Free Cash Flow, Debt Financing And Over-Investment

China’s real estate market started to cool down in 2014 while investment growth also decelerated visibly. In light of the decline in both revenue and net profit, destocking has become most real estate companies’top priority. This paper investigates on whether companies will over-invest based on their free cash. By taking comprehensive consideration of the debt index and regional factors, the paper decides each debt’s role in the decision-making of project investment.The paper selected 103 real estate companies listed on Shanghai & Shenzhen Stock Exchange in 2008～14 and conducted following empirical analysis:(1) Based on Richardson’s inefficient investment model, the author calculated the sample companies with over-investment behavior and analyzed the impact of free cash flow. (2) Based on the high leverage ratio of real estate sector, the paper elaborates on the correlation between over-investment and overall debt level, maturity and structure. (3) The paper classifies the real estate sector into three categories based on the urban regional division and compares the impact of different debts on the over-investment behavior.Conclusions have been made based on the results of empirical tests:(1) China’s listed real estate companies are mostly subject to high investments and high debts while over-investment exists in 38.25% of the investigated companies. (2) China’s real estate companies tend to over-invest their free cash flow. (3) The overall debt helps restrain listed real estate companies’over-investment, especially in the first-tier cities. (4) Unlike L-T debts that could suppress companies’over-investment (except in the third type of regions), S-T debts have little effect. (5) The bank loan ratio could also help adjust companies’ over-investment but commercial credit could not. The deposit received by real estate companies has little impact while payables could relieve the over-investment to different degree. However, the impact of deposit received and commercial credit on the over-investment differs in medium-sized/small cities.The paper’s innovations include:(1) It illustrates the impact of the real estate sector’s debt financing on the over-investment of free cash flow from the perspective of overall debt level, maturity and structure. The different perspectives help the author make a comprehensive analysis. (2) It classifies the real estate markets into three categories based on the region and explores practical policies by studying on the effect of debt management in each region.