What do lower growth forecasts for China mean for its real estate markets and the wider Asia-Pacific region? Christine Senior reports
From a European perspective, shrinking economic growth is a subject of intense concern in the current climate. In China the opposite is the case. The government's expected growth target of 7.5% announced by premier Wen Jiabao is regarded by many as something to be welcomed, a deliberate policy to keep growth within reasonable bounds.
If past experience is anything to go by, the target is likely to be exceeded. March figures from Consensus Economics, which aggregates data from various economic forecasters, put the expected growth figure for 2012 at 8.4%, somewhat above Wen's target.
Looking further into the future, the World Bank, in its report ‘China 2030', forecasts that growth will slow to 5% between 2026 and 2030. Given that growth has averaged around 10% pa over the past 30 years, such a shrinking might seem significant and even ominous. But it has to be seen against the background of China's economic evolution and its global importance.
"Even a longer-term stabilisation of the growth rate in China to around 5% is still extraordinarily strong, particularly when it's combined with the increasing proportion China makes up of the global economy," says Tim Jowett, research and strategy director at Moonbridge Capital. "If you think about the world economy split roughly a third each between US, Europe and Asia with current real growth forecasts of Europe hovering in the 1-2% range and the US 2-3%, then if Asia, driven by China, is growing above 5%, clearly Asia becomes an ever larger part of the global economy and the aggregate growth rate of the world becomes larger as well."
In any economy that has enjoyed such a history of strong development, a reduction in the growth rate is to be expected as the economy matures. China's declared strategy is to move away from an export-driven economy and instead stimulate domestic demand through higher wages. This also means a shift of emphasis away from lower-value manufacturing to service industries and value-added manufacturing production, with consequences for the real estate sector.
Tony McGough, global head of forecasting and strategy research at DTZ, says: "Fifteen years from now China will be more mature. Mature economies tend to have very high consumption ratios. They consume as much as they produce; they have less to invest in because they have done capital investment already. For real estate, that might mean a significant increase in demand for offices as well as for retail."
As the engine of growth for the region, it is hardly surprising that what happens in China should carry such weight. But lower growth, particularly on the scale expected, although it will have an impact on Asia, should not overly depress real estate markets, either in China itself or the rest of Asia Pacific.
The story by sector
Mark Kemper, a partner at KPMG in China, says: "The slowdown is not big enough to have a major impact on real estate prices in the Asia Pacific region. For a slowdown in prices you would have to have a much more significant slowdown in economic growth. Growth of 7.5% compared with 8.5% might cause some delays to achieving goals for a particular project. But at the same time I don't think it will be a decision as to whether the project continues or not."
Within China, it is the retail sector that is attracting most attention, partly because government measures to cool the residential market have forced investors to find other sectors in which to place funds. Data from Knight Frank & Holdways show that in the second half of 2011 new stock of retail property coming on stream did not have an adverse impact on vacancy rates: stock of high-specification shopping centres grew between 110,000 and 485,000 sq m in seven major Chinese cities, but vacancy rates dropped compared with the first half of the year in six of them. Vacancy rates in second-tier cities averaged 6.6%.
Thomas Lam, head of greater China research at Knight Frank, says: "After the crisis many developers felt they could not put all their portfolio in the residential market. That's why they built many commercial properties. In tier 2 and 3 cities, land prices were relatively lower than in tier 1 cities, which means they could get a larger development site. In many cities they can't build a high-end office building because no one will take up the space; what they can do is build a shopping mall."
The continued urbanisation of China also favours the development of shopping malls. The China National Bureau of Statistics announced in January this year that urbanisation had reached a 50% level of the population, a significant milestone in economic development, attained much earlier than previously expected. A growing middle class, rising salaries with higher levels of disposable income fuel consumer demand for opportunities to shop.
Kenny Sim, associate fund manager for Asia property at Henderson Global Investors. says: "Most investors seem to be keen on China retail. Retail is more a case of investors wanting to get into the whole story of urbanisation. The middle-class, middle-income growth story, the story of retail, is supported by actual fundamentals in China. There is real demand from consumers for retail space. There is demand for this sort of quality asset from the domestic institutional investor down the line or even foreign investors."
But still not all retail projects are equal. While supply is growing, the market divides into those projects that will be successful and those that will fail to meet consumer expectations.
Sim says: "The supply of retail in China is growing, but there will be some supply which is not up to par; some built by international players who do not understand the local market. There is some supply built by domestic players who don't understand how to build a sophisticated retail mall that will capture the new sophisticated Chinese consumers."
Prospects for the Chinese office sector look good: the maturing economy, with more growth from the service sector, will drive demand for office space. At the moment, office rents are rising in Beijing and Shanghai, with mixed fortunes elsewhere.
Megan Walters, head of research for Asia Pacific capital markets at Jones Lang LaSalle, says: "There are pockets in specific cities where occupiers are adopting a more conservative approach to office expansion with leasing activity slowing - for example, Guangzhou and Shenzhen, where rents have stopped growing and may remain stable or correct by up to 5% in 2012. By contrast, Beijing rents grew about 50% last year."
The second- and third-tier cities in China are predicted to be centres of future growth by JLL. It has highlighted 50 cities set to prosper. They would constitute an economy worth $2.9trn in their own right and would rank as the world's fifth-largest economy if they were a separate state. JLL says over 80m sq m of retail and nearly 30m sq m of grade-A offices will be built here over the next decade. But among the 50 cities, nine are identified as being ahead of the pack, which JLL categorises as "tier 1.5", as they benefit from massive infrastructure and economic development.
Chinese second- and third-tier cities are still home to considerable numbers of people.
McGough says: "Moving down the chain of cities, the third-tier cities still have populations of four to five million. Some are developing advanced central business districts with international-quality offices."
Still, for overseas investors wanting to get access to Chinese real estate the process presents some difficulties. Local partnerships are crucial but picking the right partner is essential.
Jowett says: "For international investors to buy good-quality core buildings in China is very difficult now. They need to rely to some extent on development programmes to get access to that kind of stock. Clearly, in that environment the choice of partner is incredibly important. Do they partner with a local developer who might have access to opportunities but [has] governance issues - where partners are often not at all versed in the reporting and transparency that international investors want? Or do they go through larger, more established names that typically run pan-Asian funds but have not necessarily delivered the kind of track record that investors would look for?"
What happens in the Chinese economy has repercussions for the rest of Asia Pacific. Australia, specifically, is susceptible to any shrinking in demand for its commodities.
Yet some Asian hubs, particularly the financial centres of Hong Kong and Singapore, could be more at risk from the impact of Europe's financial woes than what happens in China.
"Australia is directly connected by the supply of resources. The same goes for Indonesia," says Walters. "Japan is connected through supplying goods and services that Japanese technology companies make and supply to China. Taiwan, Korea and Japan supply machine tools, ships and other services up the value chain. Hong Kong and Singapore act as servicing centres for China, so will be affected, but are more affected by the European financial sector than by what's going on in China."
Jowett feels that Australian rental growth expectations might suffer from a slowing of Chinese growth. But any slide in the value of the Australian dollar versus the US dollar could be positive for international investors seeking exposure to Australian property.
"The Australian dollar has not typically traded above parity with the US dollar. There has been nervousness from some international investors in coming into Australia," he says. "If the currency falls away a bit you could see a modest pick-up from investors who feel more comfortable investing in the Australian economy."
Australia is particularly attractive to foreign investors because of its strong economy and transparent real estate market - the most transparent in Asia-Pacific - and high yields in its office sector.
International investors want the diversification that Asian investment offers. Given that future economic growth is most likely to come from Asia, it makes sense for them to get exposure.
David Schaefer, head of DTZ Investment in Asia Pacific, says the developed Asian markets of Hong Kong, Korea, Singapore and Taiwan are attractive to investors because of their economic growth, compared with China which still has the risks of an emerging economy. "In China you have less certainty, given central policy changes, and a legal system that is not as robust as in OECD countries," he says.
"Most of the real estate in China takes the form of development which has a very long tail, and takes a long time to mature. In a developed market, investors can acquire properties that are already built and are income-producing, and a legal structure where they have a high degree of confidence that contract law will prevail and they are unlikely to have policy decision surprises."
Of the two Asian BRIC countries, China is the more high profile, but Schaefer says India is also attracting attention. "China attracts a lot more interest but the growth rate of foreign investment in India will continue to accelerate," he says. "There was a lot of interest in India before the global financial crisis which the GFC knocked back and we are now seeing the interest redevelop."
Sim points to renewed interest in the Japanese office sector: "Some more forward-looking investors have started to explore Japanese office. New entry players and those looking to get back into Japanese office are beginning to do research on Japanese office on when is a good time to go back into it."
One of the stimuli to renewed activity in the Japanese market is post-earthquake reconstruction, according to Sim. "And the Japanese government has been trying to prop up the J-REITs market, so periodically they engage in massive buying of J-REITs, artificially boosting sector prices. At the same time, Tokyo is a very liquid market; you have a lot of stock in the office sector traded by both J-REITs and international investors."
But in the financial centres of Hong Kong and Singapore the office market is suffering as jittery investors are concerned about potential headwinds from events in Europe.
"In Singapore and Hong Kong office space, most of the investors are not jumping into doing investment deals at this time," says Sim. "They are waiting on the sidelines because office is linked to the European market and the financial services sector they hope will recover. Most feel there will be a bit of an impact should the European market go south. That doesn't mean deals aren't being discussed."
But other events outside the region could pose more of a threat to Asian real estate markets than a Chinese slowdown. As well as concerns about how the European debt crisis might pan out, another threat is forthcoming regulation. Tighter banking regulation in the form of Basel III and Solvency II for financial institutions could affect international investors' appetite for real estate in the region.
Kemper says: "For the investors from the US or Europe - pension funds, or banks, or other institutions - various legislation is tightening up and that does increase the threshold for new investment to come into Asia. There are liquidity rules so they have to put more money on their balance sheet and that's an expense.
"But I think in due course that capital will find its way back to Asia. These institutions need to have higher-than-average results, and where else can they get that but in Asia? Diversification is on their agenda, but they have to meet their local requirements."