Real Estate Market in China
Klaus Koehler, Managing Director, Klako Group

Real estate development is a crucial driver in the economic growth and therefore the progression of this market is a good way of promoting the economic development of China. In the first quarter of the year 2006, China's gross domestic product increased by more than 10 percent. One of the reasons is the excessive growth of fixed-asset investments and lending. In addition, the lack of investment opportunities elsewhere in the Chinese economy is responsible for the paramount increase in these sectors.

History of China's Real Estate Market

The development of the real estate market does not have a long history in China. In the middle of the 20th century urban housing development lagged far behind economic development, which resulted in inadequate infrastructure, over-crowded population and poor housing conditions. To adjust to this disequilibrium the government in 1949 confiscated the land in the cities and announced state ownership. The state then allocated land-use rights to socioeconomic units, called Dan Wei. As these Dan Weis were state-owned, too, the appropriation was free of charge. Therefore land-use rights and land ownership were institutionally inseparable and land markets vanished completely, when all land was either state- or collectively owned by 1958. While urban land was state-owned, most of the farmland was collectively-owned. But the state converted the collectively-owned land as well by providing compensation packages including job opportunities, housing compensation, compensation for the loss of crops and granting of urban residency licenses to the farmer. These city residency licenses, called Hukou, were very important to the residents as it provided social welfare as medical insurance, pension plans and access to high-quality schools.

The adoption of the so-called "open door" policy in 1979 challenged the land tenure system first, as the state-controlled land allocation system conflicted with the ultimate goal of introducing market mechanism. This should improve economic efficiency as the land allocation by the government failed to meet efficiency in the past years, when land were only allocated according to the socio-economic development plans. With the opening for foreign investors the political and economic environment improved. In the 1980s China established special economic development zones (SEZ) along the east coast to attract foreign investors. In these areas foreign investors could lease land for a certain period of time. Therefore land-use rights and land ownership were separated for the first time. But the most significant changes occurred in the late 1980s when the bureau of land administration was established. This bureau was responsible for land policy reform, land allocation and acquisition and the monitoring of land development. From this point the land market started to develop slowly step by step until 1991 when land users were finally allowed to let, transfer, rent, and mortgage land-use rights. However, with the new regulations the government still controlled parts of the transfer of land. The objectives of the land policy reforms improved the land-use efficiency and increased government revenues, but there were also unwanted consequences as social inequality and increasing costs of land caused problems for the people.

Real Estate Market Today

However, the situation has improved for residents in China. For example Shanghai's average living space has increased from 6.6 square meters in 1990 to 13.1 square meters per person today. Up to now, 90 percent of local residents are living in apartments with separated sanitary and kitchen facilities while in the past about two-thirds of families had to share a bathroom and a kitchen with their neighbors. The city has built 197 million square meters of new housing and invested approximately
USD $48billion as a result.

But there are still difficulties related to the real estate market as the China market is considered far from a normal or orderly market. If new properties hit the market, many people flood to the showrooms to throw down cash. Because of the rising income more people can afford to buy a home. However, the demand cannot be satisfied due to the scarcity of payable housing, which have driven prices up. Moreover inflation fears are high and the government has indicated, that it will not increase interest rates to relieve pressure on the currency. Under these circumstances, where the actual interest rate decreases, many investors turn to real estate and other fixed-asset investments to protect their capital. There is little doubt that a housing bubble exists, as housing prices are increasing much faster than people's salaries. Across China incomes have risen about 50 percent over the past five years, while for example in Shanghai the average housing prices have tripled in the last two years.

New Regulations to Cool the Property Market

As the governmental target of eight percent growth for the Chinese economy in 2006 was already exceeded by May, the China Academy of Social Sciences has warned of an overheating of the Chinese economy, especially in the fix-assets sector. The government also fears of an overheating of the real estate market and has begun to control soaring housing prices in many of China's major cities. According to the National Bureau of Statistics the housing prices in most of China's major cities showed an increase particularly during the first quarter of 2006. For example the housing prices jumped 20% in Beijing during all of 2005 and further 17% in the first two months of 2006. Therefore since June 2006 the authorities have issued new regulations for the real estate industry.

The council issued a circular of 15 measures aimed at stabilizing property prices. Among the measures, four will have a direct impact on the real estate market. The minimum down payment for a new apartment larger than 90 square meters will be raised from 20 to 30 percent of the total price. Moreover a transaction tax will be imposed on people reselling their properties within five years of purchase, instead of the current two years. In addition, local governments are required to ensure that 70 percent of the units built are no larger than 90 sqm and finally the government will levy penalties on land which is not developed after one year of the contracted project commencement date.

These regulations are welcome as they give a clear message that the central government aims to create a transparent and balanced market with a reduced level of speculative activities and artificial price movement. Moreover the developers will be discouraged from building bigger and more expensive units while homebuyers are demanding smaller units. The target is to ensure that there is adequate housing in the low- and middle-income ranges. This aims to slow down the growth in fixed-asset investment, rein in the continuing rise in property prices and prevent urban housing issues from causing other social problems.

It remains to be seen, how effective these measures will become, as the threat of confiscations has existed before. Local variation of the actual interpretations of changed rules is known in China as well.

After this general overview about the real estate market in China the following sections will provide a closer look on the situation in the office and residential market in Shanghai, Beijing and Guangzhou.

Shanghai

Two years after the Asian Financial Crisis in 1997 the Shanghai office market reached the bottom of the real estate cycle. But since then there has been a significant growth in supply and demand. As China is attracting increasingly more multi-national corporations (MNC's), Shanghai is one of the main benefactors. By being a preferred destination for many corporate headquarters in the Asian Pacific Region, it rivals with traditional 'locations of choice' such as Hong Kong or Singapore.

Because of its rising popularity and a strong demand in occupancy in addition to the limited new supply for some years and the completion of state-of-the-art Grade A office buildings built to suit higher quality demands from large international and local corporate tenants, the rents for prime office space has risen continually.

Due to the government's macro policies there was a substantial decline in 2005 compared to the past years. The government introduced measures to control the real estate market in Shanghai even before the council introduced the general regulations for major cities in China in June 2006. The measures included climbing taxes and restrictions on sales to control the market and prevent speculators investing in property, which artificially raised the overall market price. Therefore both buyers and sellers hurried to make deals before the new government polices came into effect on June 1st 2005 and prices raised. However, with the introduction of the measures, the prices for residential properties dropped and the market became stabile.

This will change in 2006 again, as five Grade-A office buildings will be finished and space is leasing quickly. Moreover the general vacancy rates will be relatively low. It is therefore expected that rental rates will rise again. In the financial district, Lujiazui, especially rents are likely to rise, because of a strong demand by MNC's and the continuing growth in the financial sector.

In comparison to the commercial market the residential market is relatively quiet as the government's index for new home sales continues to slide. Therefore investors should consider the declining prices for investments. The downward pressure affects especially the rentals of luxury apartments and the villa market, while the rentals of serviced apartments are unconcerned of the decline, as there is a constant demand for these types of apartments. During the traditionally quiescent period at the beginning of the year some landlords offered seasonal promotional activities to increase occupancy. After this period, in March, the rentals again were observed to be increasing. Due to Shanghai's role as a business, conference and exhibition hub as well as the rapid growth of the city's expatriate business community, there is a solid foundation of demand in serviced apartments. For the future this trend is expected to increase, due to the constantly growing expatriate community living in Shanghai, who are there for a short-term basis.

Beijing

In comparison to the increasing Shanghai office market the supply and demand for offices in Beijing has slowed. There has been no new projects completed in the beginning of 2006 and as a result a progressive increase of available space is apparent. In line with the decrease in completions, the level of absorption declined as well. In the past there has been a failure to meet MNC's requirements, who are generally seeking specific offices. This is one of the reasons for the drop in demand of existing projects that do not meet these standards. Moreover the upcoming Olympic Games 2008 in Beijing cause a "wait and see" approach of some companies regarding the establishment of new headquarter locations.

The different sub-sectors of the Beijing office market react in different ways. Prices for offices in the central business district remain almost constant, while there is an increase in prices for Zhongguancun, the technical hub, and the Finance Street of Beijing. Especially the center's domestic financial institutions are beginning to attract the attention of foreign organizations, as the government provides benefits to overseas monetary corporations which purchase and lease offices in the Finance Street area. However foreign investors are not the only ones with office acquisition activity, there is an increase with the domestic organizations in this area, too. Nevertheless for the near future the rentals for office should remain relatively constant, until some new projects are finished in the end of 2006.

On the market for luxury units new developments were completed at the beginning of the year, but the dynamics on the residential market varies; distinguished between luxury apartments and villas. Rentals for high quality villas remained steady, while less quality villas have lower prices in order to increase occupation, which results in a general decrease of average villa rentals. For the short-term the capital values of the market for luxury apartments deflated caused by the injection of new units in the beginning of the year. But for the mid-term, the value is predicted to rise again, because of the finite supply of urban space. Related to the improvement in urban infrastructure and regeneration in the inner city area fuelled by the approaching Olympic Games, the market for luxury residential real estate remains strong in Beijing.

Guangzhou

Guangzhou is one of the major business hubs in southern China with growing prominence. The increase in the rental of office space by local and overseas companies is continuing. The traditional central business districts in Huanshi Road and Dongfeng Road lost popularity initially, especially when the new Sports Center business area and the Pearl River New City in Tianhe district were promoted by the city's municipal authorities. In order to counter balance this shift of business, the city's authorities have generally improved the environment and overall attractiveness of the traditional districts. Yet not only new companies are attracted by the rapid economic growth of the city, but also established companies are planning on expanding. This development results in climbing requests for the prime office spaces. Although demand increases there is still a relatively high vacancy rate, which has increased prices slowly. Moreover a large quantum of supply has arisen in 2006 in the top-tier office property as it is still seen as being attractive to investors due to their outstanding quality.

Similar to other cities there is also a strong demand in luxury units according to the continuing robust demand from expatriates working for MNC's. Therefore the vacancy rate dropped in the beginning of 2006 and prices increased. In addition, prices are affected by developers reducing supply. As mentioned the continually increasing prices in the residential market forced the government to implement measures aiming to restrain price growth. Until these measures came into effect at the beginning of June, prices rose accordingly. Especially a week before the 'cooling policy' came into effect, people queued outside the real estate service center to complete the transfer of housing ownership, purchase and resell procedures.

Forecast

In a further effort to slow down the real estate sector, the government is issuing a new regulation created jointly by six different ministries, including the Ministry of Industry and Commerce and the Ministry of Construction. The new regulation restricts foreign investment by allowing only foreign institutions with branches in China or individuals who have been living in China for more than one year to purchase real estate for self-use. The regulation stipulates that the buyer must provide his real name, the size of the property will be directly related to the number of employees of the company. If the foreign entity or person is not buying for self-use then the foreign company must register a real-estate firm in China, especially for projects with investment of over USD $10 million. On top of this the registered capital must be 50% or more than the investment volume, which is a 10% increase from the current requirement of 40%.

One can see that the Chinese government is curbing real estate investments in China in order to slow down development and stabilize the market. The government is extremely worried to have a bubble burst in a similar experience to Hong Kong before the Asian Financial Crisis.

If you require assistance with the above subject, please contact us at info@klako.com with your detailed questions.

All information in this report is verified to the best of our ability and is assumed to be correct at time of release; however, Klako Group does not accept responsibility for any losses arising from reliance on the information provided within.