Haunted house

China property dispute unearths debt skeletons

When investing in property, check the basement. Kaisa shows what happens when that advice is ignored. Days after rattling lenders with a late interest payment, the Chinese developer has announced its debts are double the level it reported at the end of June. That raises the stakes for the company's restructuring, and others that may follow.

Kaisa, putting its affairs in order ahead of a potential takeover from rival Sunac, says its debt at the end of December totalled 65 billion yuan ($10.4 billion), around half of it from lenders other than banks. That may help explain why the apparently cash-rich company failed to pay a $26 million interest payment on time, and recently had to raise $380 million for working capital.

Where the extra debt came from is a mystery. Part of it may be borrowing by unconsolidated subsidiaries: those entities had 42 billion yuan of debt at the end of 2013. But if Kaisa is now recognising those liabilities, it should count the subsidiaries' assets, too. Another explanation could be that Kaisa has reclassified other liabilities as debt.

Painting a bleak picture could be a tactic. Kaisa's offer from Sunac depends on the company restructuring its debts, and one way to soften up creditors is to suggest they're much worse off than they thought. The company's bonds due 2017 dropped from 70 cents on the dollar to 66 cents on Monday. But if bondholders resist, the rescue could fall apart.

The dispute has wider resonance. China's property sector is unusually complex when it comes to raking over who owes what to whom. Projects are often set up through minority investments in separate vehicles. Kaisa has hundreds. The debt doesn't show up on the balance sheet unless it is guaranteed by the parent company.

Investors should start looking for other dark crannies. Sunac had 36 billion yuan of consolidated debt at the end of June - but its subsidiaries had at least 85 billion yuan, according to its last bond filing. Shimao, which just issued an $800 million bond, reports 55 billion yuan of debt, but more than 115 billion yuan including subsidiaries. When debts sit not just across the border but also below ground, there's plenty of room for confusion - and disappointment.