The rise and boom of the Shanghai property market

Alysha Webb looks at the burgeoning residential property market in Shanghai

Sam and Vinnie aren't an exception in Shanghai, they are the norm. Many Shanghainese own multiple dwellings. Indeed, a Morgan Stanley survey found that 27% of home purchases in Shanghai were made purely for investment reasons; only 16% of those surveyed were first-time buyers.

Buyers from outside Shanghai are also flocking to this city of 20m to invest in real estate. In 2003, according to a report by Shanghai Cetaline Property Agency Ltd, investors from outside Shanghai - including Hong Kong and Taiwan - sunk some 15bn yuan (US $1.8bn) into the Shanghai property market, up 33% when compared to 2002.

In many markets, this kind of purchasing pattern might create a bubble, pushing prices up and encouraging developers to build where there was in fact no demand. The high prices would be unsustainable, loan defaults would follow, and personal and business bankruptcies would litter the landscape.

But China's property market isn't like many other emerging markets. For one, many of the purchases are made with cash. As much as 22% of buyers in a Morgan Stanley/Shanghai Forte Land survey planned to pay cash for their purchase. More importantly, there is simply a huge demand for housing in China, where private home ownership became possible only 15 years ago in Shanghai and even later in other cities.

Tremendous demand

All of which makes this fertile ground for foreign companies, from property developers to real estate agents to home improvement retailers. 'In the three to six-month timeframe there may be some volatility in China's housing market,' says Hong Kong-based Morgan Stanley analyst, Douglas Sung. 'But in the medium to long term there is tremendous demand for housing in China. We are quite positive with regards to the market.'

Capitaland shares that optimism. The Singapore-based property developer has invested more than 12bn yuan (US $1.45bn) in the mainland China property market since 1994, in both commercial and residential properties. At the end of 2003, Capitaland had 4,000 middle to high-end housing units in Shanghai. Earnings before interest and tax from the company's China operations grew 345% from 2001-2003 to S$118m. Despite a slew of stories in the local press lately about falling housing prices, Capitaland isn't worried. 'We expect the market to remain healthy for the next five to 10 years,' says Lim Ming Yan, CEO of Capitaland China.

The Shanghai market has certainly been healthy for the last three years. After falling in 1998-99, housing prices rose in Shanghai by 8.8% in 2001, 13.3% in 2002 and 21.5% last year. In comparison, housing prices in Beijing rose by only 2.4% in 2003. For the whole country, housing prices rose 4.8%. In the US, prices tend to rise 3%-5% a year.

And while there may be a small bubble in high-end housing, it won't crash, predicts Guy Hollis, country director for real estate company, JonesLangLasalle. 'At the middle and low-end, there is not any bubble at all,' he says.

To be sure, the China property market is full of uncertainties. The Chinese Government, anxious to prevent overheating, often issues what Michael Hart, head of research - Shanghai for JonesLangLasalle calls 'somewhat experimental' regulations. 'This sometimes causes them to throw the breaks on development with new policies that developers could not have anticipated,' he says. For example, last year the Shanghai Government reduced the plot ratios - the square footage that can be built on a certain sized piece of land - without warning. It also froze land sales for villa use (i.e. building free-standing villa-type houses), but there are so many villa projects already started that the impact will be limited in the near future.

Lack of transparency is another problem in China. Land used to become available through government connections. Though, last year, the Shanghai Government passed a law requiring that the land be tendered, as is common in developed markets. 'It hasn't really gotten rolling,' says Hart. Exchange controls make it tough for foreign investors to expatriate profits, which are in yuan. The yuan's non-convertibility is 'obviously part of the equation when people assess feasibility in China,' says Morgan's Sung. 'But I would assume a lot of the overseas developers are looking to build long term presence in China. Besides, who knows what the currency policy will be further down the road?'

Language and cultural difficulties are another stumbling block in China and one reason why Singaporean and Hong Kong developers dominate the landscape here. 'Local knowledge is critical in the real estate industry as you have to deal with so many locals, including the relevant approving authorities, local design institutes, contractors, suppliers and home owners,' says Capitaland's Lim. Western developers are often uncomfortable with the lack of true ownership of land in China, says Hollis. In China, all land is owned by the Government and users take out long term leases on the land - 40 years for office use, 50 years for retail and 70 years for residential use.

In the last year or so, some uncertainties have begun to fade. Banks used to offer preferential lending rates to local companies. The Government has since, however, cautioned them on the practice and it is now fading, says Joe Zimny, CEO of Shanghai-based New Choice Mortgage Services, which helps property buyers and investors line up financing with Chinese banks. 'Two years ago, we had banks telling us openly they weren't following the rules,' he says. 'Now they mostly stick to the policies.' District and city agencies like the real estate exchange, where all property transactions must be registered, have also become much more professional and 'more willing and able to prevent fraud.'

As regulation of China's real estate market regulation improves, another group of investors are taking a first look at, or sometimes returning to, the sector. New Choice has several small investment fund clients - one with $15m another with $50m - looking for residential real estate investments here. 'One looked at the property market here in the past and said no. Now they are willing to invest,' says Zimny. 'The other thinks it is risky, but is willing to take the chance.' Hollis is seeing bigger fish come into the market. 'There is much interest from European pension funds which we wouldn't have seen two or three years ago,' he says. 'They are buying real estate - office blocks, shopping centres, serviced apartments which offer a steady income stream.'

That doesn't mean foreign investors will find it smooth sailing in China, however. 'Government policy is levelling the playing field and opening doors,' says Hollis. 'But I wouldn't want anyone to think it is easy here because it is not. The biggest difference is bureaucracy. You need four different documents just to develop a building.' Zimny agrees: 'The biggest drag is time spent getting all the people who need to chop a document together in one room.'

Foreign retailers are braving that bureaucracy to take advantage of the boom in private home ownership. In China, apartments are generally sold as empty shells; owners have to install everything, including the kitchen sink. Britain's B&Q, a part of the Kingfisher Group, is there to help. The retailer has 15 stores in seven cities, and plans to have 75 stores in 30 cities by 2010. Sales on the opening day last October at a 250,000 square feet Beijing store hit £300,000.

Shoddy regulation of local home building material retailers is helping boost demand for stores like B&Q, where prices might be a bit higher but so is quality. Vinnie Shen and Sam Flemming used B&Q to outfit their new apartment after Vinnie used local contractors to build out her first apartment in 1999. 'It was a disaster,' she says. 'The quality was really bad.' She had to haggle over every price and constantly be on guard for substandard materials. With B&Q, they paid a set 100,000 yuan for materials on the 140 square metre apartment plus 20,000 yuan for labour. Some 80% of the materials came from B&Q, so quality was assured. 'For two-income couples, it's really good,' says Shen. 'You don't have to compare prices.'

Other foreign retailers are entering the fray. Germany's Obi has three stores in China, with plans to open 100 by 2010. US giant Home Depot has just opened an office in Shanghai, though its representative here declined to discuss his company's China ambitions. France's Leroy Merlin is eyeing China, as is Japan's Komieri.

They will probably be looking to China's undeveloped inland cities for new opportunities, especially if more coastal cities follow Shanghai's lead. To help curb shoddy workmanship in apartment interior outfitting - a major source of lawsuits these days - and to provide more convenient housing choices, the Government recently told developers to start providing more completed units. Shen figures these stores had better expand their furniture offerings. 'Now, more finished apartments are being offered,' she says. 'There is less work on the decoration scene and, therefore, more work on the software, like furniture.' Maybe in Shanghai or Beijing. But for retailers and for developers like Capitaland, says Lim, 'there are ample opportunities in second tier cities such as Chongqing, Chengdu, Dalian, Nanjing and Shenyang'.

Alysha Webb is a business journalist based in Shanghai.