As far as real estate developers go, SPG Land is no giant. The company launched a single residential project on the outskirts of Shanghai in 1999, which led to a second and a third – all luxury homes for affluent family types willing to commute.
At the time, high-end real estate in Shanghai was one of the hottest sectors in China. The developments sold well and the company became a respected industry player. But it wasn’t until last year that things really took off.
Towards the end of 2006, SPG listed in Hong Kong and used the capital raised to buy large chunks of land in cities like Huangshan and Kunming. Its land holdings, jumped 160% in the few months after the initial public offering.
This made the investment banks sit up and take notice.
In person, SPG Land CEO Stones Tse is reserved but his plans for the company and his take on the future of real estate in China are anything but. Investing hundreds of millions of dollars in relatively untested cities requires a certain amount of vision.
This vision was put to the test in early September when a SPG interim report revealed a 60%-plus decline in revenues. Surprisingly, the stock price held relatively steady, with only a slight drop that coincided with a general market malaise.
According to Tse, however, the interim results were merely an accounting chimera: The result of regulations that don’t allow the company to include partial revenues for unfinished projects. Thanks to the company’s new land bank investments, the future, he insists, is bright.
“When we buy land, we have sent our people there two years before,” said Tse.
“We think you should know the depth of the water before jumping in. Or at least know the temperature. We are not financing remote cities. We pick up cities with good growth potential.”
Earlier this year, before the company announced its results, analysts agreed. Not only does investment bank Macquarie expect a recovery in the Shanghai market, but it is also backing SPG to see a high rate of return from its land acquisitions elsewhere. These account for 66% of the company’s land for development.
In that sense, SPG is not unique but rather a marker of a trend that has been sweeping the real estate market recently and should soon begin to pay off. The future of real estate in China is outside the big four cities of Shanghai, Beijing, Shenzhen and Guangzhou.
However, profits will not only go to the early movers; better products will count for much more than they once did. First of all, there are now a lot more players in the market, particularly international companies with tested business models. Customers are also developing a taste for better products and services. Just putting up a building or a few houses in a plot of land is no longer enough.
Eric Wong, a property analyst at investment bank UBS, believes mainland developers have seen the last of their relatively easy profits. “They can’t win any more as they compete with international developers,” he said.
As this is a battle that will be fought in China’s second- and third-tier cities, domestic developers should be able to leverage their local knowledge. But the international players are no longer strangers in a strange market. They know what they are after and, often, how to get it.
“We are going to open an office in Qingdao in the next month or two in response to client demands,” said Wee Liat Lee, head of China research for property manager Jones Lang LaSalle (JLL).
The company’s biggest service bases are in the big four cities but, moving forward, its focus will stretch beyond them. JLL opened an office in Chengdu in 2006 and will do the same in Tianjin this year. The goal is to open up to three new offices per year over the next few years.
“A lot of developers are looking at the second-tier cities,” said Lee.
This coincides with renewed government emphasis on cities outside the top tier which, despite exhibiting strong economic prospects, have yet to capitalize on this potential or have yet to capture the imagination of property developers.
Tianjin, for example, is mentioned specifically as a target for development in the 11th Five-Year Plan. Beijing wants to boost the Bohai Bay area’s economic output with Tianjin as the commercial hub.
New malls and mixed-use developments have sprung up as Mayor Dai Xianglong, a former governor of China’s central bank, bids to change common perceptions of Tianjin as merely a port city and a satellite of Beijing.
He has touted the city as a test bed for some of China’s boldest financial initiatives. Tianjin is the pilot city for a scheme that will allow mainlanders to invest in Hong Kong stocks while the Tianjin Binhai New Area, a special economic zone, is to become a breeding ground for domestic venture capital funds.
“Almost every week, when I talk to my guys, they are meeting with developers or international funds,” said Lee.
Way out west
Beyond Tianjin, government efforts are focused on cutting the wealth gap between eastern coastal cities and their western brethren. For several years now, tax incentives and infrastructure investments have been dangled in front of companies to try and lure them into China’s interior.
As a result, there are more employment opportunities in these second-tier cities and salaries are going up. This is what property developers want to hear – higher incomes translate into higher demand for luxury homes.
In Chengdu, the proportion of new graduates who stay and look for work locally rather than try their luck out east is higher than in any other Chinese city.
Per capita income has grown up to 50% in the last five years, even if it is still half of what it is in the first-tier cities.
But even with this growth, commercial real estate remains a complex business. Simply putting up a few stores does not make a mall. Therefore, developers are building mixed-used complexes that both offer a better residential living experience and allow for multiple revenue streams.
Multinational companies experienced at dealing with these “complete package” products are rushing to get on board.
Simon Property, the largest real estate group in the US, entered China in 2005. It is working with Shenzhen International Trust & Investment and Morgan Stanley Real Estate Fund to build 12 shopping malls. Besides Shanghai, the company plans to invest in Nanjing, Hangzhou and Suzhou. The investment arm of Macquarie has sunk US$500 million into malls operated by Dalian-based developer Wanda. CapitaLand also plans to double its China assets by adding 35 malls to its portfolio, according to JLL.
Safe as houses
This international interest is tied to the fact that second-tier cities are a much safer bet than they once were. These locations are not new targets – investment in coastal cities grew 23% last year compared to 38% in central and western China – but they are more mature ones.
It is not just about rising per capita incomes. Many of these cities are shifting their development strategies in order to match theory more closely to reality and forward-looking property developers like SPG are looking to capitalize on this.
Of the half a dozen projects SPG has underway, Tse is most excited about Huangshan and Kunming. The Huangshan development will feature resort-style residences, which will be marketed as second homes to the east coast rich set. In Kunming, the prospects could be even brighter. SPG acquired some 600,000 square meters of land at negligible cost, which means prices only have to be a fraction of Shanghai or Beijing levels for the company to reap big profits.
“We expect a quite safe and profitable return for this project,” is Tse’s typically understated assessment. His words may lack superlatives, but they may turn out to be music to investors’ ears.