Serviced apartments are still feeling the pinch of the economic crisis, with soaring vacancy rates that raise questions about the future prospects of the sector. "It’s been pretty challenging for the last 12 months, with fewer expats on the ground," said Michael Klibaner, head of research at Jones Lang LaSalle in Shanghai.
Unlike other parts of the domestic residential real estate market, serviced apartments have yet to see a serious recovery in demand. A recent Colliers International report recorded a 34% vacancy rate for serviced apartments in China in the last quarter, up from 32.4% in the previous quarter. Concurrently, rates per square meter over the past 18 months have also declined steadily.
While Colliers predicts that rentals for serviced apartments will flatten in 2009, and increasing capital values will cause a reduction in gross yield, foreign investors nevertheless have cause to reassess their exposure to the sector.
Serviced apartments were once the next best thing to a can’t-lose proposition for property management firms. As foreign investment in China burgeoned, waves of foreign executives were imported to run new ventures. Few spoke Chinese, nor were most interested in living in traditional Chinese housing. Serviced apartments not only offered comfortable living but also made life livable for a significant portion of this expat population, who otherwise could not be convinced to relocate themselves – and their families – to the country.
Chinese service providers were originally at a natural disadvantage, as most had little understanding of expat residents’ lifestyle requirements. David Schlosser, assistant manager of serviced apartment Chi Residences, said that this created ample space for foreign firms. Western property managers could easily sell services to local property owners, allowing them to market their residences to foreigners and reap higher margins, and market to multinational corporations looking to house incoming employees.
"A lot of big foreign investment groups formed some kind of liaison with a serviced apartment company," said Ingrid Kamphuis, director of sales in Shanghai at Hong Kong-based serviced apartment provider Shama.
Living out of a suitcase
The structure of lease terms and provision of all the necessities allowed new tenants to spend the bare minimum of time and effort buying silverware, trashcans and setting up utilities. "The only thing you have to bring is your suitcase," Kamphuis said.
For executives in China for relatively short periods of time, or those constantly on the road, the convenience and pampering of serviced apartments was quite appealing. Indeed, some expats lived better in China than they did at home.
This package allowed serviced apartment providers to charge healthy premiums, and still does to a certain extent. For example, a basic two-bedroom serviced apartment in Shanghai’s Xujiahui district is advertised as leasing for more than RMB19,000 (US$2,780) per month, between two and four times more than similar non-serviced apartments which can easily be found on English-language expat websites in the city.
However, Kamphuis argues that if one compares like to like, the difference is less drastic. Shama’s serviced apartment rents are usually between 20-25% higher than non-serviced apartments in the same complex, she said.
Even so, the premium difference helps explain why the sector continues to attract fresh investment. Chi Residences, for example, opened in China last year in the depth of the recession. "What we’ve seen for the last number of years, and are continuing to see, is the number of players in the market increasing," said Kamphuis. This reflects continued entry from maturing domestic competitors, but it means more downward pressure on prices just when investors need consolidation.
The major foreign investor in the sector, Morgan Stanley Real Estate (Shama’s majority stakeholder) is currently selling its 219-unit Shama Xujiahui for a sale price of approximately US$114 million to a local investor. The company may simply be cashing in on one particular project – or it could be preparing to reduce its overall exposure. Morgan Stanley Real Estate didn’t respond to requests for comment.
Regardless, there are valid concerns about the long-term prospects for serviced apartments’ profit margins. For one thing, the concept of a "home away from home" caters to a particular class of foreigners whose numbers may be in permanent decline. The new wave of expats moving to China are younger and keener to integrate into the Chinese way of life, swarming to sign leases in renovated hutongs and shikumen.
At the same time, a new generation of Chinese managers is moving into the positions once occupied by highly paid Western executives. With expatriate wages costing companies twice the local equivalent, pressure will most likely be placed on residency packages. Whether expats – or their multinational employers – will still be willing to pay the same premium for "service" is questionable.
Little local interest
Unfortunately, there appears to be limited offsetting demand from the domestic side. This is not to say it does not exist. Lee Chee Koon, managing director of serviced apartment operator Ascott China, said that up to 30% of his tenants are Chinese executives who are repeatedly being relocated around the country by large domestic firms. "Serviced apartments are cheaper for them than five-star hotels, and they can stay as short as a week or as long as two years." But most other operators say that their domestic tenant ratios range from 0-5%.
Lee admits that margins in Beijing and Shanghai may remain under pressure for the long term. Ascott’s strategy is to continue pushing out into cities in western China that are still considered hardship posts by most expats.