China’s property developers have grown rich on the back of strong demand for residential real estate. In many ways they have been the beneficiaries of a perfect storm: a combination of a fast-growing economy, rising household incomes and a government policy that actively encourages urbanization.
Although these driving forces are still prevalent, in recent years there have been signs that the winds are changing. Property players are looking to bolster their traditional offering of apartment buildings with a smattering of office towers, shopping malls and hotels.
"We work with several of the top developers in China that are all looking to diversify their portfolios toward a more balanced residential and commercial set of holdings," said Nigel Smith, executive director for office services in Greater China at international real estate consultancy CB Richard Ellis (CBRE).
Hong Kong-listed developer R&F Group is one of these companies. In the first half of 2007, R&F had 22, predominantly residential, for-sale projects under construction, with a total floor area of 3.75 million square meters. A further 2.11m sqm is expected in 2008.
The construction and leasing of commercial properties didn’t play a major role until 2004. Since then, though, R&F has aggressively pursued a diversification strategy. Its prime commercial holdings include a clutch of Guangzhou properties – the R&F Center, a 55-story grade-A office tower in Guangzhou, and the newlyopened Grand Hyatt and Ritz-Carlton hotels – as well as Beijing R&F City.
"We have set a target to build an investment portfolio that represents 25% of our balance sheet," said Adrian Chan, assistant to the chairman of R&F Group. Chan stressed that developing mass residential real estate would remain R&F’s primary business – in recent years the company has met its target of doubling contracted sales every two years – with investment properties coming online every three years or so. "These serve as bonuses to our shareholders,"
Chan explained. With many rival developers following a similar path, a number of explanations have been put forward for diversification into the commercial segment.
Commercial property is often regarded as a safer bet by Western investors, which means overseas listed developers can obtain high credit ratings and lower debt ratios. This makes it easier for firms to raise additional funds, CBRE’s Smith explained.
Much is also made of the impact of government measures to curb speculation in the residential market. It has been suggested that this may be driving developers toward commercial holdings.
According to Chan, the movement into commercial is a natural byproduct of residential development. Local governments usually stipulate that some commercial be built as part of any large-scale residential project. Rather than sprinkle lots of small commercial units among the apartment blocks, developers tend to go for shopping malls and office towers, which can bring in substantial revenue once the residential population reaches a critical mass.
"At the same time, the government welcomes any developer who builds commercial assets that help bring in longterm tax income," said Chan. "It’s a win-win for everybody. If your project spans three years, you should have reached critical mass due to residential sales by the third year. If the construction costs are reasonable, it makes sense to branch out into commercial assets."
Rental income is already being generated by the "commercial podiums" within residential developments, such as R&F Modern Plaza and R&F Square, both of which are in Guangzhou. Smith and his colleague Alvin Lau, who is managing director for south China at CBRE, also prefer to see the diversification in terms of natural evolution, although they place greater emphasis on wider industry trends.
"It’s just like in mature markets," said Lau. "Developers focus on residential, but also want to have commercial properties in order to diversify their risk. It is a natural stage of development." It is also a response to changing market demand – an area in which the mainland appears to be following the Hong Kong model. In the office property segment specifically, not only are domestic companies looking for high-end real estate but they also more willing to lease than buy.
There are practical and aesthetic considerations: Expanding firms may quickly outgrow their existing premises while image-conscious operators don’t want to remain in a building once betterquality alternatives come online. Whatever the companies’ motivation, property developers are well-positioned to profit from the changes.
"In the early days of Hong Kong, there was a trend to buy," said Smith. "The market for lease-in was driven by leasing and holding for investment but then maximizing return by having threeyearly lease patterns. In this way, developers were winning all around – investment and high rental return." There may also be signs of Hong Kong’s influence on the properties themselves, in Guangzhou at least. R&F made its first foray into mixed-use real estate with the 300,000-square-meter commercial complex attached to Beijing R&F City, which includes a shopping mall, office tower and a five-star hotel.
R&F now plans to replicate its Beijing property in Guangzhou – on an even bigger scale. Hong Kong developer Sun Hung Kai, as well as local player KWG Property, has been brought on board as an equal-value partner. "It will be a large commercial complex featuring hotels, serviced apartments, office towers and shopping malls," said R&F’s Chan. "We think it will be a popular part of the Pearl River New City."