2008, under the 2007 long term incentive plan, we granted stock options for an aggregate of 360,000 common shares to our employees, at a weighted average exercise price of US$2.98. These options have a vesting period of either 33 months or 36 months and will expire no later than July 1, 2018 and will vest only if the holder is still a director or an employee or an affiliate of our company at the time of the relevant vesting.

 

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In March 2009, under the 2007 long term incentive plan, we granted share options to purchase up to 500,000 common shares to an employee, at an exercise price equal to the market price of our common shares on the grant date (US$1.87 per share). These options have a weighted average grant date fair value of US$1.255 per option, and a total expected compensation cost, net of expected forfeitures, of US$564,750. These options have vesting periods based on length of service of 36 months and will expire no later than March 31, 2019.

In August 2009, under the 2007 long term incentive plan, we granted share options to purchase up to 100,000 common shares to an employee, at an exercise price of US$1.30 per share, which is below the market price of our common shares on the grant date (US$2.71 per share). These options have a weighted average grant date fair value of US$2.12 per option, and a total expected compensation cost, net of expected forfeitures, of US$190,800. These options have vesting periods of 27 months and will expire no later than August 11, 2019.

Results of Operations

The following table presents a summary of our consolidated statements of operations by amount and as a percentage of our total revenues during the periods indicated. Our historical results presented below are not necessarily indicative of the results that may be expected for any other future period.

 

     Year Ended December 31,  
     2007     2008     2009  
     US$     %     US$     %     US$     %  

Revenues

   309,725      100.0      356,632      100.0      448,984      100.0   

Cost of revenues

   (208,135   (67.2   (356,981   (100.1   (359,739   (80.1
                                    

Gross profit

   101,590      32.8      (349   0.1      89,245      19.9   

Selling and distribution expenses

   (10,515   (3.4   (13,578   (3.8   (11,443   (2.5

General and administrative expenses

   (17,077   (5.5   (32,343   (9.1   (22,215   (4.9
                                    

Operating income (loss)

   73,998      23.9      (46,270   (13   55,587      12.5   

Interest income

   1,417      0.5      3,492      1.0      2,388      0.5   

Interest expenses

   (3,204   (1.0   —        —        —        —     

Exchange gains

   3,083      1.0      3,603      1.0      80      —     

Other expenses

   —        —        —        —        (383   (0.1

Share of income in equity investee

   8,686      2.8      9,843      2.8      4,402      1.0   

Change in fair value of derivative liabilities

   (8,602   (2.8   16,422      4.6      170      0.0   

Income (loss) from operations before income taxes

   75,378      24.3      (12,910   (3.6   62,244      14.0   

Income taxes

   (29,715   (9.6   (10,730   (3.0   (19,825   (4.4

Net income (loss)

   45,663      14.7      (23,640   (6.6   42,419      9.6   

Accretion of Series A convertible redeemable preference shares

   (2,739   (0.9   —        —        —        —     

Deemed dividend

   (182,229   (58.8   —        —        —        —     

Net income (loss) attributable to ordinary shareholders

   (139,305   (45.0   (23,640   (6.6   42,419      9.6   

Year Ended December 31, 2009 Compared to Year Ended December 31, 2008

Revenues

Revenues increased by US$92.4 million, or 25.9%, to US$449.0 million for the year ended December 31, 2009 from US$356.6 million for the year ended December 31, 2008.

Real estate sales

Revenue from real estate sales increased by US$89.2 million, or 25.3%, to US$441.3 million for the year ended December 31, 2009 from US$352.2 million for the year ended December 31, 2008, as continued weak residential real estate demand in the first quarter of 2009 was more than offset by a strong recovery in the second, third and fourth quarters of 2009.

Full accrual method revenues

Revenue from the sale of properties where the construction period, the period from the construction permit award date to the unit delivery date, is expected to be 12 months or less, is recognized by the full accrual method when the sale is consummated and the unit has been delivered. A sale is considered to be consummated when the sales price has been paid, any permanent financing for which we are responsible has been arranged, all conditions precedent to closing have been performed, we do not have any substantial continuing involvement with the unit and the usual risks and rewards of ownership have been transferred to the buyer. Costs are recorded based on the ratio of the sales value of the relevant units completed and sold to the estimated total project sales value, multiplied by the estimated total project cost. For these projects, our policy is that cash payments received from the buyer are recorded as a deposit liability and costs are capitalized as incurred, up to when the sale is consummated and the unit has been delivered.

 

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Delivery and closing take place only after the local government has certified that the building is completed and ready for habitation (comparable to a certificate of occupancy in the United States) and the following events have occurred:

 

   

The sales department has determined that the sales contract is signed, the sales tax invoice is properly issued, the purchaser is physically present and the purchaser’s identification cards are checked;

 

   

All consideration has been paid by the purchaser; and

 

   

The unit has been inspected and accepted by the purchaser.

The following table sets forth for the year ended December 31, 2008 and 2009 the aggregate GFA and the related revenues recognized under the full accrual method by project:

 

Project

   Total
GFA (1)
   GFA Delivered For
The Year Ended
December 31,
   Percentage of
Total GFA
Delivered as of
December 31,
   Revenues Recognized For The Year Ended
December 31,
          2008    2009    2008    2009    2008    2009
              %(2)    %    US$    %(3)    US$    %

Henan Segment

                          

Zhengzhou Xinyuan Splendid I

   62,623    1,069    —      99.9    100.0       1,030,516    0.3       —         —  

Zhengzhou City Family

   39,226    3,338    —      100.0    100.0       1,908,470    0.4       —         —  

Shandong Segment

                          

Jinan City Family

   61,065    4,849    —      100.0    100.0    1,240,750    0.5    —      —  

Total

   162,914    9,256    —            4,179,736    1.2    —      —  

 

(1) The amounts for “total GFA” in this table are the amounts of total saleable GFA and are derived on the following basis:

 

   

% for properties that are sold, the stated GFA is based on the sale contracts relating to such property;

 

   

% for unsold properties that are completed or under construction, the stated GFA is calculated based on the detailed construction blueprint and the calculation method approved by the PRC government for saleable GFA, after necessary adjustments; and

 

   

% for properties that are under planning, the stated GFA is based on the land grant contract and our internal projection.

(2) Percentage of total GFA delivered is the total GFA delivered as of a period end divided by the project’s total GFA.
(3) Percentage of all real estate sales revenues for the financial year, including revenues recognized under full accrual method and under percentage of completion method.

Percentage of completion method revenues

Revenue from the sale of properties where the construction period is expected to be more than 12 months is recognized by the percentage of completion method on the sale of individual units based on the completion progress of a project, as described below.

We apply the percentage of completion method to projects with an expected construction period of over 12 months, not including any unforeseen delay or delays beyond our control. For these projects, our policy is that cash payments received from the buyers are initially recorded as customer deposits, and costs are capitalized as incurred.

Revenue and profit from the sale of these development properties are recognized by the percentage of completion method on the sale of individual units when the following conditions are met:

 

   

Construction is beyond a preliminary stage;

 

   

The buyer is committed to the extent of being unable to require a refund except for non-delivery of the unit;

 

   

Sufficient units have already been sold to assure that the entire property will not revert to rental property;

 

   

Sales prices are collectible; and

 

   

Aggregate sales proceeds and costs can be reasonably estimated.

 

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Under the percentage of completion method, revenues from units sold and related costs are recognized over the course of the construction period, based on the completion progress of a project. In relation to any project, revenue is determined by calculating the ratio of incurred costs, including land use rights costs and construction costs, to total estimated costs and applying that ratio to the contracted sales amounts less business tax. Cost of sales is recognized by determining the ratio of contracted sales during the period to total estimated sales value, and applying that ratio to the incurred costs. Current period amounts are calculated based on the difference between the life-to-date project totals and the previously recognized amounts.

The following table sets forth the percentage of completion, the percentage sold and related revenues for our projects recognized under the percentage of completion method for the year ended December 31, 2008 and 2009.

 

Project

   Total
GFA
   Percentage
Complete as of
December 31 (1)
   Percentage Sold (2)
Accumulated as of
December 31,
   Revenues Recognized For The Year Ended
December 31,
          2008    2009    2008    2009    2008    2009
        % (1)    %    %(2)    %    US$    %(3)    US$    %

Chengdu Segment

                          

Chengdu Xinyuan Splendid I

   230,893    54.5    67.4    4.1    50.2    4,053,916    1.2    56,601,483    12.8

Jiangsu Segment

                          

Suzhou International City Garden

   205,161    64.1    77.6    10.4    30.2    17,158,200    4.9    44,041,089    10.0

Suzhou Lake Splendid

   196,920    98.0    99.6    97.2    99.6    61,314,116    17.4    8,108,570    1.8

Suzhou Colorful Garden

   80,474    92.0    99.5    62.8    98.2    45,384,982    12.9    39,110,448    8.9

Kunshan International City Garden

   497,076    50.3    57.5    1.9    39.0    4,356,340    1.2    106,810,581    24.2

Shandong Segment

                          

Jinan Elegant Scenery

   100,217    98.6    100.0    99.3    100.0    23,463,332    6.7    1,480,722    0.3

Jinan International City Garden

   264,416    79.9    98.8    66.3    99.2    97,549,755    27.7    88,232,508    20.0

Henan Segment

                          

Zhengzhou Xinyuan Colorful Garden

   191,786    76.8    96.4    25.5    70.8    29,708,577    8.4    86,875,048    19.7

Zhengzhou Commercial Plaza

   67,172    93.0    100.0    94.7    97.0    21,310,379    6.1    3,174,775    0.7

Anhui Segment

                          

Hefei Wangjiang Garden

   145,455    92.3    100.0    98.8    99.7    43,701,407    12.4    6,902,453    1.6

Total

   1,979,570                348,001,004    98.8    441,337,677    100.0

 

(1) Percentage of completion is calculated by dividing total costs incurred by total estimated costs for the relevant project, estimated as of the time of preparation of our interim financial statements as of and for the year ended December 31, 2009.
(2) Percentage sold is calculated by dividing contracted sales value from property sales by total estimated sales value of the relevant project, estimated as of the time of preparation of our interim financial statements as of and for the year ended December 31, 2009.
(3) Percentage of all real estates sales revenues for the financial year, including revenues recognized under full accrual method and under percentage of completion method.

The following table sets forth the square meters sold and average selling price per square meter by each project, each reportable segment and on a consolidated basis for the year ended December 31, 2008 and 2009.

 

     Year Ended December 31,
     2008    2009

Project

   Contract Sales    Square
Meters
Sold
   Average
Selling
Price
   Contract Sales    Square
Meters
Sold
   Average
Selling
Price
     US$       US$/m²    US$       US$/m²

Chengdu region

                 

Chengdu Xinyuan Splendid I

   7,873,143    13,854    568    87,017,439    120,225    724
                         

Total

   7,873,143    13,854    568    87,017,439    120,225    724

Jiangsu region

                 

Suzhou International City Garden

   28,342,340    26,056    1,088    55,047,727    43,767    1,258

Suzhou Lake Splendid

   32,147,452    30,814    1,043    5,589,006    5,315    1,052

Suzhou Colorful Garden

   51,563,942    46,111    1,118    37,301,065    29,863    1,249

Kunshan International City Garden

   9,163,799    11,346    808    196,022,279    215,223    911
                         

Total

   121,217,533    114,327    1,060    293,960,077    294,168    999

Shandong region

                 

Jinan Elegant Scenery

   15,593,452    18,711    833    504,670    555    909

Jinan International City Garden

   192,281,112    249,271    771    68,169,663    86,908    784

Jinan City Family

   143,525    222    647    —      —      —  
                         

Total

   208,018,089    268,204    776    68,674,333    87,463    785

Henan region

                 

Zhengzhou Xinyuan Colorful Garden

   40,921,807    47,000    871    86,634,184    97,851    885

Zhengzhou Commercial Plaza

   12,249,709    15,157    808    -70,174    41    -1,712

Zhengzhou Xinyuan Splendid I

   956,196    1,069    894    —      —      —  

Zhengzhou City Family

   1,908,602    3,338    572    —      —      —  
                         

Total

   56,036,314    66,564    842    86,564,010    97,892    884

Anhui region

                 

Hefei Wangjiang Garden

   28,747,033    41,823    687    281,732    282    999
                         

Total

   28,747,033    41,823    687    281,732    282    999
                         

Grand Total

   421,892,112    504,772    836    536,497,591    600,030    894

 

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The total square meters sold increased to 600,030 square meters for the year ended December 31, 2009 from 504,772 square meters for the year ended December 31, 2008. The overall aggregate average selling price per square meter for the year ended December 31, 2009 increased to US$894 from US$836 for the year ended December 31, 2008. The price increase was primarily due to an overall recovery of demand for residential real estate in China in the second, third and fourth quarters of 2009.

Chengdu region. In the third quarter of 2008, we commenced sales of our first project in the Chengdu region, Chengdu Xinyuan Splendid I. The square meters sold for the year ended December 31, 2009 increased to 120,225 square meters from 13,854 square meters for the year ended December 31, 2008. The average selling price per square meter for the year ended December 31, 2009 increased to US$724 from US$568 for the year ended December 31, 2008. The increase in square meters sold and average selling price resulted from the fact that we commenced sales of this project in September 2008 amidst market weakness with aggressive introductory pricing to gain sales momentum. Since March of 2009, we have raised prices several times on this project.

Jiangsu region. The square meters sold for the year ended December 31, 2009 increased to 294,168 square meters from 114,327 square meters for the year ended December 31, 2008 on very strong sales of the Kunshan International City Garden. The average selling price per square meter for the year ended December 31, 2009 decreased to US$999 from US$1,060 for the year ended December 31, 2008. The average selling price decrease from 2008 to 2009 resulted from a change in project mix as we started sales of lower-priced Kunshan International City Garden while sales of higher-priced mature projects (i.e. Suzhou Lake Splendid and Suzhou Colorful Garden) were winding down.

Shandong region. The square meters sold for the year ended December 31, 2009 decreased to 87,463 square meters from 268,204 square meters for the year ended December 31, 2008, due to declining inventory as the Jinan Elegant Scenery project was completed and the Jinan International City Garden was 99.2% sold. The average selling price per square meter for the year ended December 31, 2009 increased slightly to US$785 from US$776 for the year ended December 31, 2008.

Henan region. The square meters sold for the year ended December 31, 2009 increased to 97,892 square meters from 66,564 square meters for the year ended December 31, 2008. The average selling price per square meter for the year ended December 31, 2009 increased to US$884 from US$842 for the year ended December 31, 2008, resulting from increased selling prices of Zhengzhou Xinyuan Colorful Garden to meet higher demand in 2009.

Anhui region. The square meters sold for the year ended December 31, 2009 decreased to 282 square meters from 41,823 square meters for the year ended December 31, 2008 as the only active project in that region, Hefei Wangjiang Garden, was essentially sold out by the end of 2008.

Real estate leasing

Real estate leasing income decreased by US$58,622, or 15.6%, to US$320,458 for the year ended December 31, 2009 from US$379,080 for the year ended December 31, 2008. The decrease resulted from the termination of the rental contracts of one office building in 2009 which will be sold in 2010.

Other revenue

Other revenue increased by US$3.3 million, or 79.9%, to US$7.3 million for the year ended December 31, 2009 from US$4.1 million for the year ended December 31, 2008. The increase primarily resulted from expanded operations from our property management services. Specifically, during the year ended December 31, 2009, we delivered five projects, Hefei Wangjiang Garden, Jinan Elegant Scenery, Jinan International City Garden, Suzhou Lake Splendid and Zhengzhou Commercial Plaza. Our property management arm provides property management services for all five of the projects.

 

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Cost of revenue

Cost of revenue increased by US$2.8 million, or 0.8%, to US$359.7 million for the year ended December 31, 2009 from US$357.0 million for the year ended December 31, 2008.

Cost of real estate sales

Cost of real estate sales decreased by US$0.9 million, or 0.2%, to US$351.4 million for the year ended December 31, 2009 from US$352.3 million for the year ended December 31, 2008. Total land use rights cost decreased by US$7.3 million, or 4.5%, from US$160.3 million (44.9% of cost of real estate sales) for the year ended December 31, 2008 to US$153.0 million (42.5% of cost of real estate sales) for the year ended December 31, 2009. The construction cost, including capitalized interest, increased by US$61.4 million, or 44.8%, to US$198.4 million for the year ended December 31, 2009 from US$137.0 million for the year ended December 31, 2008, as construction spending was accelerated in the second, third and fourth quarters of 2009 to meet the increasing demand.

Cost of real estate leasing

Cost of real estate leasing increased by US$15,745, or 2.6%, to US$598,255 for the year ended December 31, 2009 from US$582,510 for the year ended December 31, 2008. The increase was primarily due to greater depreciation cost from an increase of properties held for lease.

Other costs

Other costs increased US$3.6 million, or 88.0%, to US$7.7 million for the year ended December 31, 2009 as compared to US$4.1 million for year ended December 31, 2008. US$2.3 million of the increase was due to spending for property management at the five projects delivered in the first half of 2009. US$1.3 million of the increase was due to a payment of compensation to some customers for late delivery of residences at Suzhou Colorful Garden, as we slowed construction activities in late 2008 and early 2009 to match construction spending with contract sales proceeds.

Gross profit

Gross profit increased to US$89.2 million for the year ended December 31, 2009 from a gross loss of US$0.3 million for the year ended December 31, 2008. Gross profit margin was 19.9% for the year ended December 31, 2009 compared to a gross loss margin of 0.1% for the year ended December 31, 2008. The gross loss in 2008 was due primarily to the US$21.8 million recognized future loss on Suzhou International City Garden and a US$55.0 million impairment loss on the same project. In addition, gross profit in 2009 favorably impacted by increased prices and a higher revenue level in 2009.

Selling and distribution expenses

Selling and distribution expenses decreased by US$2.1 million, or 15.7%, to US$11.4 million for the year ended December 31, 2009 from US$13.6 million for the year ended December 31, 2008. The decrease was primarily due to a US$1.6 million reduction in advertising and promotion expenses and a US$0.5 million decrease in staff cost, traveling, communication and other miscellaneous expenses. We began effective cost control measures in 2009, and employed a new sales outsourcing plan in the second quarter of 2009. As of March 2009, we outsourced 80% of sales to third party sales agencies. This percentage increased to 100% in September 2009. As a percentage of revenue, selling and distribution expenses decreased to 2.5% for the year ended December 31, 2009 from 3.8% for the year ended December 31, 2008. As revenue expands in the future, we expect selling and distribution expenses as a percentage of revenue to be flat or decrease slightly.

General and administrative expenses

General and administrative expenses decreased by US$10.1 million, or 31.3%, to US$22.2 million for the year ended December 31, 2009 from US$32.3 million for the year ended December 31, 2008. In the year ended December 31, 2009, our stock option expenses decreased by US$4.9 million due primarily to forfeitures by departing employees (US$3.0 million), and the completion of vesting of certain options to executives (US$1.9 million). Headcount reductions also led to a US$2.6 million decrease in salary and welfare expenses. We also experienced lower consulting fees by US$1.0 million due to reduced utilization of professional services.

As a percentage of revenue, general and administrative expenses decreased to 4.9% for the year ended December 31, 2009 from 9.1% for the year ended December 31, 2008.

Interest income

Interest income decreased by US$1.1 million, or 31.6%, to US$2.4 million for the year ended December 31, 2009 from US$3.5 million for the year ended December 31, 2008. The decrease was mainly due to lower interest rates in the year ended December 31, 2009.

 

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Interest expenses

All interest costs were capitalized for the years ended December 31, 2008 and 2009. Total gross interest costs incurred amounted to US$34.8 million for the year ended December 31, 2009, including US$24.1 million of interest on loans, US$0.5 million of accretion of discount arising from embedded derivative on convertible notes, US$3.7 million of accretion of discount arising from warrants and embedded derivative on floating rate notes, US$1.4 million of amortization of debt issuance costs and US$5.0 million related to the contingent put option held by our convertible note holders. In the year ended December 31, 2008, the gross interest costs of US$32.2 million consisted of similar components, not including contingent put option costs.

Exchange gains

For the year ended December 31, 2009, we recorded an unrealized foreign exchange gain of US$0.08 million, as compared to US$3.6 million in year ended December 31, 2008, arising from translating certain U.S. dollar-denominated debts into Renminbi using the exchange rate at the balance sheet date. The reduction in exchange gains was due to the stability of the exchange rates between the U.S. dollar and the Renminbi during the period.

Share of income in an equity investee

Share of income in equity investee represents profit associated with our 45% equity interest in Jiantou Xinyuan. We recorded income of US$4.4 million for the year ended December 31, 2009, compared to income of US$9.8 million for the year ended December 31, 2008. Our equity investee, Jiantou Xinyuan, recognized net income of US$9.8 million during the year ended December 31, 2009, compared to net income of US$21.9 million during the year ended December 31, 2008. The decrease primarily resulted from a decrease in sellable units in 2009, which led to a significant reduction in Jiantou Xinyuan’s real estate revenues. The decrease also slightly reflects our 45% share of US$7.5 million in penalties incurred by Jiantou Xinyuan in the third quarter 2009 as a result of Jiantou Xinyuan’s late payment of land premiums.

Change in fair value of derivative liabilities

We issued warrants to Series A preference shareholders and our floating rate notes holders, which were accounted for as derivative liabilities. The warrants issued to our floating rate notes holders entitle them to purchase our common shares at 80% of the price per common share sold to the public in our initial public offering in December 2007, or US$5.6 per share. During the year ended December 31, 2009, due to the shorter time to expiration, the fair value of such warrants decreased by US$169,736, from US$170,000 to US$264, which was charged to our earnings in 2009. During the year ended December, 2008, due to the decrease in our stock price, the fair value of such warrants decreased by US$16.4 million, from US$16.6 million to US$170,000, which was recorded to our earnings in our 2008 results.

Income taxes

Income taxes increased by US$9.1 million, or 84.8%, to US$19.8 million for the year ended December 31, 2009 from US$10.7 million for the year ended December 31, 2008. The increase was primarily due to an increase in our pre-tax income, partly offset by the reversal of allowance for deferred tax asset from Suzhou International City Garden. The reversal of allowance resulted from the improved profit outlook at Suzhou International City Garden. Our effective tax rate increased to 31.9% for the year ended December 31, 2009, from (83.1%) for the year ended December 31, 2008. In 2008, the valuation allowance arising from the impairment charge for Suzhou International City Garden contributed (115.6%) of effective tax rate. Excluding the impact of the above, the effective tax rate was slightly flat in 2008 and 2009, primarily resulting from that the favorable effect of the US$2.3 million reversal of allowance for the deferred tax assets from Suzhou International City Garden was offset by the negative effect of the US$2.1 million one-time tax charge related to our 2008 China tax returns filed in the second quarter of 2009.

We incurred a US$2.1 million tax charge related to our 2008 China tax returns filed in the second quarter of 2009. The adjustment resulted primarily from a one-time tax charge based on a central government interpretation, which was clarified during the second quarter of 2009. According to the new interpretation, provisional deemed profit tax payments made prior to January 1, 2008, when tax rates were at 33%, will be considered final and not subject to adjustment for the new tax rate of 25% effective January 1, 2008. Prior to the release of the new interpretation, we accounted for income taxes on pre-sales as prepaid taxes, measured at the applicable current tax rate in the year pre-sales occurred. Prepaid taxes then were credited against subsequent tax obligations when sales were finalized. As a result of the release of the new interpretation, we are no longer entitled to credit prepaid taxes against subsequent tax obligations to the extent prepaid taxes were assessed based on a tax rate in excess of the tax rate applicable in the year the sales are finalized (i.e. 33% prepaid tax will now be credited based on a tax cost of 25%).

Net income (loss)

Net income increased by US$66.1 million, from a loss of US$23.6 million for the year ended December 31, 2008 to a profit of US$42.4 million for the year ended December 31, 2009.

 

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Year Ended December 31, 2008 Compared to Year Ended December 31, 2007

Revenues

Revenues increased by US$46.9 million, or 15.1%, increase to US$356.6 million for the year ended December 31, 2008 from US$309.7 million for the year ended December 31, 2007.

Real estate sales

Revenue from real estate sales increased by US$46.5 million, or 15.2%, to US$352.2 million for the year ended December 31, 2008 from US$305.7 million for 2007, primarily as a result of increased residential unit sales. In 2008, we recognized revenues from Suzhou Lake Splendid, Suzhou Colorful Garden, Suzhou International City Garden, Kunshan International City Garden, Zhengzhou Commercial Plaza, Zhengzhou Colorful Garden, Hefei Wanjiang Garden, Jinan City family, Jinan Elegant Scenery, Jinan International City Garden, Chengdu Xinyuan Splendid I under the percentage of completion method, while revenue from other projects was recognized under the full accrual method.

Full accrual method revenues

The following table sets forth for the years ended December 31, 2007 and 2008 the aggregate GFA and the related revenues recognized under the full accrual method by project:

 

Project

   Total
GFA (1)
   GFA Delivered For
The Year Ended
December 31,
    Percentage of
Total GFA
Delivered as of
December 31,
    Revenues Recognized For The Year Ended
December 31,
 
          2008    2007     2008     2007     2008     2007  
     m2    m2    m2     %2     %2     US$    %(3)     US$     %(3)  

Zhengzhou Xinyuan Splendid 1A

   62,623    1,211    884      100.0   97.8   1,030,516    0.29   864,357      0.3

Zhengzhou Xinyuan Splendid 2B

   27,041    —      —        100.0   100.0   —      —        19,600      0.0

Zhengzhou Xinyuan Splendid 3A3B3C

   114,774    —      225      100.0   100.0   —      —        127,232      0.04

Zhengzhou Xinyuan Splendid City Homestead

   45,378    —      645      100.0   100.0   —      —        407,701      0.1

Other

   —      —      —            —      —        —        —     

Zhengzhou Xinyuan Splendid Subtotal

   249,816    1,211    1,754          1,030,516    0.29   1,418,890      0.5

Zhengzhou City Family

   39,392    3,249    5,968      100.0   91.8   1,908,470    0.54   3,391,900      1.1

Zhengzhou City Manor

   118,716    —      (57   100.0   100.0   —      —        (36,860   0.0

Jinan City Family

   47,411    162    42,661      100.0   99.7   1,240,750    0.35   30,704,002      10.0

Total

   455,335    4,623    73,883          4,179,736    1.20   35,477,932      11.6

 

(1) The amounts for “total GFA” in this table are the amounts of total saleable GFA and are derived on the following basis:

 

   

% for properties that are sold, the stated GFA is based on the sale contracts relating to such property;

 

   

% for unsold properties that are completed or under construction, the stated GFA is calculated based on the detailed construction blueprint and the calculation method approved by the PRC government for saleable GFA, after necessary adjustments; and

 

   

% for properties that are under planning, the stated GFA is based on the land grant contract and our internal projection.

(2) Percentage of total GFA delivered is the total GFA delivered as of a period end divided by the project’s total GFA.
(3) Percentage of all real estate sales revenues for the financial year, including revenues recognized under full accrual method and under percentage of completion method.

Percentage of completion method revenues

The following table sets forth the percentage of completion, the percentage sold and related revenues for our projects recognized under the percentage of completion method in the years ended December 31, 2007 and 2008.

 

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Project

   Total
GFA
   Percentage
Complete as of
December 31 (1) ,
    Percentage Sold (2) —
Accumulated as of
December 31,
    Revenues Recognized For The Year Ended
December 31,
 
          2008     2007     2008     2007     2008     2007  
     m2    %     %     %     %     US$    %(3)     US$    %(3)  

Zhengzhou Central Garden-East

   165,206    100.0 %   100.0 %   100.0 %   100.0 %   —      —        32,850,675    10.7 %

Zhengzhou Central Garden-West

   190,384    100.0 %   100.0 %   100.0 %   100.0 %   —      —        41,222,650    13.5 %

Suzhou Lake Splendid

   196,920    98.0 %   74.5 %   97.2 %   80.0 %   61,314,116    17.4 %   95,473,693    31.2 %

Jinan Elegant Scenery

   99,745    98.6 %   82.5 %   99.3 %   80.9 %   23,463,332    6.6 %   41,908,893    13.7 %

Zhengzhou Commercial Plaza

   67,280    93.0 %   61.5 %   94.7 %   71.2 %   21,310,379    6.1 %   19,175,646    6.3 %

Suzhou Colorful Garden

   81,077    92.0 %   74.5 %   62.8 %   3.9 %   45,384,982    12.9 %   2,670,704    0.9 %

Hefei Wangjiang Garden

   145,450    92.3 %   60.3 %   98.8 %   67.8 %   43,701,407    12.4 %   31,656,566    10.4 %

Jinan International City Garden

   254,035    79.9 %   46.5 %   66.4 %   6.6 %   97,549,755    27.7 %   5,231,733    1.7 %

Zhengzhou Xinyuan Colorful Garden

   191,783    76.8 %   —        25.5 %   —        29,708,577    8.4 %   —      —     

Suzhou International City Garden

   205,161    64.1 %   —        10.4 %   —        17,158,200    4.9 %   —      —     

Chengdu Xinyuan Splendid I

   230,893    54.5 %   —        4.1 %   —        4,053,916    1.2 %   —      —     

Kunshan International City Garden

   497,076    50.3 %   —        1.9 %   —        4,356,340    1.2 %   —      —     

Total

   2,325,010            348,001,004    98.8 %   270,190,560    88.4 %

 

(1) Percentage of completion is calculated by dividing total costs incurred by total estimated costs for the relevant project.
(2) Percentage sold is calculated by dividing contracted sales value from property sales by total estimated sales value of the relevant project.
(3) Percentage of all real estates sales revenues for the financial year, including revenues recognized under full accrual method and under percentage of completion method.

Real estate leasing

Real estate leasing income increased by US$0.04 million, or 12.0%, to US$0.38 million for the year ended December 31, 2008 from US$0.34 million for the year ended December 31, 2007. The increase was primarily due to an increase in leasing of parking space.

Other revenue

Other revenue increased to US$4.1 million for the year ended December 31, 2008 from US$3.7 million for 2007. The increase primarily resulted from revenue for real estate related services from operations we acquired in 2006. Property management fees increased by US$0.8 million to US$3.6 million for 2008, compared to US$2.8 million in 2007, mainly due to the expansion of our property management business, partially offset by a US$0.4 million decrease in landscaping fees.

Cost of revenue

Cost of revenue increased by US$148.8 million, or 71.5%, to US$357.0 million for the year ended December 31, 2008 from US$208.1 million for the year ended December 31, 2007.

Cost of real estate sales

Cost of real estate sales increased by US$147.1 million, or 71.7%, to US$352.3 million for the year ended December 31, 2008 from US$205.2 million for 2007. Total land use right cost increased by US$62.4 million, from US$97.9 million for the year ended December 31, 2007 to US$160.3 million for the year ended December 31, 2008. We recorded a total loss of US$76.8 million on the Suzhou International City Garden project, among which US$21.8 million was recognized as future loss and US$55.0 million was recognized as impairment loss on the project. Future loss recognized was the full expected gross loss over the life of the project at the time of estimated revision, regardless of the number of units sold. Additionally, for this project, an impairment loss was recognized by writing down the project carrying cost to the fair value of the project as determined by discounted future cash flows at a rate commensurate with the inherent risk associated with the project and related future cash flow. The construction cost, including capitalized interest, increased by US$29.7 million, to US$137.0 million for the year ended December 31, 2008 from US$107.3 million for the year ended December 31, 2007.

 

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Cost of real estate leasing

Cost of real estate leasing decreased by US$0.1 million, or 11.0%, to US$0.6 million for the year ended December 31, 2008 from US$0.7 million for 2007. The decrease was primarily due to the sale of assets that was previously held for lease.

Other costs

Other costs were US$4.1 million for the year ended December 31, 2008, as compared to US$2.3 million for 2007. Other costs represent costs incurred in connection with the property management services, landscaping and computer network engineering services, real estate agency services and other property related services we provided.

Gross profit

Gross profit/(loss) decreased by US$101.9 million, or 100%, to US$(0.3 million) for the year ended December 31, 2008 from US$101.6 million for 2007, due primarily to the US$21.8 million recognized future loss on Suzhou International City Garden and a US$55.0 million impairment loss on the same project. Gross loss was 0.1% in 2008 versus a gross profit of 32.8% in 2007.

Selling and distribution expenses

Selling and distribution expenses increased by US$3.1 million, or 29.1%, to US$13.6 million for the year ended December 31, 2008 from US$10.5 million for 2007. The increase was primarily due to higher headcount in our sales force, the launch of additional projects, as well as the increased level of marketing activities as we entered into new markets in 2008. As a percentage of revenue, selling and distribution expenses increased to 3.8% for the year ended December 31, 2008 from 3.4% in 2007.

General and administrative expenses

General and administrative expenses increased by US$15.3 million, or 89.4%, to US$32.3 million for the year ended December 31, 2008 from US$17.0 million for the year ended December 31, 2007. The increase was primarily due to raise of staff salary base, higher office rental and travel expenses since we relocated to Beijing, in addition to the full year impact of stock-based compensation amortization.

As a percentage of revenue, general and administrative expenses increased to 9.1% in the year ended December 31, 2008 from 5.5% in the year ended December 31, 2007.

Interest income

Interest income increased by US$2.1 million, or 146.4%, to US$3.5 million for the year ended December 31, 2008 from US$1.4 million for 2007. The increase was primarily due to favorable savings arrangements with our banks.

Interest expenses

Interest expenses, net of interest capitalized, decreased by US$3.2 million, or 100%, to US$ nil for the year ended December 31, 2008 from US$3.2 million in 2007. The gross interest expenses for the year ended December 31, 2008 consisted of US$26.5 million of interest on loans, US$0.5 million of accretion of discount arising from embedded derivative on convertible subordinated notes, US$3.7 million of accretion of discount arising from warrants and embedded derivative on senior floating rate notes and US$1.5 million of amortization of debt issuance cost. In the year ended December 31, 2007, the interest expenses consisted of the same components and change in fair value of embedded derivative on long-term debts.

Total interest costs incurred amounted to US$32.2 million for the year ended December 31, 2008, including US$8.3 million interest on our floating rate notes and convertible notes issued in April 2007, and US$6.4 million for the year ended December 31, 2007. Total interest expenses capitalized as part of the construction cost for the year ended December 31, 2008, 2007 and 2006 amounted to US$32.2 million, US$11.3 million, and US$1.5 million, respectively.

Exchange gains

For the year ended December 31, 2008, we recorded an unrealized foreign exchange gain of US$3.6 million, as compared to US$3.1 million in 2007, arising from translating certain U.S. dollar-denominated debts into Renminbi using the exchange rate at the balance sheet date.

 

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Share of income (loss) in an equity investee

Share of income (loss) in equity investee represents profit or loss associated with our 45% equity interest in Jiantou Xinyuan. We recorded income of US$9.8 million for the year ended December 31, 2008, compared to income of US$8.7 million for the year ended December 31, 2007. Our equity investee, Jiantou Xinyuan, recognized net income of US$21.9 million during the year ended December 31, 2008, compared to net income of US$18.9 million during the year ended December 31, 2007. The increase was primarily due to one new project launched in 2008.

Change in fair value of derivative liabilities

We have issued warrants to our Series A preference shareholders and floating rate note holders, which are accounted for as derivative liabilities. The warrants issued to the holders of our floating rate notes entitle such holders to purchase our common shares at 80% of the IPO price per common share in December 2007, or US$5.60 per common share.

Under US GAAP, we are required to recognize the fair value of the outstanding warrants as a liability on our balance sheet. We determine the fair value of the warrants on a quarterly basis using the Black-Scholes valuation method with increases/decreases in value resulting in a charge/credit to other income/expense.

At December 31, 2007, the fair value of the warrants and associated liability was estimated to be approximately US$16.6 million. At December 31, 2008, the market value of our common shares declined to US$1.22 per share, or US$2.44 per ADS. Due to the decline in 2008 in the market price of our common shares combined with the shorter remaining exercise period prior to the expiration of the warrants, the valuation of the warrants and associated liability as of December 31, 2008 decreased to US$170,000, resulting in corresponding credit of US$16.4 million to other income/expense.

The warrants issued to Series A preference shareholders became valueless as they expired without being exercised upon the consummation of our IPO on December 12, 2007. The decrease in the fair value of warrant liability of US$631,000 was recorded into earnings as “change in the fair value of warrant liabilities” in the year ended December 31, 2007.

Income taxes

Income taxes decreased by US$19.0 million, or 63.9%, to US$10.7 million for the year ended December 31, 2008 from US$29.7 million for 2007. The decrease was primarily due to a decrease of our pre-tax income and an unrecognized tax uncertainty benefit of US $8.7 million recognized in year ended December 31, 2007 arising from the adoption of a deemed profit method by one of our subsidiaries for statutory tax purposes, as well as the decrease of LAT. The decrease was also due to a net deferred tax asset of US$9.5 million arising from the impairment loss charged to Suzhou International City Garden project. Our effective tax rate decreased to (83.1%) for the year ended December 31, 2008 from 39.4% for the year ended December 31, 2007. The valuation allowance arising from the impairment charge for Suzhou International City Garden contributed (115.6%) of effective tax rate. Excluding the impact of valuation allowance, the decrease was primarily due to the reduction of the CIT rate from 33% for 2007 to 25% for 2008.

Minority interest

Minority interest for the year ended December 31, 2008 was nil, as compared to nil for 2007. The nil minority interest was due to the fact that Beijing Xinyuan Jinhe Investment & Development Co., Ltd., a company 99% owned by us, was dissolved in November 2006.

Net income

Net income decreased by US$69.3 million, from US$45.7 million for 2007 to a loss of US$23.6 million for the year ended December 31, 2008.

Discussion of Segment Operations

We consider each of our individual property developments as a discrete operating segment. As presentation of segment information for each property development would not be meaningful, we have aggregated our segments into the following reporting segments: (i) property developments in Zhengzhou, Henan Province, (ii) property developments in Jinan, Shandong Province, (iii) property developments in Suzhou and Kunshan, Jiangsu Province, (iv) property developments in Hefei, Anhui Province, (v) property developments in Chengdu, Sichuan Province and (vi) property management services and other real estate-related services we provide.

 

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     For the Year Ended December 31,  
     2007     2008     2009  
     (US$ in thousands, except for percentages)  

Zhengzhou, Henan

      

Total revenue

   98,455      53,717      90,520   

Total cost of revenues

   (50,369 )   (43,542 )   (73,343

Gross profit

   48,086      10,175      17,177   

Gross margin

   48.8 %   18.9 %   19.0

Operating income (loss)

   38,026      (5,304 )   4,219   

Jinan, Shandong

      

Total revenue

   77,863      123,543      89,783   

Total cost of revenues

   (63,996 )   (99,303 )   (75,463

Gross profit

   13,867      24,240      14,320   

Gross margin

   17.8 %   19.6 %   15.9

Operating income (loss)

   10,496      19,916      11,549   

Suzhou, Kunshan and Xuzhou, Jiangsu

      

Total revenue

   98,150      128,442      198,198   

Total cost of revenues

   (67,700 )   (176,696 )   (153,230

Gross profit

   30,450      (48,254 )   44,968   

Gross margin

   31.0 %   (37.6 )%   22.7

Operating income (loss)

   25,632      (56,909 )   36,580   

Hefei, Anhui

      

Total revenue

   31,670      43,642      6,954   

Total cost of revenues

   (23,773 )   (30,498 )   (4,356

Gross profit

   7,897      13,144      2,598   

Gross margin

   24.9 %   30.1 %   37.4

Operating income (loss)

   5,865      11,763      2,045   

Chengdu, Sichuan

      

Total revenue

   42      4,078      56,620   

Total cost of revenues

   —        (3,816 )   (47,818

Gross profit

   42      262      8,802   

Gross margin

   —        6.4 %   15.5

Operating income (loss)

   (1,502 )   (3,505 )   6,209   

Others

      

Total revenue

   3,546      3,209      6,909   

Total cost of revenues

   (2,298   (3,125 )   (5,529

Gross profit

   1,249      84      1,380   

Gross margin

   35.2   2.6 %   20.0

Operating loss

   (4,518   (12,232 )   (5,015

Year Ended December 31, 2009 Compared to Year Ended December 31, 2008

Zhengzhou, Henan. Total revenues increased by US$36.8 million, or 68.5%, from US$53.7 million for the year ended December 31, 2008 to US$90.5 million for the year ended December 31, 2009. The increase was primarily due to expanded sales from Zhengzhou Xinyuan Colorful Garden. The gross profit for this region was US$17.2 million in the year ended December 31, 2009, representing an increase of US$7.0 million, or 68.8%, as compared to US$10.2 million in the year ended December 31, 2008. The increase in gross profit resulted from increased selling prices of Zhengzhou Xinyuan Colorful Garden to meet the higher demand in 2009. Net operating income was US$4.2 million for the year ended December 31, 2009, improved from a loss of US$5.3 million in the year ended December 31, 2008. Such improvement was due to the increase in revenues as described above.

Jinan, Shandong. Total revenues decreased by US$33.7 million, or 27.3%, from US$123.5 million for the year ended December 31, 2008 to US$89.8 million for the year ended December 31, 2009. The decrease was primarily due to a reduction in sellable units during the year ended December 31, 2009. Revenue during the year ended December 31, 2008 was mainly derived from Jinan Elegant Scenery and Jinan International City Garden, while in the year ended December 31, 2009 the only project with remaining sellable units was Jinan International City Garden. The projects in the Jinan, Shandong segment generated a gross profit of US$14.3 million in the year ended December 31, 2009, compared to a gross profit of US$24.2 million in the year ended December 31, 2008. The gross margin decreased to 15.9% for the year ended December 31, 2009 from 19.6% for the year ended December 31, 2008, which mainly resulted from the increase the total project estimated cost as the project was near completion in 2009. Net operating income was US$11.5 million for the year ended December 31, 2009, down from US$19.9 million in the year ended December 31, 2008. Such decrease was due to the decrease in revenues as described above.

 

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