If China expands cooling measures beyond residential, will investors lose confidence? Shayla Walmsley investigates

It is probably too early to tell whether efforts by the government of the special administrative region (SAR) to control the Hong Kong property market through tightening measures will have a radical impact, nor how long it will last if it does.

Knight Frank notes a “slight” cooling of investment activity so far, with prime office vendors lowering their asking prices somewhat. It is the increase in tax that has so far hit hardest.

The imposition at the end of February of a double stamp duty contributed to a significant reduction in the number of March retail property sales, although Knight Frank believes retail will turn out to be the SAR’s most resilient sector over the longer term, thanks to gradual macroeconomic growth, tourism and retailers’ demand for additional space.

In mainland China, the cooling measures instituted by the Beijing government have so far been limited to residential. Arguably, they are ill-conceived. Diana Choyleva, director of
economics consultancy Lombard Street Research, says raising interest rates would be a much more effective cooling strategy because keeping deposit rates low encourages households to pile into the housing market. “Unless policymakers mop up this excess liquidity with higher rates, every time they try to ease policy to stimulate the economy, house prices will shoot up,” she says.

In any case, it is moot whether the government’s measures have had much impact.
Thomas Lam, director and head of research and consultancy for greater China at Knight Frank, says the net impact will be to increase prices for luxury residential this year, but less than 10% in a chilled market.

First-tier cities, charged with stricter implementation of tightening policies, will be harder pressed. According to an April policy update, many second-tier city reports avoided all mention of the 20% profit tax imposed on property re-sellers.

Some local officials are simply ignoring Beijing’s demands, which is indicative of problems facing the central government in trying to keep up with the apparently limitless ingenuity of local officials and investors to thwart its best regulatory efforts. Joe Magrath, director of development for China at Henderson Global Investors, suggests that few of the measures to date have resulted in any actual cooling.

“For many municipalities, it is not in their interests, because the sale of residential generates income and they bank on that for their own infrastructure spending,” he says.
“They turn a blind eye or loosely enforce centrally mandated cooling measures. The measures – for example, to restrict the sale or the acquisition of second homes – haven’t been successful but what you have seen is some panic buying immediately after they were announced. “

He adds: “The measures are counter-productive. It’s always a question of the government’s ability to stay ahead of efforts to get around the measures.”

Cooling measures tend to affect residential, but not necessarily other segments. Will there be a knock-on impact? It is doubtful.

Retail, which is Henderson’s focus in China, has its own drivers, and regulation is only one of them. Much more significant is the fallout from global macroeconomic downturn. International retailers are slightly slowing their expansion plans for the first time in China since 2009. High-end retailers that had been looking at third-tier cities are pulling back.

Still, domestic demand drivers remain strong. “Expendable income is going up and
up and there is no indication that will change,” says Magrath. “The numbers here are mind-boggling. There are enough people with enough money that you would have to have huge numbers of outlets for it to impact us. You could have 30 centres with the same retailers, all thriving.”

Even if current measures have a negative impact on residential, the displaced capital will flow into non-residential, such as serviced apartments, which aren’t included, suggests Tony He, Henderson director of property for China. Failing that, investors will just move into the commercial sector.

“The only way to quell the property market will be a property tax. It’s unlikely. If it were to happen, there would be a backlash. Investment options are limited for local investors so there is more demand for them to go into commercial,” he says.

Anticipating what kind of regulation the Chinese government might attempt implies a certain macro rationale to government decision-making. But at a recent conference a US investment manager suggested that recent armed conflicts off China’s shores should tell investors at least as much as the touted growth story based on urbanised consumer demand.

Speaking of the dangers not only to real estate investors but investors more generally, Alison Graham, CIO of Voltan Capital Management, said the key to understanding the Chinese market was political, rather than economic, pointing out that capital allocation decisions would be based on politics as much as profit. “The underlying philosophy is that the purpose of capital is to promote the national interest,” she said.

Her case is that, faced with an end to cheap capital and rising labour costs, the government is unable to deal with non-performing loans to state-owned companies which are estimated to be up to 40% of lending, because to do so – that is, to allow recession – would jeopardise an implicit social contract that exchanges rising living standards for political control. The alternative would be to tolerate 10 years of 1-2% growth, but to do that would entail the government risking its own removal. Instead, she argued, the government had taken the third alternative: sabre-rattling off its coast in a bid to rally popular (and distracting) nationalist sentiment.  

In the meantime, investors in Chinese real estate have other things to worry about. GDP growth fell 8% in 2012, although the beleaguered rural provinces slid less than central regions, hit by a major drain on funding as cooling measures hit a primary source of investment, according to the Economist Intelligence Unit.

Even if, as Magrath suggests, domestic demand for retail will encourage continued investment in at least that sector in the short term, within 15-20 years, he says, the ageing population will have put major pressure on the service sector and created a labour supply deficit.  “There is a limited window for retail to enjoy,” he says.

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