In the wake of this year's National People's Congress (NPC), Premier Wen Jiabao said government measures to cool the property market had been successful. Less than three months on, house prices are still rising, up 5.5% year-on-year in large and medium-sized cities. The average residential property price in Shanghai is 10 times the average annual family income, compared to global levels of three to five times. The government has inevitably been forced to take further action, raising minimum deposits, introducing higher property taxes, tightening up lending and cracking down on luxury real estate in order to boost the supply of affordable housing. Failure to rein in runaway growth could see the inflation and subsequent bursting of a property bubble, while a hard-line regulatory approach risks undermining real estate as a healthy investment option. Beijing is treading a fine line in its battle to control house prices, as Chris Brooke, managing director of CB Richard Ellis for Greater China, told CHINA ECONOMIC REVIEW.
Q: With fixed-asset investment continuing to progress rapidly, what are the implications for the property market? Will the sharp rise be followed by a hard fall?
A: At the moment the general view of the property market – if you talk to developers, investors, consultants, advisors – is that it's relatively stable. There have been significant price increases in some cities – in a lot of places it's driven by end-user demand, a rapid growth in new households and people upgrading to new space. If it continues at the current rate, it's still controllable; but if there is a lot of additional fixed-asset investment and rapid price increases in some markets, then that would be a cause for concern. I don't think we're going to see a hard fall because the government will step in at some point to make sure that it doesn't happen. We might see some corrections in some cities where there's either a high level of speculation or oversupply. But I think if you look at China as a whole – which is a particularly difficult thing to do because there are many markets within a market – the situation is still under control.
Q: To what extent have the government measures implemented so far been successful in cooling the property market?
A: There were two sets of measures; those in 2004 were primarily targeted towards the supply side, and then last year the measures were more targeted towards the demand side and purchasers. In terms of the immediate effects in terms of stabilizing the market, adding some structure and reducing speculation – particularly in Shanghai – it's been successful. I think it's also been successful in the sense that it hasn't resulted in a very serious correction in the market, and people still have confidence in it even though the measures are cooling things down. Clearly the prices are still rising in some markets, but because the real estate sector is so important economically, I think that's almost inevitable. Taking into account the end-user demand and economic growth, I wouldn't say the measures have failed just because prices are rising.
Q: What further regulatory measures can or should be taken to stabilize the property market? What about ending the pre-sales system, for example?
A: Pre-sales now is quite highly regulated anyway, particularly in Beijing and Shanghai. Obviously developers have to meet quite a lot of requirements before they can do their pre-sales. I think full-scale pre-sale restrictions would potentially slow the transaction volume down a bit, because obviously developers would have to finish the building before they can sell it. But I don't necessarily think it would affect value. One of the measures they might look at is using interest rates as a way to control the market, as is the case in the US and Europe. The recent interest rate increase was relatively small and the impact has been nominal – it will make people think a little bit before they take a mortgage, but it's not going to slow down the end-user market. The government is trying not to interfere too much so, rather than trying to control through an edict or a new declaration, it will be more adjusting interest rates or looking at monetary policy.
Q: To what extent is the regulatory battle one to control the effect of speculators?
A: Obviously the government doesn't want the market to get into a situation where it's driven by unrealistic pricing or investors who are just pushing up values and making things completely unattainable for end users. But real estate is an important sector of the economy so the government doesn't want to slow it down completely, or kill it off. You're always going to have investors in real estate. You can't keep them out of the market and so there will always be – whether you call them speculators or investors – people buying in the expectation of capital growth or as a means of putting their money aside for the long term.
Q: How significant a problem are regulatory changes for investors?
A: Investors obviously like stability, certainty and reduced levels of risk. If you look at the country risk associated with China, one of the things people mention is swift changes of policy and, under the government decision-making system, the rules can change quickly and everyone has to comply. But I think people have built that into their investment strategies for China.
Q: The property market seems quite localized. What drives the differences between the markets in Beijing and Shanghai, and how are they likely to develop?
A: Real estate is very heavily influenced by local culture, local trends and local economy. In terms of the commercial sector, each city has its own drivers. Shanghai tends to be the manufacturing sector, marketing and sales. Beijing is heavily influenced by government, administration and strategy; the headquarters of state-owned enterprises. Residential has tended to be driven more by end-users in Beijing than Shanghai, because Shanghai people had more money to dispose of more quickly and therefore it became more of an investment market. The geographical size of the country means there is a lot of difference. But you can see some general trends coming through, in terms of urbanization.
Q: What do the second- and third-tier cities have to offer in terms of opportunities for foreign investors?
A: The attraction in the second- and third-tier cities is really an opportunity to get into the market at an early stage when the cities are relatively immature. Entry costs will probably be lower and you can take advantage of the potential of the cities to secure more return on investment, whether it's through appreciation of residential values or increased rentals from shops and offices. They also offer the opportunity to do things on a bigger scale because they need to build units, particularly for people coming in from the rural areas. Developers can build very big schemes, which helps with economies of scale. Trying to get land for that kind of project in Beijing or Shanghai is now pretty difficult.
Q: What improvements are being made in after-sales services, and how far does China have to go to catch up with the West?
A: After-sales services is a critical issue which has really only come to the fore over the last couple of years. In the past, developers had a "build it, sell it and we'll move on and do something else" mentality, so they weren't too concerned about what happened in the after-sales. Now, if you look at international and domestic office tenants or retail tenants, there is an expectation that they are going to be looked after on an ongoing basis, whether it's managing the common areas of an office building or helping to promote the shopping center. It's difficult for developers to justify investment in some areas because it's a low-margin business – the will is there but it's a question of resources, time, money and actually finding people who understand the service culture.
Q: To what extent is building quality still a problem in China?
A: Quality is improving an awful lot; the finishes are much better, the designs are good. Whilst they are not perhaps up to the standard of say, Hong Kong or Singapore, the gap has narrowed quickly over the last couple of years. Some of the shortfalls have been because of a lack of understanding of what international tenants or modern domestic companies need. If you look at the grade-A office buildings in Shanghai, they are pretty close now to an international building in Hong Kong. Beijing still has some catching up to do, and in the secondary cities there are very few very good-quality office buildings. Residential is where the gap has closed most quickly, partly because a lot of developers have joint ventures with Hong Kong or international partners. It's a challenge making sure the contractor understands why it is important and then ensuring that they have the resources and the labor force to do the job properly.