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Danke (Part 1): China's High Profile Real Estate Ponzi Scheme

Danke ("dahn-keh" - pronounced similarly to the German word for thank you), full name Phoenix Tree Holding Limited (Chinese: 蛋壳公寓) (NYSE: DNK), is a Chinese real estate company founded in 2015 that offers standardized rental accommodation to primarily individuals but also corporate clients across various cities in China. The company's philosophy is "to help people live better", by leasing from landlords and providing affordable accommodation with consistent and high quality services to renters in major Chinese cities. Danke claims to possess an extensive technology infrastructure, including an artificial intelligence decision engine and a big data platform which the company relies on to carry out its business processes.

Whilst the technology claim may seem like a stretch, the idea of affordable, standardized rental accommodation in big cities where the cost of living can be very high, does sound like an attractive and viable business idea. Nevertheless, problems surrounding Danke's business model and cash flows quickly emerged not long after the company's IPO on the New York Stock Exchange in January 2020, and the founder of the company was subsequently arrested for investigation five months later. By October 2020, the COO and the majority of Danke's accountants and finance employees had left, and in early November most of the company's assets were frozen in the face of multiple lawsuits. By December last year, the CFO had resigned, and the company was in a state of resolution as renters and landlords across the country negotiated with Danke and Tencent's WeBank to decide on mutual solutions.

What seemed like a promising business idea had proved itself to be the most high profile Ponzi scheme in China's real estate market. Danke was fueling a heavily debt-driven expansion by encouraging renters to engage in rent financing arrangements with partner financial institutions, whereby almost a year's worth of rent would be advanced in loan to Danke upon the inception of each rental contract. The company used these "rent loans" to lease additional properties, while simultaneously offering above-market rates to attract new landlords as part of an attempt to increase market share in key strategic areas of many major Chinese cities. With the COVID-19 pandemic as a trigger, Danke couldn't fulfill the high leasing costs incurred as a result of the company's rapid expansion and eventually defaulted on payments to landlords and contractors, as renters were asked to leave their homes while still being expected to make continued rental payments to partner banks in order to pay off Danke's rent loans.

This article is the first installment of the Danke series, where we provide an introduction to the company's history and business model, followed by a brief prelude to the eventual downfall.

In Part 2, we analyze the company's collapse by examining Danke's financial statements and relevant news reports to identify the key factors that contributed to and could have potentially predicted the company's downfall.

In Part 3, we provide a recap of the rise and fall of Danke, as well as discuss some of the questions, issues brought up, and lessons learnt from the collapse of this real estate Ponzi scheme.


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History and Business Model

Launch of Danke Apartment

Danke was founded in January 2015 with the launch of the product Danke Apartment, a standardized long term rental accommodation scheme whereby Danke leases apartments from individual property owners and renovates and furnishes the properties to the company's standards. The apartments are then primarily rented out to individual renters as either private rooms within a multi-bedroom apartment (i.e. co-living space), but also occasionally as an entire multi-bedroom apartment unit. Danke manages the servicing of apartments leased through the company's platform by serving as the sole intermediary and single contact point for renters and landlords, whilst hiring reliable third-party contractors to carry out the necessary services in a timely manner. The entirety of the leasing process is conducted online, and Danke does not have and never did have any physical storefronts.

Danke's stated goals are to provide centralization and standardization to China's residential rental market through the use of an online platform. According to the company's prospectus, Danke Apartment's primary clientele are young, college-educated working professionals in the 22 to 30 age group who value affordability, consistency, high quality service, and convenience.

Danke's Business Model
Source: Danke Prospectus

Introducing Dream Apartment

Danke introduced a second product, Dream Apartment, in November 2018 to target underserved blue collar workers struggling to find accommodation in major Chinese cities with high costs of living. The company leases several floors and/or entire buildings from property owners, and transforms the leased properties into dormitory-style apartments with multiple beds in each room. The rooms are then rented out to corporate clients for employee accommodation. Dream Apartment's clientele range from local business owners to large corporates such as hotel chains, hospitals, and delivery companies. Danke's goal in launching Dream Apartment is to "provide value-for-money options" to corporate clients and improve the living condition of blue collar workers in expensive big cities.

The Role of Danke Brain

One of the key selling points Danke tries to promote is its emphasis on technology, where Danke claims that the company is run "like a data science company" rather than as a traditional real estate rental firm. Danke's technology system consists of an artificial intelligence decision machine called Danke Brain, which "makes real-time and unbiased decisions based on data analytics to guide each step of [the company's] business operations". Danke Brain is supported by Danke's big data platform, which can generate rapid pricing decisions that take into account a myriad of factors without relying on local real estate agents.

Rental Contracts and Financing

Danke Apartment

Danke usually enters into four- to six-year leases with property owners and pays rent to the owners on a monthly or quarterly basis. On the other hand, renters can choose to prepay rent on an annual, semi-annual, or quarterly basis.

Rent Financing Schemes

Danke also cooperates with licensed financial institutions (predominantly WeBank) to offer rent financing arrangements to renters who pass a credit check. The rent financing agreements are structured such that Danke is effectively taking a loan from the bank with future rent payments pledged as collateral, where the bank gives Danke an upfront payment (i.e. essentially a loan) typically worth 11 months' rent (the first month's rent is prepaid by the renter) which renters will gradually repay over time to the bank with their monthly rent payments. Danke pays the corresponding interest on the loan to the financial institutions. In the event of early termination of a lease or a renter's default, Danke is liable for returning the upfront payment for the remaining lease term to the partner financial institution.

How Rent Loan Financing Works
Rent Loan Financing Scheme

Dream Apartment

Danke enters into ten-year leases with property owners and pays rent to the owners on a semi-annual basis. Dream Apartment's corporate clients typically sign one- or two-year leases with Danke and pay rent to Danke on a quarterly or semi-annual basis.

The Appeal of Danke

Danke's business model has aspects that appealed to and drew in many renters and property owners, allowing the company to quickly dominate many popular residential areas in major Chinese cities.

Above-Average Service and Individual Co-Living Units for Rent to Attract Young Renters

Danke attracted many young professional renters by providing above-average service through hiring reliable third-party contractors to service the company's apartments. Whereas renting directly from a landlord typically involves variable service depending on the individual landlord, Danke's partner contractors usually provide consistent, good quality and timely service. Additionally, renting one bedroom out of a multi-bedroom apartment unit (which are very common in big Chinese cities) can be easily done through Danke, compared with the traditional method of finding a group of friends to rent together or renting the entire unit out and then subletting to others.

Above-Market and Guaranteed Rent Payments to Attract Landlords

Danke attracted property owners to lease with the company by promising above market rent payments to landlords, in addition to guaranteeing monthly rent payments even if a property is not rented out. Although these promises did increase Danke's operating expenses, however since Danke dominated popular residential areas in many cities and charged rental rates that were slightly above the market rate, the company did have some ability to pass on the increased costs to renters.

Achieving Market Monopoly

The rent financing scheme whereby Danke was able to obtain a year's worth of rent upfront in the form of a loan, in addition to the attractive perks that drew in many renters and owners, allowed the company to expand very rapidly, quickly reaching monopoly status. For example, in 2018, most rental properties in Beijing were leased by long term rental companies including Danke, as the city witnessed colluded rent manipulation where the average market rent increased by 50% over a matter of weeks until the local government eventually intervened.

Rapid Growth and Expansion

Danke expanded rapidly since its founding in January 2015, especially with its Danke Apartment product which was the core focus of the company's business since inception.

Danke Apartment - Rapidly Generating Ready-to-Move-In Units

Danke operated 2,434 individual Danke Apartment units in Beijing in December 2015, which grew to 438,309 units in 13 different cities in China by the end of December 2019, representing a 180-fold increase (note: the diagram below from Danke's prospectus shows a 166-fold increase from December 2015 to September 30th 2019). As of the end of 2019, approximately half of the total Danke Apartment units were located in Beijing, Shanghai, and Shenzhen.

Number of Danke Apartment Units per year
Source: Danke Prospectus

During the March 2019 to March 2020 period, the number of opened units (defined as apartment units with ready-to-move-in status, irrespective of whether or not they are rented out) increased substantially, whereas the number of pre-opening units (defined as apartment units that are not yet ready for renters to move in) dropped substantially during the second half of the year. As of December 2019, the occupancy rate for Danke Apartment was 76.7%.

Danke apartment status
Source: Danke Q1 2020 Earnings Report

Dream Apartment - A Project Still in the Making

As of the end of 2019, Danke operated nine Dream Apartment facilities in Beijing with a total of 8,558 beds. At the same time, Danke also had four additional facilities under renovation in Beijing, Shanghai, and Shenzhen, with a total planned capacity of 3,752 beds. One of the facilities had finished undergoing renovation in December 2019, whilst another two facilities were expected to be completed in Q2 2020 and a third facility in Q3 2020. No further updates were provided regarding the statuses of these facilities in Danke's Q1 2020 earnings report.

Six Rounds of Financing and Going Public

Since the company's inception in 2015 to the end of 2019, Danke received six rounds of financing from notable Chinese venture capital firms and other investors, most notably Ant Financial (now known as Ant Group). On January 2017, Danke had its first initial public offering on the New York Stock Exchange with an opening price of US$13.5 per share.

The Collapse

Along with its aggressive expansion, the leasing costs Danke owed property owners rapidly accumulated, while the company also burnt a substantial amount of cash renovating new properties to conform with the Danke standard. With the onset of the COVID-19 pandemic during the lunar new year, many Chinese residents were locked down in their hometowns and couldn't return to the cities where they worked. This left major cities with a huge oversupply of empty apartments, as Danke's rapid expansion was halted and the company was forced to fulfill all of its built-up financial obligations with only existing resources.

Danke at first delayed and then eventually defaulted on lease payment obligations to property owners, leading many landlords to evict the tenants living in their apartments. At the same time, renters engaged in a rent financing scheme were still asked by partner banks to continue making rent payments in order to pay off the upfront loans granted to Danke. As Danke's financial turmoil continued to worsen, the company ceased paying the majority of its employees, resulting in no point of contact for landlords or renters to manage or terminate their leases. Chaos ensued as property owners, tenants and even Danke employees gathered outside the company's headquarters to protest.

UPDATE: Trading of Danke stock was suspended on March 15th, 2021, and the company's American depository shares were subsequently delisted from the NYSE on April 6th, 2021.

To Be Continued...

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Explore the Danke Series


The New Anti-Trust Law - What Does the Future Hold for China's Internet Giants?

Investing in China

Glossary of All China-Related Terminology


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