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Before making any argument, let's refer to the following numerical example for the illustration of financial projection of real estate project including calculation of IRR.
It was reasonable to presume readers to have basic accounting background and knowledge of all PRC taxation relevant to real estate project, such as Business Tax, Deed Tax, Land VAT, etc.
Again, please be reminded that all figures of sale and cost quoted below were for illustration purpose, of which the reasonableness should not be questioned.
Suppose that:
(1) one newly set up project company was 100% owned by one developer;
(2) the parent company can provide equity finance to the project company at any time, hence no external finance was required;
(3) the project company acquired land right from government at time 0 which was located in a city of PRC.
(4) the development period will last for 4 years.
(5) the development cost will be paid equally in each FY.
(6) the progress of cash sale will be equal in each FY.
(7) there is no prepayment from customers because of lack of decoration.
(8) Operating Data:
total revenue of project = 4 Bn (by assumption)
total development cost other than land cost = 0.5 Bn (by assumption)
total operating expense = 0 Bn (by assumption)
total Land Cost = 1.4 Bn (byassumption)
Then, the calculation of tax payable relevant to real estate project except for Stamp Duty (in Chinese"印花税") was shown as below:
(1) total Deed Tax (in Chinese"契税") of land acquired = 1.4 Bn*3% = 0.042Bn
(2) total Business Tax (in Chinese "营业税") = 4 Bn*5% = 0.2 Bn
(3) Sum of Tax for Maintaining and Building Cities (in Chinese "城市维护建设税"),Education Supplementary Tax (in Chinese "教育费附加") and Local Education Supplementary Tax (in Chinese "地方教育费附加")= 4 Bn*5%*10% = 0.02 Bn
(4) Computation of total Land VAT (in Chinese "土地增值税"):
(4.1) total Land Value Added = taxation income - recognized land cost -recognized development cost - recognized operating expense - recognized additional deductible - any taxes relevant to project
= 4 - (1.40+0.042) - (0.5) - (0)- (1.40+0.042+0.5)*20% - (0.2+0.02)
= 1.4496 Bn
(4.2) total deductible item's sum
= (1.40+0.042) + (0.5) + (0) +(1.40+0.042+0.5)*20% + (0.2+0.02)
= 2.5504 Bn
(4.3) total Land Value Added / total deductible items
= 1.4496 / 2.5504 = 57%
(4.4) total Land VAT payable
= 1.4496*40% - 2.5504*5% = 0.45232Bn
(5) Computation of total Corporate Income Tax (in Chinese "企业所得税"):
(5.1) Taxation Profit of each FY
= 4*25% - 1.442*25% - 0.5*25% -0.22*25% - 0.11308
=0.34642 Bn
(5.2) total Corporate Income Tax of each FY = 0.34642*25% = 0.086605 Bn
the Cashflow data of project:
at time 0: (1.442) Bn
at time 1: 0.620315 Bn (4*25% - 0.5*25% - 0.22*25% - 0.45232*25% - 0.086605)
at time 2: 0.620315 Bn
at time 3: 0.620315 Bn
at time 4: 0.620315 Bn
IRR = 25.89%
Besides, the assumptions adopted by previous example should be criticized by following reasons:
(1) most project companies are heavily leveraged of which the deductibility of finance cost depends on the form of financing, such as shareholder’s loan, loan borrowed from nature person, loan borrowed from FI,etc, as the corresponding tax treatment when calculating land VAT and Corporate Income Tax depends on form of financing in accordance with relevant PRC tax laws.
(2) project companies usually collect down-payment once the S&P agreement was signed, and rest of AR will be settled till developers deliver the sold apartments,so that settlement of sale receipt is not in line with accounting sale and taxation sale (also applicable in the case of prepayment).
(3) sometimes, some costs allocated to project cannot be deductible when calculating Land VAT and Corporate Income Tax, which make tax computation even more complicated.
(4) In practices, whenever project companies has taxation profit or loss, project companies must prepay Land VAT and Corporate Income Tax in each FY. Accordingly, the prepayment of Land VAT and Corporate Income Tax results impact on net cashflow pattern.
With reference to the example as said before, I hope that you can understand the complication of calculating IRR of real estate project, even if lots of assumptions being made in previous example, on which any proposed business decisions, including but not limited to decoration of apartment before sale, may have adverse or constructive effect.
Also, I am sure that readers can code up situations, by altering the assumptions and parameters, to support the claims that “if selling decorated dapartment, IRR of ONE specific real estate project will be enhanced”, and “if selling decorated apartment, IRR of ONE specific real estate project will not be enhanced”.
What I am trying to emphasize was that the financial projection must be revised for each proposed business decisions to determine whether IRR and net cashflow pattern is improved.
To me, the statement "精装修都会有助于IRR的",claimed by you, implies that “if selling decorated apartment, IRR of ANY real estate projects must be enhanced”. But, as discussed before, there is no causation relationship (in Chinese "因果关系") between selling decorated apartment and IRR of ANY projects since that business decision may have adverse or constructive effect on IRR.
除非极端情况，精装修都会有助于IRR的。极端情况，房子卖不掉，大量现房，装修完还没卖出去。但这不是精装修的初衷。
此外，最早公开对外说精装修降低毛利率，提升IRR和ROE的，不是恒大，是万科的董秘。
1st, I agree with the point that the decoration will be charged at a mark-up of cost.
2nd, the prepayment from customer could be viewed as loan of zero interest rate, but the corresponding effect of lowering finance cost will totally depend on the amount of prepayment received and the annual interest of project financing in billion RMB. Therefore, no one could tell the resultant effect of lowering finance cost unless a detailed financial projection was reached.
At last, it is not a must to increase IRR if selling decorated apartment.
恒大的房子都是“赠送”精装修。所以装修款都是和房款同时收上来的。另外，虽然精装房售价（比如6500）并不高于周边毛坯房售价（比如5500）加名义装修标准（比如1500），但还是高于毛坯房加实际装修成本（比如800）的。所以，精装修单独看肯定不亏，但毛利率不如毛坯房，所以会拉低公司毛利率。但无疑提高了净现金流和IRR。
Above all, the additional decolorating business is profitable due to large purchasing volume. Secondly, the developer receives the decolorating payment from customers in advance, many months before paying to the suppliers. That means, the business must be benefit to the cashflow and IRR.
But, we should consider whether the business decision of selling decorated apartment (in Chinese "精装修房 ") will really increase IRR of project, of which the answer will depend on specific situation of each projects, especially the net profit marginand timing of additional cash inflow/outflow.
Again, please be reminded that all figures quoted below were for illustration purpose, of which the reasonableness should not be questioned.
Assume that one project company was 100% owned by the developer to which developer injected capital of 20 Mn,and the net profit margins of each fiscal year (in short "FY") were equal to net cash flow of each FY.
Original Net Cash inflow/(outflow)'s Data
initial time: (40) Mn
at 1st FY end: (-10) Mn
at 2nd FY end: 50 Mn
at 3rd FY end: 50 Mn
Original IRR = 35.44%
Situation (1): Assume the business decision of selling decorated apartment did not increase net profit margin, finance cost remained unchanged and relevant tax effect was ignored, in which the additional cost of decoration of 1 Mn was paid in 1 FY and additional sale receipt of decorationof 1 Mn was collected in 3rd FY, then the modified cash flow data was shown asbelow
initial time: (40) Mn
at 1st FY end: (-11) Mn
at 2nd FY end: 50 Mn
at 3rd FY end: 51 Mn
Original IRR = 35.02%
Situation (2): Assume all conditions of situation (2) was as same as that of situation (1) except for that 0.5 Mn were collected both in 2nd and 3rd FY, then the modified cash flow data was shown as below
initial time: (40) Mn
at 1st FY end: (-11) Mn
at 2nd FY end: 50.5 Mn
at 3rd FY end: 50.5 Mn
Original IRR = 35.11%
From the above numerical example,the IRR was decreased, mainly due to the timing of cash inflow and outflow of decorating apartment, even if the net profit margin of selling decorated apartment was zero.
In addition, the tax effect of selling decorated apartment would definitely affect cashflow of real estate project adversely, since the additional receipt will increase gross revenue which will further increase tax burden of Land VAT and Business Tax causing additional cash outflow generally.
Practically, it was suggested that the developer should examine cash flow analysis precisely before judging whether the business decision of selling decorated apartment increase or decrease the IRR of real estate project.
You're abosolutely right! While in the long run, the higher the IRR for every single project, the higher the ROE for the whole company.
Based on my past practical experience, real estate developers usually evaluate any real estate development projects (in short "projects") by examining "Internal Rate of Return" (in short "IRR") of projected cash flow analysis, rather than appraising "Project ROE" (in Chinese "项目ROE"), of which the reasons was illustrated by following example of 3-year development periods:
Assume that one project company was 100% owned by the developer to which developer injected capital of 20 Mn, and the net profit margins of each fiscal year (in short "FY") were equal to net cash flow of each FY.
Please be reminded that all figures quoted below were for illustration purpose, of which the reasonableness should not be questioned.
Net Cash inflow/(outflow)'s Data:
initial time: (40) Mn
at 1st FY end: (-10) Mn
at 2nd FY end: 100 Mn
at 3rd FY end: 100 Mn
Then, the "Project ROE" of 1st, 2nd and 3rd FY would be -50% (-10/20), 500% (100/20) and 500%, so "Project ROE" (in Chinese "项目ROE") does not seem to be a reliable project appraisal tool due to its fluctuating numerical pattern supported by previous example.