China Sector Watch: Real Estate

December 17, 2008 Posted by China Briefing Reading Time: 7 minutes

This is the first of a regular series that will take an in-depth look at the industries that are shaping Chinese economy today.

By Joyce Roque

Highrise construction in Shanghai Dec. 17 – In the 30 years since Deng Xiaoping instituted reforms, the concept of investing in real estate remains relatively new. In 1978, Deng led reforms in the China that valued the sentiment of pragmatism over dogma. Change during this time was aggressive as many state-owned assets were privatized and huge tracks of once communal land were turned over to developers.

It was only in 1997 that people were encouraged to buy private property. Private ownership didn’t exist in Mao’s China, but land reforms under Deng forced people from relying on the state for their housing needs to saving up for their own thus laying the ground for the basic law of market economy.

This housing reform gave citizens more freedom to explore employment outside state-owned industries because they had the security of owning their home. Under Maoist thinking, the state provided basic housing for its workers and charged only minimal rent and covered other costs through state subsidies. As late as 1998, the concept of a home mortgage for the Chinese was still something new.

This is in contrast to today when an estimated 80 percent of China’s urban households own their home. The residential property markets of China’s major cities became overheated during the late ‘90s when the vacancy rate for buildings in Shanghai was 38 percent and Beijing was 30 percent.

Private property
The year 2007 became a landmark for the real estate industry in China when the central government passed the private property bill legalizing an individual’s real estate rights. The bill stated that “ownership rights of the state, groups and individuals are protected by law, and no individual or organization may violate these rights,” thus giving private property the same status as state property.

The bill was considered controversial because it would make it harder for local governments to illegally seize land. More so, others saw it as another way for corrupt officials to makes themselves rich. Private real estate ownership is a sensitive issue because the rapid changes in China’s economy has resulted in one of the most unequal societies in the world. The gap between the rich and poor has been worsening which can only lead to mass social unrest if left unchecked.

According to The Guardian, the ratio of urban to rural income per capital reached 3.31:1 in 2007, the widest since economic reforms began in 1978. Per capita rural incomes last year rose to RMB4,140 compared to RMB13,786 in urban areas. While the number of Chinese people surviving on less than US$1 a day fell by more than 600 million from 1981 to 2005 this still leaves as much as 100 million people just scraping to get by.

The real estate market in the country is divided among those for residential and commercial use, buildings for commercial purposes and office buildings. The residential real estate market in China is driven by rural migration, urbanization and lack of options for investing money.

People coming from the provinces and moving to the city for work will want to buy homes and China is poised to witness one of the largest waves of urbanization in the world as their standard of living improves. According to a forecast made by the United Nations, it is estimated that around 16 million and 22 million people will move from rural areas to urban areas annually until 2020.

By that time, the total urban population should reach 300 million needing about six billion square meters of housing. Owning real estate is considered one of the keys of wealth and an emotional purchase in terms of wanting to ensure security in the future. According to a survey done by the Oriental Morning Post and Sohu.com, 4,000 respondents believed that the real estate business was still considered as one of the most profitable industries.

The market
China’s real estate market is labeled as a semi-transparent market, according to the latest edition of the Global Real Estate Transparency Index from real-estate firm, Jones Lang LaSalle. The report ranked real estate transparency among tier cities in the mainland, Hong Kong, Taiwan and Macau. Hong Kong was among one of the world’s most transparent real estate markets while Taiwan had has a slightly higher level of semi-transparency than the mainland. On the other hand, Macau had a low transparency below mainland first-tier cities but higher than second- and third-tier cities.

The ranking was based on six categories to determine market transparency along with the market’s openness for overseas investment. China was said to have addressed problems in regulatory and legal issues but still ranked the lowest in terms of market fundamentals.

The Global Real Estate Transparency Index named four reasons for China’s improving real estate sector: globalization, a major force behind real estate transparency, with increasing capital and companies in China expediting the requirement for accurate market information and adoption of global practices; openness of real estate’s direct correlation to the growing volume of investment transactions; increasing number of public listings by property developers and more market information through annual reports; and central government policies and more publicly available information through the China Real Estate Intelligence Services.

Denis Ma, head of the research department of Jones Lang LaSalle Beijing told China Daily: “We are confident about China and anticipate further transparency improvements in its real estate market over the coming years, primarily in terms of market fundamentals, regulations and legal issues. By 2010, we project the transparency score will move from 3.3 to 3.1 or 2.7, putting China at the upper end of the semi-transparent category and on a par with current transparency levels in Russia and Brazil.”

Economic slowdown
The real estate industry is considered as one of the pillars of the Chinese economy and over the years has weathered its own string of boom and bust cycles. Real estate speculation has been rampant, threatening the market from overheating.

Reuters reports that it was real estate speculation that caused billions of dollars of foreign capital to pour into the Shanghai stock market creating a bubble. Today, the market has lost more than 60 percent of its value from its peak in 2007.

in China, real estate contributes on average 25 percent of city investment according to China Daily. In some cities, that figure can climb as high as 50 percent of investment. Overall, the property market accounts for about 10 percent of the Chinese economy.

The global credit crisis that has sent economies around the world reeling makes the industry far from immune. The economy has been hit by slowing export demands from its top markets currently suffering from recession; the United States, Japan and Europe. This has already led to mass layoffs and factory closures in the manufacturing hub of Guangdong and other surrounding provinces.

Under the real estate industry, construction drives the economy and accounts for a quarter of fixed-asset investment while also employing 77 million people. In October, the construction of homes, offices and factories plunged at least 16.6 percent compared to last year’s 32.5 percent.

The China Real Estate Association (CREA) has already submitted policy proposals to the National Development and Reform Commission to help property firms cope with the slowdown. CREA suggested the reduction of income tax for real estate firms, banks supporting promising property projects and encouraging the local government to purchase common residential buildings for low-income housing. The government has already launched an economic stimulus plan worth US$586 billion that should buoy the economy further.

It is with this money that the government wants to maintain investment and domestic demand to keep the economy’s GDP from slowing any further. A GDP of below 9 percent for China is risky and could lead to mass social unrest.

Unfortunately, the stimulus package is not meant to extend help to real estate developers directly. Zhang Baoquan, chairman of the Beijing-based developer Antaeus Group, told Reuters: “Developers will get no real benefit from the government money. It’s for social, or low-income, housing, to secure industries like cement and steel.”

Developers tend to avoid projects that cater to the low-income market because it would mean lower profits as well.Credit Suisse strategists said in a research report that property prices should fall further by 10 percent to 15 percent in 2009.

“We suggest investors use short-term technical rebounds as exit opportunities to trim their exposures to the sector,” they said. “Long-term investors should re-enter the market only when a more sustainable recovery trend is confirmed, which could come as early as in the second half of 2009.”

Forecast
Office space has also been affected by the crisis as vacancy rates for prime offices in Beijing rose to 18.5 percent in the first three quarters of the year, 5.1 percent higher to last year’s figure. It is estimated that the total supply for prime office space in Beijing should exceed 1.2 million square meters, the largest supply thus far.

Apartment sales climbed 52.4 percent in Beijing from October, while Shanghai grew 41.98 percent, according to municipal departments in charge of tracking such statistics. According to numbers from the Beijing Municipal Construction Committee, 12,479 apartments, with a combined floor area of 1.19 million square meters, were sold in Beijing in November. In comparison, the China Real Estate Information Circle System (CRIC) says that the total floor area of apartments sold in Shanghai during the same period increased by 708,500 square meters.

The increases do not paint a picture of a recovering industry because of depressed sales level in October. However, some are seeing opportunity despite plunging market value and are acting based on contrarian investing. The regional director of LaSalle Investment Management, David Edwards told Reuters:”We are seeing a decline in values throughout the region. There are properties that are being sold at much lower prices than the market’s perception of their values.” He says Hong Kong and Singapore are expected to bounce the soonest from the credit crunch.

ING Asia Pacific managing director Nicholas Wong added that his company is focusing investment in China and Japan. “Most of our clients are from the U.K. and Europe and traditionally, they invest only at home,” Wong told Reuters. “Now, they want global exposure and most of them want to go to Asia for diversification.” As a whole, the real estate market performance in the short term will depend on how China makes use of its economic stimulus plan. How will the money be able to provide the 10 million jobs needed to maintain GDP at 9 percent? There is also the factor of the new United States president; when Barack Obama is sworn into office, will he be able to implement the reforms that the United States needs? And how will this affect Chinese exports? There have been reports that the Chinese government will devalue the RMB to help struggling exports.

Figures show that China’s export growth for October dropped by 19.2 percent compared to last year’s numbers. “As part of the macro-control measures, adjustment of the renminbi’s exchange rate is reasonable and necessary,” Pei Changhong, director of the Institute of Finance and Trade Economics was quoted by China Daily as saying. Pei adds that the real export growth numbers could be worse since the currency’s appreciation does not reflect real export figures based on the value of the dollar. He said, “The real export growth is only about 8 percent to 9 percent.”