Southern star

To just skim the headlines about China’s property sector is deceiving. Throughout 2007 the central government strived to control the housing market, introducing measure after measure in an attempt to tighten liquidity and stamp out speculation.

While life may have been hard in the high-end residential segment, which bore the brunt of these measures, the same cannot be said of high-end commercial property. A rising number of developers have begun diversifying their businesses to focus on offices for lease, rather than just apartments for sale.

Bigger and better office property is emerging – notably in Guangzhou, the city that aspires to become China’s southern business hub.

The Pearl River New City (PRNC) is the embodiment of this ambition: A 6.6 square-kilometer site that has been earmarked as the city’s new central business district (CBD). In due course, the skyline will be filled with skyscrapers, but for now it is the R&F Center – a grade A office tower built by Hong Kong-listed developer R&F – that dominates proceedings.

“In the past, Guangzhou has been behind the pace compared to the likes of Beijing and Shanghai, but in the last few years we have seen massive change,” said Alvin Lau, managing director for south China at international real estate consultancy CB Richard Ellis (CBRE).

“Shenzhen and Guangzhou are both building new CBDs and Guangzhou must push hard to remain competitive.”

Local strength
The significance of R&F Group in this push stretches beyond ownership of a trophy building in the PRNC. As of June 2007, R&F had 3.75 sq km of land under development across 22 projects nationwide. Guangzhou accounted for 1.63 sq km of the land and over half the projects.

While residential real estate remains the firm’s primary business, it has entered the commercial sphere in recent years with projects such as the R&F Center and two soon-to-open five-star hotels, the Ritz-Carlton and Grand Hyatt.

“We are looking to deliver investment property products every three or so years,” said Adrian Chan, assistant to the chairman of R&F Group. “We are building high-grade commercial sector properties at a time when the economy is booming but construction costs are still reasonable. In our view, these assets carry great potential in terms of valuation appreciation, as well as steady rental income.”

This premise is backed up by what appears to be rich potential for high-end commercial real estate in Guangzhou.

CBRE calculated that a record 860,000 sqm of newly completed office space came on to the market in 2007, 630,000 sqm of which was taken up by tenants. In the fourth quarter alone, over 250,000 sqm of prime office space was introduced. Average monthly rental for grade-A property rose 3.7% over the previous three months, outperforming the overall office market. The PRNC did even better, posting a rental increase of 8.2%.

What’s more, the investment yield on prime office space in Guangzhou currently stands at 8-9%, higher than in Beijing and Shanghai. This is largely a result of strong leasing demand from multinational corporations (MNCs), which can be tied to the economic strength of Guangdong province as a whole.

Lau expects  a new wave of grade-A office property to arrive in 2009 and 2010. Despite talk of tough times ahead as the US economy continues to struggle, any slowdown in MNC demand for these new buildings is likely to be offset by a buoyant domestic market.

According to Nigel Smith, CBRE’s executive director for office services in Greater China, where once multinationals occupied roughly two-thirds of the average high-end office tower, with local companies accounting for the remainder, now demand is showing signs of an equal balance.

Smith believes this is being driven by the fact that corporate China is far more brand-conscious – as well as substantially better off – than it once was. As such, having a nicer office than your direct competitor can be a big plus.

“Recently, we were working with a Chinese utility company that was looking to move into a premium building in a second-tier city – but they only wanted to take the top two floors, they were absolutely insistent,” he said. “When we asked them why, they just said: image.”

Reasons to lease
This need to stay ahead of the game runs contrary to the standard Chinese practice whereby a company buys the building it is based in. Most built-for-sale office towers can’t boast the specifications of leased premises. Fast-moving firms that buy also risk outgrowing a building before the ink dries on the purchase contract.

Furthermore, any company looking to purchase a grade-A office building must accept that, over time, improved properties will come on to the market. This could erode the status of the purchased building and reflect negatively on the company that owns and occupies it.

“There is this issue of ‘flight to quality’,” said Smith. “Because of the maturity of the market, there will be a trend of Chinese companies wanting to lease so they can hop into new buildings and maintain their image.”

As a prime location in Guangzhou’s emerging business hub, R&F Center is likely to be a draw for these image-conscious and upwardly mobile local firms. Beyond that, the challenge will be to retain these tenants once the competition intensifies in the PRNC. This is where service standards, the adaptability of the building and the quality of the surrounding infrastructure will come into play.

But the raw potential of this market is one of the reasons R&F remains so bullish about opportunities in first-tier cities.

“We see great potential in second-tier cities, but our view remains that the strongest growth will still come from first-tier cities,” said Chan. “This is where income growth and spending power – the overall economics – are strongest.”