By Nancy Zhang
Opportunities in the commercial property sector in mainland China has long been overshadowed by the furore over price bubbles in the residential sector. But commercial property is set to become increasingly lucrative for investors and developers, especially in certain key second and third tier cities, says Dr. Tang Daizhong, deputy dean of the Jingwei Real Estate Research Institute in Shanghai. The institute is affiliated with Tongji University, one of the top research centres for urban planning and architecture in mainland China.
Tang, who is an advisor to district governments around the country as well as companies, tells RFP how developers and investors are being encouraged to turn to the commercial sector as policies tighten around residential property. However there are several risk factors here that make bubbles in future even more likely than in the residential sector, and more difficult to control once formed.
2010 was marked by decisive moves from the Chinese government to curb rising house prices, including suspending mortgages for third-home purchases and interest rate hikes. By October, these measures resulted in the slowest price growth in ten months across 70 major Chinese cities, according to figures from China’s statistics bureau. And now into 2011 we see residential prices slowly dipping in a few key cities where the bubble was viewed as most severe.
Yet for investors, property still remains attractive relative to the risk of the stock market, and due to the lack of other investment options.
In contrast, the commercial sector is not subject to recent tightening measures and is unlikely to be targeted by future policy changes.
Moreover, demand and rental prices will grow steadily over the next five to ten years, according to Tang, as the 1980s generation enter their 30s.
“Commercial property, especially retail, will benefit from the coming generation change in China. The 1980s, single-child generation will soon enter their earning peak with both parents still supplying them with additional financial help. Their spending power will therefore peak around 2015 and then taper off as they start to take on the burden of supporting two sets of ageing parents.”
In this regulatory environment, developers are transferring some of their capital from the residential to commercial sector. The move also helps to diversify their portfolio as commercial properties provide steady rental incomes. The record profits earned so far with one-off sales of residential housing cannot be sustained indefinitely.
But the shift to commercial property investment holds several risks.
“The success of retail and office developments relies a great deal on management. The skill is not there yet in many Chinese developers,”explains Tang. “Secondly, the herd mentality common in Chinese investment is also at work here, which may lead to bubbles. Thirdly, even if prices overheat, the government would
not consider it a matter of national security like it is in the residential sector. Consequently they will not intervene to cool prices or regulate the market.”
The most important factor in the success of a commercial development is location and environment. But it is not easy to make good choices across China’s vast landscape – the process of selecting location poses the greatest risk for commercial property developments, as well as the greatest opportunity.
“Certain second and third tier cities have solid economic foundations and great potential for retail developments,” says Tang. “Their citizens have high spending power, but need to be directed and educated in their spending habits. This represent a good opportunity to mould brand loyalty if a well thought out, large scale retail development could be organized.”
But these locations have to be picked out carefully as areas across China have great diversity. Some cities, such as Hangzhou and Ningbo both in Zhejiang Province, are home to hidden wealth and spending power that cannot begauged by GDP or other standard measures. Other cities have inflated property prices that do not reflect their underlying economic health or future potential.
Media headlines have grabbed attention with skyrocketing property prices in the central business districts of first tier cities like Shanghai and Beijing. But Tang is more sceptical of developments in less tried and tested areas – such as the outskirts of established cities, and fast growing third-tier cities.
Though a few have economic potential, the rest of these developments are risky at best.
“In the residential sector, price growth has slightly reduced in first tier cities and stabilized in second tier cities. But fast growth continues in third tier cities. For example in Ganzhou City, Jiangxi Province, prices have almost doubled this year. Many of these places I think is problematic and likely to turn into bubbles,” says Tang.
The same risks apply to the commercial sector. Tang spends most of his time travelling. Recently he has been called on to advise a number of ‘New Towns’ – urban areas built from scratch on the outskirts of established cities. They include both commercial and residential properties.
Most of these however, he says, are not promising.
Retail and office districts require a long time to mature. In developed cities like Shanghai and Beijing, there is always profit to be made from upgrading retail facilities in both central and more suburban districts as income levels rise. Also, increasing transport links make it a profitable investment long into the future.
The importance of established central districts is even more important for offices. To this end, grade A offices in the primary CBDs of first and second-tier cities will not lack demand, says Tang, as will the low end office market. Opportunities for mid-level offices remain limited across the country.
However, for the ‘new towns’ under construction, it remains unclear whether conditions are in place to make them successful once complete.
Like developments in more remote cities, these have been mandated by local government from the top down. Many of these, especially outside the developed coastal and Yangzte delta areas, rarely take into account the grassroots economic demand. Instead they are often a tool in advancing political careers.
“Another reason they are being built is that these local governments are preparing to accommodate future urbanization. They have to build now as the cost of waiting is just too high with rising land, property and construction costs. Therefore things are being built before the time is mature.”
Worryingly, this is a common approach that is replicated across the country, and a significant contributing factor to the current residential property bubble.
