Key Trends In China Property Sector

Source : The Business Times, April 3, 2008

Despite slower economic growth and uncertainty over Beijing’s austerity measures, China’s residential, retail and office markets still offer attractive investments, says KENNY HO

THIS is the year of the Beijing Olympics and all eyes will be on China as it celebrates its arrival as a major global power.

Politically, this is the first full year of President Hu Jintao’s second five-year term. Having consolidated his power following the 17th Party Congress, Mr Hu will likely push forward with reforms over the next five years as he builds his political legacy. And with the US economy moving closer to a recession, we expect China to enlarge its prominence as a growth engine for the world economy.

This article provides an overview of the key trends affecting residential, retail and office property markets across China and our advice to the individual and institutional property investors.

Office supply and demand

By mid-2008, the completion of the Shanghai World Financial Centre, one of the world’s tallest buildings, will mark the official beginning of the second office supply boom in Shanghai (the first one was from 1996 to 2001). In fact, all across China, we are in or will soon be entering a five-year supply cycle. Cities across China are trying to copy the Pudong model in creating new central business districts (CBD), though we are alarmed to see various Tier III cities, such as Yantai, trying to promote themselves as international financial centres.

The obvious question is: ‘Will there be enough demand?’ Our answer is yes and no.

Yes, there will be demand, but it will not be enough to fill all of the new space. In the medium term, office demand should continue on an upward trend in major Tier II commercial hubs as companies eagerly try to tap into China’s growing domestic market. But while cities such as Shanghai will be able to absorb most of the 800,000 square metres of new supply this year, we expect office supply in most Tier II cities to outpace demand over the next 12 months, and in some cases by a wide margin.

The good news for investors is that good quality buildings will still achieve a significant rental premium over the market average while attracting the most prestigious tenants.

Therefore, as an office property investor, it is crucial that a) the quality of your building can withstand a rapidly evolving market, and b) you have a solid grasp of the competition in your particular market segment.

Hot retail locations

As revealed in our recently published 2007 Retailer Sentiment Survey Asia, retailers will continue to expand their China presence in 2008, and are optimistic on both revenue and profit margins.

Nevertheless, it is important to keep in mind that while the retail scene in Tier I cities such as Shanghai and Beijing is rapidly diversifying and maturing, most Tier II and III markets remain much less sophisticated.

The reality of these markets is that the majority of consumers in China still prefer to save a significant portion of their income and spend it on necessities, child education and quality of life items such as homes and cars.

When Chinese consumers do spend on luxury items, their choices are often guided by their need for identity, social status and bragging rights. It is no wonder that well-established brands such as Louis Vuitton and Gucci are hugely popular in Tier II markets while lesser known brands trail them by a wide margin.

We expect retailers to invest heavily in marketing their brands to the Chinese consumers. This means that highly visible retail space in prime locations will continue to be the hottest commodity, whether in Beijing, Chongqing or Foshan.

Outside of the best locations, mall owners must work hard to attract and maintain a winning roster of retail tenants, and by doing so create an irreplaceable retail destination for shoppers.

Affordable housing

Over the last few months, we have often been asked: ‘Will further policy tightening lead to a major correction in residential prices?’

In short, the answer is no. Contrary to popular belief, the government’s policy goal is not to lower prices in the existing market. Instead, it is working hard to ensure the future availability of affordable housing in three ways:

Increase effective land supply, either by releasing new land plots or repossessing dormant land plots from the hands of developers;

Lower land prices, by introducing more land supply and limiting the ability of developers to bring capital from offshore sources (such as foreign funds or the Hong Kong stock market) and use it to capitalise their onshore project companies.

Discourage investment demand in the residential market, by increasing the downpayment requirement (from 30 to 40 per cent) and raising the mortgage rate (from 6.6 to 8.6 per cent) for second-home buyers.

On the demand side, owner-occupier demand remains strong as the population’s standard of living continues to improve. However, markets such as Shenzhen, where prices have been driven largely by speculative buyers from Hong Kong, are experiencing a slowdown, and in some cases, significant price drops.

It is best to confine purchases to areas where demand is visible and easily understandable - CBDs, traditional high-end residential clusters or areas near mass transit stations.

For residential investors, it is important to keep in mind that with current taxes and mortgage rates, your total transaction cost adds up to over 20 per cent of your purchase price. While we are comfortable with a steady 10 per cent annual growth in residential prices given that urban income rises at around the same rate, a 20 per cent transaction cost will eat up most of your profit if you hold the property for less than two years.

In conclusion, while we expect slower economic growth, a large amount of new office supply and continued uncertainty around government austerity measures in 2008, the long-term demand outlook remains positive for all three property sectors in China. For patient investors, 2008 may turn out to be a good year to look for bargains and to start building long-term positions in your China portfolio.

The writer is head of research - China, Jones Lang LaSalle