Shifting Property Landscape In ChinaPerhaps more than anything capital outbound from China is having a global influence. Individual and institutional buyers are snapping up office towers, luxury apartments and warehouses all over the world, but as most real estate professionals will tell you, a market is only as healthy as its domestic sector. The days of frantic economic growth in China are in the past — much to everyone’s terror — but that doesn’t mean the country’s massive and varied property market is on the verge of collapse.

Lay of the Land
For the most part, all eyes are on China’s residential market, which is currently on simmer after years of boil. As healthy as things might look, there are a few issues to keep an eye on. “The key issue with the residential market is over-build in the lower tier cities. There have been too many new residential buildings entering the market and the government has been too aggressive in terms of selling land building up significant unsold inventory,” explains James Macdonald, director and head of China research for Savills in Shanghai. “As a result, this will take a longer period of adjustment to correct. The first- and second-tier cities tend to be in a slightly healthier position … however they face the issue of relatively high pricing.

Accord to June research by Knight Frank that unsold inventory could take up to 20 months to clear despite 25 percent fewer housing starts in the first four months of 2014. As for prices, Knight Frank stated first-tier (Beijing, Shanghai, Guangzhou) mass residential prices are expected to rise by 3 to 5 percent by the end of 2014, and 6 to 8 percent in the luxury sector but only up to 2 and 5 percent in the second-tier cities (Tianjin, Wuhan, Chongqing). Developers are starting to cut prices between first and second phase launches in Shanghai and Beijing, and Macdonald points out that there has been some piecemeal loosening of restrictions in selected cities, chiefly how many properties can be purchased, aimed at supporting the property market rather than restricting it. “Once this happens the expectation is that buyers will come back into the market. However, in the lower tiers, even though there are specific incentives, buyers may not come back as quickly resulting in a longer period of adjustment.”

It’s that aggressive development and, some argue, poor planning that has led to the supply glut and (at least in theory) China’s famous ghost towns. Macdonald agrees they exist, but are more rare than some media would have us believe. It’s less an issue of misallocation of resources than simple numbers. Smaller second-tier cities will always see lower demand than big centres with strong infrastructure and businesses that attract residents no matter how much investment goes into them.

Keeping Local
None of this had much impact on overseas investors. China is all about exports, but that excludes its property. “Overseas buyers have never been that significant,” says Macdonald. “The regulations controlling foreign buyers have been in place for a long time and yields here are so low that it doesn’t seem practical.” Non-nationals must be resident in China to be eligible to buy property, and the majority of inward property investment is institutional, and even that is a minority.

“Even from the institutional side of things [foreign investment] is still a relatively small percentage of the total real estate market … It is made of up of more than just Shanghai and Beijing. It’s made up of 300 different cities all with new development occurring. The vast majority of China’s real estate market is owned by locals,” notes Macdonald.

One sector that could emerge quickly is the office market. Though it’s not a major factor yet, the Mainland’s move away from manufacturing and into services is pushing the number of Chinese firms taking up Grade A office space in Shanghai up — to 40 percent in some properties. Manufacturers looking at options in Vietnam and Cambodia, “[Are] not a key concern to China. They’re already shifting away from manufacturing and focusing on services industries. They don’t want the garment manufacturing and low value manufacturing, instead they feel they’ve matured and are looking into IT or advanced manufacturing,” Macdonald says.

Lucky Seven
Planned economies are all about the future, and for China, the future is nowhere near 25 percent annual growth. Annual income growth has dropped from nearly 20 percent in 2002 to roughly half that in 2013; GDP has dropped from 15 percent in 2007 to roughly 7. Forecasts for the coming years are in the 5 percent range (the EU would kill for 5 percent). Is this just the way it’s going to be? “What you’ve seen over the last 20 or 30 years has been a significant demographic gain with more and more people entering the work force, globalisation generating new jobs, new export markets and so on. This has all been very beneficial and [the growth rates] have come from a much smaller base than before,” theorises Macdonald. It’s also created new demand for property, the backbone of any market.

Still, the market is not without its challenges, one of which is interest rates, an obsession for Hongkongers. Rates are already at 6 percent in China, and so some analysts are expecting stimulating rate cut. “One of the biggest issues is debt,” states Macdonald. “How much debt does China have and how are they going to finance it? How overstretched are some of the smaller developers? The top 20 developers have access to financing but the smaller ones are a concern.” Small developers are the majority on the Mainland, and the market is much more fragmented. The overextended ones may eventually have to leave the market if there’s a protracted slowdown. That’s not a bad thing for the long term, as it should lead to a healthy consolidation, better developments and stronger regulatory oversight with fewer to manage. Macdonald again points to oversupply in second-tier residential and, to a degree, commercial overbuild, even in top tier cities — which will likely be taken up eventually.

The growth of the last decade is unsustainable and after a spurt, China is finally finding its comfort zone — from retailing to property. “People are coming to the realisation that we are unlikely to go back to [the former] pace of growth,” finishes Macdonald. “It’s the beginning of a new norm.”