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 (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 quality 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, which the company used to lease more properties to rent out. At the same time, Danke was offering above-market rates to attract property owners as part of an attempt to increase market share and monopolize many popular areas of major cities in China. Eventually, 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 both landlords and contractors, as renters were asked to leave their homes while still being expected to make continued rental payments to the banks to pay off the 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 focus on analyzing Danke's collapse by first looking at a timeline of major events marking the company's gradual decline, then subsequently discussing the key factors that precipitated and could have predicted the end of the Ponzi scheme. In Part 3 (forthcoming), we conclude the rise and fall of Danke and reflect on the important lessons learnt from this phenomenon.
Explore The Danke Series...
Part 1: Company Overview
In Part 1, we provide a general overview of the company by exploring Danke's detailed history and business model.
In Part 2, we start with a timeline capturing the main events surrounding Danke in 2020, from IPO to collapse. We next dissect Danke's financial statements and related news reports to analyze the factors that contributed to Danke's downfall, in addition to discussing the extent to which Danke's collapse was foreseeable.
Part 3: Recap and Lessons Learnt
In Part 3 (forthcoming), we conclude by providing a recap linking Parts 1 and 2. We also discuss the lessons learnt from Danke's collapse, and provide a glimpse as to whether or not the phenomenon of Danke's downfall will be repeated in the future.
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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 where 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.
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 tried 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 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.
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 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 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 the property is not rented out. Although these promises did increase Danke's operating expenses, 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 its 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 the inception of Danke.
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 Danke Apartment units were located in Beijing, Shanghai, and Shenzhen.
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 to move in) generally went down over the year. As of December 2019, the occupancy rate for Danke Apartment was 76.7%.
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 the final facility in Q3 2020. No further updates were provided regarding the statuses of these facilities in Danke's final 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.
As Danke rapidly expanded, the leasing costs Danke owed to property owners quickly accumulated, while the company also burnt a substantial amount of cash in renovating properties to conform with the Danke standard. Ultimately, with the COVID-19 pandemic as the final trigger where many Chinese people were locked down in their hometowns and couldn't return to work in other cities, Danke could no longer sustain its rapid expansion and defaulted on rental payment obligations to landlords. This led many property owners to evict tenants living in their apartments, although renters who were engaged in a rent financing scheme were still demanded by the partner banks to continue making rent payments to pay off the upfront loans that the banks granted to Danke.
With its financial difficulties, Danke stopped paying the majority of its employees, so neither landlords nor renters had a point of contact to manage or terminate their leases. Chaos ensued as property owners, tenants and even Danke employees gathered outside the company's headquarters in protest.
In Part 2, we take a look at Danke's financial statements and relevant news reports to examine the factors that contributed to the company's collapse. We also discuss to what extent the fall of Danke was predictable before and after its IPO.
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The Danke Series
Part 3: Recap and Lessons Learnt
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Glossary of All China-Related Terminology