Lifestyle

Real Estate Market Mystery In China

Real Estate Market Mystery In ChinaChina is a country of mystery, but not in the fetishistic sense of the word. On any given day, its economy — crucial to the global economy now — is weakening, or maybe getting stronger. Its residential property market is oversupplied, or maybe not. Investors and industry are tiring of it, or maybe they’re flocking there in greater numbers than ever.

The Sum of its Parts
The concept of Tier 1 and Tier 2 cities is the rule of thumb now, but figuring out where those tiers are is a bit trickier. Tier 1 is obvious and comprises the big four: Beijing, Shanghai, Shenzhen and Guangzhou. Jones Lang LaSalle defines Tier 2 cities as growth markets, and as of 2012, JLL’s China50 report, they include Qingdao, Dongguan and Xiamen. Tier 3 locations are emerging markets: Kunming, Harbin and Foshan. But there are dozens in between. Chengdu, Wuhan and Chongqing are flirting with Tier 1 status (labelled Tier 1.5, or transitional) and Zhuhai, Haikou and far-flung Urumqi are also Tier 3 — but early adopters. And that’s just a few. Suffice it to say, getting a handle on China and investing there is a full time job.

“Demand for office space and rental rates are expected to remain stable in Mainland China in 2013. There has been some reduction in consumer confidence and lower growth in spending in Mainland China, but retailers of internationally branded goods in the few high quality shopping malls remain popular. Retail rents are expected to be steady in 2013,” explains a spokesperson for Hong Kong developer Swire Properties. Active in Beijing, Shanghai and Guangzhou, Swire is pleased with the properties’ performance — particularly its Taikoo Li Sanlitun and INDIGO in Beijing and Taikoo Hui in Guangzhou — and has plans for mixed-use developments in Chengdu and Shanghai. But there’s far more to China’s property landscape than shopping centres, office towers, and rental projections.

“There are a huge number of challenges ahead for China. The current leadership is facing a very different set of challenges than any of their predecessors. Doing the same investment-led growth, which has been successful for the last 30 years, will not work any more,” explains Michael Klibaner, regional director head of research for Greater China at JLL. As he sees it, China’s enormous base numbers will make the 20 percent growth of the past nearly impossible to maintain, demanding the country find new growth drivers. The country desperately needs financial market reform, an end to structural subsidies, an expanded social safety net and more people earning more. But that doesn’t necessarily mean there’s no growth in the property sector right now anyway. Swire’s continuing to invest and they’re not alone.

Outside the Homes
For those looking to invest in China, there are some hurdles to leap. Unlike Hong Kong (part of Greater China), individuals are not allowed to buy residential property unless they’re residents, traditionally a point of entry for overseas investors. The only way in is through equities, funds and limited offshore REITs, but there’s plenty of activity elsewhere in the Mainland. However, understanding the big picture is key.

Aside from breaking China into its tiers — and there is considerable difference between them — the variation between commercial and residential property is crucial. “If we segment commercial from residential, I think within commercial real estate the majority of the investment interest is in Tier 1 cities, and the clear favourite right now is Shanghai. That’s the most active office market from an investment perspective … The double stamp duty has killed activity in Hong Kong. But Shanghai is incredibly active and there’s a lot of long term investment capital looking to be deployed in the market,” begins Klibaner. Ironically the retail sector is a national issue, where the rising middle class and structural changes have an impact, but retail is not a commodity and it runs hot and cold; management is vital anywhere in the world. Cushman & Wakefield’s Vincent Cheung, national director of valuation for Greater China agrees, adding, “Retail malls in most cities in China could be quite risky, because of construction. Most are not up to international standards, even though they are changing. There are two types of product in the market — malls from before 1990 and those from the late-’90s.” Cheung dismisses the second and third tier office markets, arguing, “Not every city is a financial market,” he says, noting London is the beating heart of the UK office market. “Why do we need so many offices?”

Industrial property, on the other hand, has seen the biggest gains in the last year or so. “[Logistics] has a very strong correlation with retail. As store networks grow, brands need distribution, as e-commerce grows logistics benefits from distribution centres,” Klibaner says, pointing out warehouses are nearly unaffected by where retail business is done. “They benefit from both trends. As a sector that’s been very attractive. It’s chronically under-provisioned.”

Finally, the status of the residential market is reliant upon understanding domestic demand. Beijing’s newest policies are structured to compel developers to move down the rising income curve and towards a true middle class. “It’s an iterative process. You need incomes to continue rising and you need developers to position projects lower. The future isn’t whether my secretary can afford a luxury flat. It’s that projects are positioned appropriately for her to buy,” theorises Klibaner. Contrary to the idea that Beijing and Shanghai are afflicted by oversupply, the market to this point has been developed with what those outside China would call mass market housing. “But really it was upper middle-class white-collar housing. That’s who [developers] were building for … I think the market is beginning to enter its next phase of development,” Klibaner notes. Booming mining towns are great, but when housing “affordable” for miners is 45 minutes away the result is a ghost town. Governments need to maximise land values by developing revenue generators, but the misallocation of resources ends in what Klibaner sees rather as chronic under-supply.

Between short-term price caps, cooling measures that rival Hong Kong’s for rigidity, and economic management policy that must strike a balance between economic growth and social stability, China has its work cut out for it. Cheung points out developers reported stronger sales than expected in the first half of this year and Klibaner likes the direction Beijing is heading. The market isn’t as opaque as it appears at first glance and investors are still sniffing around. “One of the outcomes of the financial crisis is that real estate as an asset class has gained prominence. I don’t think it’s because of the crisis, I think it’s because of the low interest rate environment,” Klibaner finishes. “But as an alternative fixed income asset real estate has become much more accepted by institutions … In addition we’ve seen a lot of these institutions realise they’re under-allocated to Asia.” The rush to China’s door isn’t over yet.