What's up guys and welcome back to wall street millennial on this channel, we cover everything related to stocks and investing over the past few months. We've spent a lot of time covering the excessive risk taking in the chinese real estate industry, which has culminated with the collapse of evergrand and other real estate developers. Excessive optimism and easy to access cheap credit have motivated developers to take on more and more extreme projects. In the hopes of making huge returns, perhaps the most extreme example of this is the 100 billion dollar forest city, artificial island development.

In malaysia, this mega project was first conceived of in 2006 and was to be jointly funded by the local government in the massive chinese property developer country garden. The plan was for the new city to house 700 000 luxury apartment units, as well as five-star hotels and other luxury amenities. However, the confluence of political events, as well as the covet-19 pandemic, have turned this once great mega project into a 100 billion dollar boondoggle, where the investors stand to possibly incur huge losses. This could be a big problem for country garden, who could end up eating billions of dollars worth of losses on the project.

Country garden is china's largest property developer by sales, they're less leveraged than their peer evergreen, and thus been able to avoid financial distress, but the losses from their forest city project, as well as the broad slowdown in the chinese real estate market, could materially affect their operations. Going forward in this video we'll go over what forest city is, why it failed and what impacts this will have on country garden. First conceived in 2006, the four city project appeared to make a lot of sense. It'd be an artificial island off the southern tip of johor malaysia and in close proximity to the island nation of singapore.

Many chinese citizens either work or have kids that go to school in singapore, but limited space on the island has pushed real estate prices sky high. While not cheap by absolute terms, apartments in the forest city development were projected to sell for about one quarter, the price of equivalent properties just a few miles away in singapore, the project was to be developed by a joint venture, called country, garden, pacific view, country garden. Would own sixty percent of the jv, while malaysia's state-owned enterprise went on the remaining forty percent country garden, planned to sell properties on the island primarily to chinese citizens who would buy them as second homes? This way they can leverage their existing expertise as china's largest property developers. They plan to take advantage of the recently passed malaysia, my second home program, which gives 10-year visas to foreigners who meet minimum net worth and income requirements.

Chinese residents who could afford to buy a home in forest city island should be able to easily meet these requirements and thus attain a visa. While the business proposition sounded solid, it would not be cheap. Construction of the artificial islands started in 2014.. The entire project was expected to last 20 years and cost upwards of 100 billion dollars.

It would consist of four massive artificial islands which would house 700 000 apartment units along with hotels and shopping centers. They also plan to make it a green city with many parks and vegetation growing from the skyscrapers. There will be an elaborate network of underground parking lots and roads such as the surface will be left completely free to pedestrians, who can use a state-of-the-art rail system for transportation. There would be tourist attractions that showcase rich wildlife and surrounding seas, including seahorses sea turtles and dugong, which are close cousins of manatees.

It will be a smart city with major buildings and infrastructure digitally connected to a central operating system which can manage congestion and utilities efficiently. In their own words, it would be an exclusive and green living paradise shortly after construction started, residents from local fishing villages started complaining about reduced catches. The effect of the new artificial islands significantly impacted the natural ocean currents in surrounding coastal regions. Environmental reports found that the development, as originally proposed would result in habitat destruction and massive fish deaths, country garden agreed to reduce the size of the islands and plant protective sea grass beds in between them.

This wasn't that big of a deal and construction of the islands continued on without much interruption, but the biggest issue with the forest city project wasn't environmental or technical, but instead political. The project was originally approved by malaysian prime minister najib razak, as well as sultan ibrahim ismail, who was in charge of the johora state. They approved the project as it promised to bring billions of dollars in economic development to the region and create tens of thousands of local jobs. In 2018, prime minister najib razak lost re-election and was subsequently charged with corruption relating to a multi-billion dollar 1mdb scandal.

His replacement was mathieu muhammad, who had a much less favorable view on foreign investment in malaysia. This would become a big problem for the forest city development throughout the preceding decade. China's foreign direct investment into malaysia had increased substantially many malaysians viewed this increased investment unfavorably as they feared for an influence over important assets in the country. The forest city development, in particular, created a lot of controversy.

While the apartments were cheaper than equivalent properties in singapore. They were still slated out to be out of reach for most residents as of 2019. They had pre-sold, roughly fifteen thousand residential units. Seventy percent of these pre-sales were to chinese citizens, while only twenty percent were the local malaysians.

Many people in malaysia feared that four city would become an isolated enclave for foreign elites and be disconnected from the broader community. In 2019, country garden was hit by a one-two punch of political headwinds that were largely beyond their control. In an effort to better control their currency, the chinese government tightened their capital controls. They implemented a new fifty thousand dollar annual cap on how much that people could spend on foreign real estate with four city apartments selling for more than one hundred thousand dollars each.

This almost completely shut the doors for many chinese buyers, but an even bigger problem came from the malaysian government. In 2018, they banned foreigners from buying properties in forest city. The ban came as the new malaysian government wanted to crack down on foreigners entering the country and having significant influence within the economy. Prime minister, mahathir mohamad, said quote: one thing is certain: the city that is being built cannot be sold to foreigners.

We are not going to give visas for people to come and live here. Our objection is because a project is built for foreigners not built for malaysians. Most malaysians are unable to buy these flats unquote. The ban was a complete disaster for the project.

From the very beginning, it was designed with the intention to sell apartments to wealthy chinese citizens with foreigners banned. There would not be enough demand to sell the 700 000 units at anything close to break-even prices. After facing severe backlash for the decision, mahathir relaxed the ban on foreign buyers, but importantly, he said that buyers would not be eligible for the malaysian my second home visa program, which was the main way that chinese buyers expected to gain entry into malaysia. With this visa program gone, it is unclear how chinese citizens could obtain a long-term visa, and even if they could get a visa, many chinese buyers would be hesitant.

Given the unpredictability of malaysia's immigration policies, the chinese currency controls, along with the visa situation, dragged new pre-sales down to near zero. By the beginning of 2020, there were a few thousand chinese citizens living in four city who had purchased their properties before the bans were enacted. But with the onset of the coveted pandemic, most of them returned home and because of covet related travel restrictions, they could not return to malaysia for the foreseeable future facing the prospect of not being able to return. Many homeowners started selling their four city properties for losses.

As great as 50 percent with travel shut down, country garden wasn't selling any new apartments, and as of today, it is estimated that as little as 500 people currently live on the island in september of 2021 country, guardian announced that it was laying off two thirds of Its malaysian staff as sales of its new apartments have ground to near zero. To date, they have invested more than five billion dollars into the project at the behest of the government country garden plans to start building, affordable homes that can be purchased by malaysian citizens. Given that foreign buyers are effectively banned from buying homes, they don't really have any other options, but reducing the prices of the homes does not reduce the cost of building the artificial island in city infrastructure. The costs of building the island were budgeted under the assumption that they would sell them for high prices to wealthy chinese buyers.

Now that they'll be selling them for much lower prices, they'll almost certainly fail to recoup the cost of building the island. Today, they've only constructed one of the four planned islands. Unless things can change quickly, the other three islands will probably not be developed. Forest city is one of the biggest, if not the biggest project, that country garden is involved in the total value of the city was originally projected to be 100 billion dollars, which is five times greater than country garden's current market cap.

Despite this, the company has been almost silent about it in their financial reports. Force city is not mentioned a single time in their 2020 annual report country, guardian pacific view, which is the name of the joint venture involving forest city, is only mentioned once in a list of all of their subsidiaries, but they give zero information about its financial performance. The last time they talked substantively about forest city was in their 2016 annual report, and they just talked broadly about what the project is without giving any concrete updates about its development cost in their disclosures about the gross floor area of their real estate. All the numbers are reportedly excluding forest city.

Their disclosure about their overseas land bank also excludes forest city. The only place we've been able to find information on country garden's investment in forest city is a malaysian publication called the star.com which says that the company has spent a little under five billion dollars on it. So far, four cities being developed by a majority owned subsidiary of country garden and according to media reports, they've already sunk, almost five billion dollars into the project. The results of four city are certainly material to country, gardens group level financials.

So it seems very strange that they've made almost zero disclosures about it in their annual reports unless we're missing something, it appears that country garden doesn't want investors to pay attention to forest city. Given the problems the artificial island has experienced over the past few years, the value of the investment probably should have been marked down by billions of dollars. By now, it is not immediately obvious how big the liabilities to country garden will be if the project continues to underperform expectations. Lack of transparency has long been a problem with chinese real estate developers.

Citrons andrew left made allegations that evergrand was hiding its liabilities back in 2016. with the company's recent financial distress. It appears that left was finally vindicated. We're not saying that country garden is anything like evergrand, and this video is not financial advice, but the lack of disclosure on their massive four-city project should give investors pause.

Alright, guys that wraps it up for this video. What do you think about the forest city debacle? Why do you think country garden has given so little disclosure about it over the past few years? Let us know in the comments section below, as always. Thank you so much for watching and we'll see in the next one wall, street millennial signing out.