Uncertain times

Last year, the market was good and nearly every industry performed well,” said Kevin Zheng, an investment banker at Shenzhen-based Vision Finance. “But now, with inflation rising, all prices are going up, while growth in real estate, stocks and manufacturing is slowing down. Financial reports show that everything is changing.”

There is a direct link between macroeconomic uncertainty and uncertainty regarding investment in China’s real estate market. In the face of a US recession, chaotic domestic stock markets, fast-rising inflation and on-going government controls, it’s little wonder that opinion remains divided over whether now is a good time to invest in grade A office property.

But the believers are still out there. Many are betting that China’s real estate market – long the strongest, most consistent sector for domestic investment – will continue to grow. The hope is that, with multinational corporations (MNCs), banks and insurance companies still looking to secure footholds in a country crucial for their own growth, grade A office space will remain in high demand.

Macro ripples
“These macro effects are definitely having an impact in terms of timing,” said Martin Chiu, CB Richard Ellis’s (CBRE) managing director in Shenzhen. “Grade A office space may take slightly longer to move now then in the past.”

Just how long it takes to move office property depends on the specific market.

While there seems to be no shortage of tenants in Shanghai and Beijing, once booming markets in the southern cities of Guangzhou and Shenzhen have cooled considerably. As the government perseveres with its tighter monetary policy while simultaneously imposing tougher restrictions on the property, market prices have generally begun to plateau.

“In Beijing and Shanghai, prospective tenants are waiting in line,” said Michael Cheung, national director for Jones Lang LaSalle. “But in Shenzhen, grade A office space is double what it once was and the take-up rate is not fast enough.”

Cheung believes Shenzhen will be oversupplied for the next three years. This view is only partially shared by CBRE’s Chiu, who expects competition for prime spots in the city’s central business district to remain fierce.

“In the short term, it’s still not that easy to find good space and tenants are fighting over top spots,” Chiu said. “For the moment, most investors are adopting a sort of wait-and-see attitude. Buyers are looking for cheaper prices while sellers are looking for an upturn, or a stabilization of prices.”

State controls
Although the impact of the overall economic climate on real estate is very much open to debate, there is little doubt that measures targeting the property in particular have taken their toll.

Firstly, there are general policies that affect all participants. These include the land appreciation tax, introduced in February 2007, and penalties  for leaving land idle, which came into effect in January of this year.

However, these policies have been accompanied by measures intended to put pressure on overseas investors exclusively.  Foreign players have been banned from borrowing off-shore, the minimum capital requirement for setting up a company in China has been raised and foreign acquisitions must go before the Ministry of Finance for approval.

Foreign companies are dealing with the new policies in a variety of ways. Some are staying put and waiting for signs of policy shift; others are forming joint ventures with local developers to get around the rules; and some larger developers are choosing to run the gauntlet of Beijing’s approval process.

“It’s challenging for foreign firms,” said Chiu. “They are struggling as to how to bring cash into China. In the short to medium term, we expect domestic investors to become more active.”

State of the market
The share of foreign investment in China’s property market dropped to 12% in 2007, from 21% in 2006. Yet city-specific data reveals assorted fluctuations in the market.

In Shanghai, foreign investment acquisitions rose 15.7% year-on-year in 2007 to US$4 billion, with 66% of the money going into office property. What’s more, foreign investors are showing an appetite for bigger deals. While 2006 saw only 323 foreign investment transactions of over US$10 million, the number rose to 658 in 2007.

Much of this investment has also begun to shift beyond the traditional focus of central business districts in China’s tier-one cities. Office property investors increasingly find attractive opportunities in satellite areas surrounding these major urban areas as well as in China’s second-tier cities like Chengdu, Chongqing, Tianjin, Xi’an and Dalian.

As developers break new ground, they are developing new approaches to diversify their investments and protect themselves against shocks in the market.

A movement away from strictly residential to commercial and mixed-use developments is yielding both higher quality office space and, potentially, interesting new investment opportunities.

Shenzhen-based Galaxy Real Estate, for example, started out as a pure-play residential developer but has shifted its focus to wholly-owned and mixed-usage projects. It opened the design- and culture-inspired shopping mall CoCo Park in late 2006 and is now working on the new Galaxy Center, a high-end, mixed-usage mall and office complex.

Both commercial and residential property markets are subject to shifts, but few are forecasting demand scarcity.

“Although people tend to be a bit hesitant at the moment, I don’t think many are serioulsy looking to change course,” said Chiu. “China’s economic fundamentals are sound and, although the take-up may take a bit longer in some places it’s only a matter of time.”