“By Invitation” felt it was time to look at the property market again (the stock market having had all the column inches recently), and our property guru – Sam Crispin, of Crispins Property Investment Management, based in Shanghai – has shared with us the following article, covering everything from “nail” houses and the property law to secondary cities and regional markets (such as the Bohai Bay Area). There are risks, yes, but opportunities abound as demand continues to outstrip supply.
Real Estate Markets in China Today
As you may have noticed by now, China’s real estate markets have been making headline news. First, on the front cover of The Economist for the Property Law that brought private property ownership up to the same level as state property ownership. Second, on CNN International for a nail household in Chongqing that refused to budge in the face of relocation pressure after the land underneath them had been sold to a developer.
The term “nail household” originates from a Chinese expression regarding stubbornness and nails and is used to describe the refusal of home owners to vacate the premises despite a government ‘relocation notice’ or eviction order. Under China’s current land sales procedures, land use rights are often sold to property developers without vacant possession; e.g., farmers or urban residents may still be living on the land when it is sold or put up for auction. The work of relocating the residents begins only after the government has a buyer. The sitting tenants have the effective equivalent of a protected tenancy rather than full ownership rights, but the government also lacks full compulsory purchase powers unless there are some public works involved. The land resumption process can take as much as two or even three years. In the recent Chongqing case a nail household held out for several weeks after the site around them had been cleared.
Today, some will cite the intangible “China risk” as a reason for giving China a wide berth. The actual reason is more like a lack of understanding of how to manage risk in China. When examined in detail, China risk is not much different from business risk in any other market. As a long term resident in Shanghai the biggest risk I find here is picking up green tea flavored toothpaste in the supermarket rather than my usual minty one. That is to say, familiarity with the China business environment results in an entirely new perspective on the different approaches to running an operation in China versus, say, in the U.S. or the EU. On closer examination, the differences are not huge (think of popular comment when foreign companies try to buy US or EU companies).
The story behind the fundamentals of China’s real estate market is compelling. China has a shortage of housing accumulated after 1949 because the state sector was unwilling and unable to build housing to keep up with population growth. Today, with urbanization taking place on an unprecedented scale, China is only 43 percent urbanized compared to 75 percent in developed economies, demand for new housing is vast. Add to that demographics that are shifting rapidly as households change from three-generation-households to two-generation-households as wealth increases. As a result, average household sizes are expected to change from 2.9 to 2.4 over the next 20 years. Among those that own their own home already, surveys show that the majority want to upgrade, everyone will want more space than the typical new 90 to 110 square meter apartment and the consuming urban classes are even seeking second homes. All this translates into an estimated demand of 13 million units per annum.
While Shanghai and Beijing have seen prices increase considerably in recent years, the less well known second tier cities are still at a low base. Affordability rates are around 40 percent compared to a more typical 60 to 65 percent in the commercial and political capitals and demand is of a healthier end user type than speculative investors.
A Brief History
In this article I will explore the historical context of the emergence of the China property markets as well as some of the investment opportunities that are likely to be of interest to international investors.
These are the major milestones in the development of today’s real estate market in China:
1988 Constitution changed to permit transfer of state owned land use rights
1992 Start of public housing sales in major cities
1995 Regulations for the sale and resale of real estate issued
1998 Abolition of all state allocated housing; establishment of residential mortgages
1999 Mortgage terms improved in terms of loan-to-value and loan term
2001 Merger of Shanghai’s overseas and domestic sale housing markets
2002 All sale of government land required to be by public auction, tender or listing
2005 National administrative control measures instituted
2006 Further control measures introduced, including restrictions on overseas investment buyers
China’s real estate market, in its current form, has existed a relatively short period of time. After the establishment of the People’s Republic of China (PRC) in 1949, there ceased to be any private ownership of land as all land reverted to the ownership of the state. Under the system of a planned economy, the use of all land was determined and allocated by the state according to different economic and policy objectives. Then, in 1988, with the revision of China’s constitution, China’s current market began to take form.
From 1988 property developers were able to acquire ‘land use rights’, 50 years for commercial use and 70 years for residential use, to develop property commercially. A mini property boom, driven largely by inward foreign demand for offices and homes, took place from 1992 to 1996. A glut was the result of the ensuing building boom which lasted until 2002 when domestic demand started to take off. In 2005 the regulator started intervening to cool off the market and by mid 2007, a succession of measures had successfully slowed the market in Shanghai, which had become the most overheated city and the primary target of central government measures. Other parts of China have continued to see growth in development, prices, and buying. There are various reasons for this but it is worth remembering that property markets are as varied as regional cuisine and languages. Cities such as Chongqing in the west, Zhuhai in the south, and Tianjin in the north have been relatively slow to develop property markets and have seen growth despite government intervention.
Three Major Economic Development Areas
Today, China has three main economic engines: the Pearl River Delta (PRD) in the south encompassing Hong Kong, Guangzhou and Shenzhen and other major cities; the Yangtze River Delta (YRD) on the eastern coast which includes Shanghai, Suzhou, Nanjing and others; and China’s northern economic engine, the Bohai Bay Area (BBA), which includes Beijing, Tianjin, Qingdao, and Dalian.
Because of industrialization and a restructuring economy, the BBA—which covers only 5.4 percent of China’s land area but contributes 25 percent of the GDP—has emerged as the current hotspot in China’s real estate market. It is the single biggest economic area, occupying an important position in the regional economic development pattern in China. What follows is an overview of the municipalities and provinces in the BBA.
Beijing (Population 15.8 million; FY05 GDP Growth 11.1 percent)
In 2006, seven million square meters of residential property were transacted valued at Rmb21.7 billion (US$2.84 billion). Due to recently announced government policies, land supply grew more than any other year in the city’s long history. Supply in the city center is limited, however, which would seem to indicate that the focus of property development is shifting further away from the center.
By December 2006, total housing supply reached 30.54 million square meters, with the cities of Chaoyang, Haidian, Fengtai and Shijingshan occupying 63.93 percent of the total.
Monthly sales volume for 2006 (13,731 units) were only marginally lower than 2005 (13,899 units) showing that the government’s macroeconomic controls have had little impact on sales volume. Sales prices for residential property have been rising steadily from Rmb8,000 (US$1,048) per square meter at the start of 2006 to Rmb10,000 (US$1,310) per square meter by the end of the year.
2007 is the last year before the Olympic Games in Beijing. Many developers would like to finish their projects as soon as possible to maximize sales time before the Olympics. When the time comes, this will definitely affect the property market in Beijing.
Shandong Province (Population 92.5 million; FY05 GDP Growth 15.2 percent) The major cities in Shandong Province are Jinan (6.4 million) and Qingdao (8.2 million).
In 2005, the average residential price was Rmb2,334.8 (US$306) per square meter, with Qingdao experiencing the biggest price increases. Among the 17 cities, Qingdao, Tai’an and Rizhao have still maintained high price increases, at 10.9 percent, 8.9 percent, and 8.6 percent, respectively. The rest have experienced increases of over 5 percent except Heze city, which rose only 3.9 percent.
Under the affect of national macroeconomic controls, residential prices are fluctuating. The average expenditure on residential property was Rmb468 (US$63.73) per square meter in 2005. However, the purchasing power of citizens in Shandong is growing. In 2005, the average disposable income was up 13.8 percent, household expenditure was up 27.2 percent, rents were up 6.7 percent, and decorating expenditure was up 27.3 percent.
Tianjin (Population 10.4 million; FY05 GDP Growth 14.5 percent)
Compared to other cities, Tianjin had a relatively stable real estate market in 2006. According to the statistics, during the first 10 months of 2006, there were 8.91 million square meters of residential supply in 2006, worth Rmb44.94 billion (US$5.89 billion), showing a year-on-year rise of 5.1 percent and 28.5 percent. The average sales price was Rmb5,000 (US$655) per square meter, a year-on-year rise of 17 percent.
At the moment, Tianjin is at the best stage in its economic history, showing both a fast pace of development and a stable economy. The city’s future goal is to strengthen its interaction with Beijing, building itself into an economic center in Bohai Bay area. With the ‘Jing-Jin’ integration underway—by which Beijing and Tianjin are growing into a single economic and urban area joined by a development corridor along lines of communication,— there will be far-reaching impacts on the value of properties in Tianjin. Major inward investment by multinationals and an emerging financial sector are promoting further long term growth.
Liaoning Province (Population 42.2 million; FY05 GDP Growth 12.3 percent)
The key cities in Liaoning Province are Shenyang (7.4 million), Dalian (6 million), and Anshan (3.6 million).
Shenyang is the provincial capital of Liaoning Province. To some extent, the development of Shenyang will represent the development of Liaoning. In 2006, apartment prices in Shenyang ranged from Rmb2,000-4,000 (US$262-524) per square meter, and accounted for 67.81 percent of the supply for Liaoning Province as a whole. Furthermore, as disposable income increases in this city, price increases are predicted for the near future.
Hebei Province (Population 68.5 million; FY05 GDP growth 13.4 percent)
The key city in Hebei Province is Shijiazhuang (8.6 million).
In the first quarter of 2007, Hebei Province witnessed a stable rise in property prices in its cities. Compared to last year, average sales prices in its cities are up 5.6 percent. Shijiazhuang is up 5 percent, Tangshan is up 5.4 percent and Qinhuangdao is up 6.3 percent.
Because of the national control of land use, whereby only limited amounts of agricultural land can be changed for other uses, the supply of land is limited, which has let to an increase in land prices. The land trade price is up an average of 4.4 percent compared to last year: residential land use is up 5.8 percent; industrial land use is up 5.3 percent; and land for business, tourism, and entertainment is up 4.8 percent.
Rents in Hebei are also rising: residential rents on average by 3.2 percent, and office rents up by 1.5 percent.
A Good Place to Enter the Market
BBA starts with a lower base than the better known PRD and YRD, so it looks attractive for market entrants. On the down side, not being well known is a problem. Many investors feel comfortable with familiar cities such as Shanghai and Beijing, but how many of us can even pronounce Shijiazhuang let alone contemplate investing there? Pooled investment may be a solution.
What does all this mean for investors? You can effectively stick your money into any city in China, whether you can pronounce it or not, and expect to see capital growth roughly in line with economic growth rates over the next 10 years or so. Better still, get in on ground up development projects where margins are more attractive and cash flows typically start coming in 12 to 18 months after breaking ground compared to 24 or more months in developed markets.
Sam Crispin has China experience from 1988 and has been living in Shanghai since 1994. He is a Member of the Royal Institute of Chartered Surveyors, Founder of Crispins Property Investment Management based in Shanghai, Chairman, British Chamber of Commerce, Shanghai and advisor to the Bund Capital Bohai Bay Property Development Fund. He can be reached by email on firstname.lastname@example.org. Learn more about him Sam at www.cpcproperty.com , or read some of his articles on http://www.cbiz.cn/column/sunday.asp#3