China’s developers shift to commercial real estate

Chinese real estate developers have been spreading the message at recent meetings with investors that they plan to shift their focus from residential to commercial property even though commercial is unlikely to offer initial returns similar to those earned from residential in recent years. The Chairman of Shimao, which operates in 20 cities, told a meeting of investors: “We will adjust our investment. In the past, our sales relied on residential homes. But we are now more involved in commerce and tourism.”

This is in line with the central government policy of pushing urbanization, consumption and services. The well-informed business magazine Caixin quotes an unnamed executive at a listed real estate firm as saying that, unlike the residential sector, the commercial-retail property market is not exposed to the government’s macroeconomic controls. This is a key factor that has attracted developers.

Data from Jones Lang LaSalle put commercial real estate investment in 2010 at under 30 per cent of total real estate investment of US$765 billion. It says that in the commercial sector 37 per cent went into offices and the same slice to complexes, for which the approach is a “residential supports commercial” model, with residential sales providing capital inflows to support long-term commercial development. Given less easy loan conditions, this makes complexes attractive as investments for developers who want to diversify from residential and have the land and initial funds to start projects.

The commercial sector has drawbacks for developers, notably the longer revenue cycle, focus on investment returns rather than value appreciation as in residential, lack of information about clients to set rental rates and the need for continuing service to occupants after completion. Patience is required – Hang Lung in Hong Kong says its Mainland high-end plazas lost money for eight years before going into strong profit.

Our Trusted Source on commercial real estate in China adds the following questions that he thinks investors should consider:

• What is the current liquidity condition in China and the role of domestic buyers vs the current liquidity cycle?
  Given that the fiscal stimulus has created a situation of decreasing cap rates due to an increase in SOE buyers, where does this leave foreign investors?
• A lot of secondary cities are building for a future office and service sector but will their plans come to fruition and to what extent? How much space is really needed? Does supply equal likely demand?
• Whereas the China property supply side is based on pure politics driven by district planning, not demand, the demand side is driven by both buyers and tenants: how do these variables affect your investment planning and decisions?
• How do investors differentiate between the different districts and supply mandates for each district? How can they organize your planning process for where you are investing?