Home to the world’s fastest-growing economy, China receives the most foreign direct investment out of all the emerging markets and is in the midst of a real estate boom.
For the past 10 years, property prices in China have continued their upward trend and speculators are snapping up property.
Claire Hill talks to James Shepherd, Senior Director, Advisory Services and Research, East & Southwest China, at Colliers International about the pressing issues affecting China’s real estate market.
Can you explain what the key issues in the Chinese real estate market are at the moment?
There are a number of important issues currently impacting China’s residential property market: inflation and appreciation of the RMB; supply of land and finished product; secondhand sales performance; future demand; pricing and affordability; the cash flow of developers; and access to funding for buyers.
Perhaps the most important is the three-way relationship between prospective buyers, real estate developers, and the government, which is impacting all of the concerns listed above.
At the beginning of 2011, a series of tightening policies was announced by the central government in an attempt to cool the overheating residential property market.
Among the measures aimed at curbing speculative buying were new restrictions on home purchases in first-tier cities such as Beijing and Shanghai, and an increase in the minimum down payment on second homes to 60% from the previous requirement of 50%.
As a result, overall sales of new homes in China witnessed a decline in the first half of 2011.
However, prices in some cities have continued to climb, prompting the government to implement further measures in cities still showing aggressive growth.
This possible introduction of future government controls remains the biggest concern for buyers and developers.
Of course, the government’s biggest concern is curbing speculation and providing stability to the residential real estate market.
Overall, there is tremendous diversity in the issues currently impacting the Chinese real estate market.
The office, industrial and retail sectors have their own specific set of issues and challenges, no two Chinese cities are identical, and even within cities performance can vary from district to district.
To what extent is China open to international investment?
China is accessible to international investment in the real estate sector through highly restrictive traditional routes.
For the larger foreign investors, one of the key problems is competition.
Many Chinese companies have improved their management, equipment and funding, are benefiting from experience, and have strong networks that are challenging to compete with. Whilst some foreign investors and developers have lost much of their shine post-financial crisis, it seems the China risk profile, as perceived by board members or investment committees not based in China, has not kept pace with the market.
In light of this perceived risk, rental returns are often considered too low to justify investment.
For smaller or individual foreign private investors, price and legal hurdles provide the biggest obstacle to investment.
High prices and recently introduced regulations requiring a period of residence in the investor’s target city are a challenge in first-tier cities like Beijing and Shanghai.
Though there are still many ways to own property in China, the risks and rental returns, especially when combined with the difficulties of managing property investments remotely, drive many foreign investors to take positions with publicly traded funds or developers, which provide a much more accessible route to investment with the added benefit of increased liquidity.
Prices have been rising every year for the past decade. Is the property market currently in a bubble?
As mentioned previously the residential, office, industrial, retail and other sectors all have their own specific set of issues and challenges, varying considerably across locations.
Demand for improved living environments in China is phenomenal and, though high, pricing across China still maintains a certain level of affordability.
In reaction to the 2008 global financial crisis, the government urged banks to increase lending as part of its fiscal stimulus package.
Mortgage loans accounted for one third of total lending activities.
Banks provided easy credit for housing development, possibly without detailed risk evaluation.
In addition, state-owned enterprises with access to low-cost credit also began to move into the real estate market.
Driven by this massive credit expansion, house prices surged markedly in 2009, underpinned by robust investment and speculative demand.
Government restrictions aimed at curbing purely speculative investment began to have an effect at the end of 2009 and an increasing number of homes are now instead being purchased for self-use as the residential market continues to adjust.
In assessing whether and where bubbles are forming, we need to take into account the local supply and demand situation, lending policy and existing equity levels in property combined with a variety of projections.
In general we find that equity levels are often high compared to the United States or Europe and demand for improved living environments is stronger.
We also note that the Chinese government is well-funded in the event banks need their support.
When and if they occur, repossessions and distressed asset sales in China are unlikely to follow the international format.
There is also greater flexibility for debt restructuring.
Local investors make up the vast majority of investment in Chinese real estate, all with different investment approaches and appetites.
All of these factors can limit the impact of any future price corrections.
Standard & Poor's recently cut its outlook on Chinese developers from "stable" to "negative." Is a correction being anticipated for real estate prices? Analysts are forecasting that home prices will fall by 10% within the next year.
The Standard & Poor’s downgrading is fundamentally related to policy and curbs on lending and cash flow issues.
The first priority for China’s policymakers is to cool and stabilize the property market, not force a massive correction.
It is possible for policy makers to soften their implementation of existing regulations, reduce the rates of various cooling measures (down payments and lending rates) and, if absolutely necessary, offer tax incentives for investment in real estate to kick start a stalled market, as has been done in the past.
In this respect Chinese policy makers are targeting “stable” and are not at all reluctant to intervene where required.
In the first half of 2011, we saw residential prices dipping slightly in a few key cities where the “bubble” was perceived as most severe.
Yet for investors, property still remains attractive relative to the risk of the stock market, and due to the lack of other investment opportunities.
Some small-sized Chinese property developers have shored up liquidity in anticipation of a downturn in the real-estate market, but this has weakened their capital structures and increased refinancing risks.
Meanwhile, opportunities in mainland China’s commercial property sector are becoming perceived as increasingly lucrative for investors and developers, especially in key second and third tier cities, in part because of curbs in the residential sector.
For the remainder of 2011, we expect price growth in the residential sector to soften in first tier cities and stabilize in second tier cities.
Fast growth may continue in third tier cities.
Interest rates and inflation are rising in China – what impact is this having? What is being done to combat this?
The People's Bank of China recently raised the one-year lending rate to 6.56% from 6.31% and the one-year deposit rate to 3.5% from 3.25%.
The move came ahead of the government announcement that the country’s CPI accelerated to 6.4% in June, a three-year high.
In response, China has tightened its lending requirements and needs to slow (but not stall) its economic engine in order to reduce rapid escalation of costs.
Rising interest rates will impact current and prospective homeowners and could impact demand for new property.
However, the perception that real estate is a good hedge against inflation and the appreciation of RMB may create renewed demand for real estate assets.
For developers, rising interest rates may have an impact on liquidity, driving them to seek alternative sources to raise capital, including joint ventures.
Meanwhile, the increasing cost of construction materials and labor is shrinking profit margins, particularly as the government continues to implement restrictions on the residential real estate market.
The World Bank still forecasts that China’s GDP will grow 9.3% in 2011, well above the growth rates in other major industrialized countries.
The strong GDP growth is an excellent sign, but the associated inflation that often surfaces as consumers increase spending may come with its own set of problems.
As prices continue to rise amid this increase in consumer spending and the impact of a potential third round of quantitative easing in the US, we anticipate more tightening via higher interest rates and/or higher bank reserve requirements.