Real estate is a core driver of China’s economic growth, but widespread expansion also brings the inevitable risks associated with a maturing market. As momentum in other key sectors now remains strong, a window has emerged for policymakers to address property excesses without slowing GDP too much.
The government pressure on banks to clean up their loan books is providing a steady flow of opportunities, says Rob Blain, executive chairman for the Asia-Pacific at CBRE. In this interview, he shares his views on the factors driving China’s real estate market, from movement of capital to appealing investment strategies.
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Rob Blain: China continues to astonish global markets with its ability to adapt and change. The medium-term future will again be no exception. From where we stand, we see China entering a period of transition within the next five-to-ten years. The primary drivers will be basic economics. Specifically, the change will come as China develops from a middle to a high-income economy. Knock-on effects of this transition will result in a pivot to high value-added manufacturing, a stronger service sector, robust consumption, and balanced geographic development, all of which are expected to drive economic growth. This will be a national story. However, in the shorter term, the impact of this transition is likely to be witnessed both in first and second tier office markets in 2018 as demand gradually tilts toward creative jobs and services.
Other economic factors also need to be considered when looking at China. While the U.S. and China will see new central bank chairs appointed in 2018, monetary policy is likely to remain unchanged. People’s Bank of China (PBoC) governor Zhou Xiaochuan will retire in March, with his successor continuing to pursue deleveraging reforms. Given this backdrop, the continuation of the relatively low interest rate environment will not exert strong pressure on property yields.
China’s pursuit of deleveraging is expected to create opportunities for non-bank lenders. Chinese developers face almost $90 billion of debt repayments over the next three years. In parallel, Chinese regulators continue to restrict property companies from issuing bonds, a move which has forced some developers to raise funds from the offshore bond market. Smaller developers in particular will be in need of alternative funding. Investors with a stronger appetite for risk can consider looking at non-performing loans (NPL) in China. Commercial banks’ NPL ratio in the real estate sector increased from 0.5 percent in 2014 to 1 percent in 2016. This, combined with the government’s pressure on banks to clean up their loan books, is already providing a steady flow of investment opportunities.
For commercial property, where will capital flow to?
China will remain a magnet for investment. Despite a more realistic economic growth trajectory going forward, capital will continue to gravitate toward China. We conservatively estimate that the country’s commercial real estate space will probably receive $14 billion of capital within the next three years. Flows of this size will also ensure that China will be the top recipient for real estate private equity capital in the Asia-Pacific. With clear signs of economic stabilization of China, our view remains that more funds will deploy to the country’s first tier cities due to the expectation for improved investment return and more investment opportunities. Think Shanghai, Beijing, and Shenzhen.
While capital flows will remain, the fundamentals of these investment flows into China will mature in the coming years. By 2020, investment strategies, including value added strategy, opportunistic strategy, and core-plus strategy, are likely to be implemented with greater confidence and frequency. Furthermore, we also see potential options including some investors to consider project repositioning, selecting investment opportunities in China’s non-performing loans, and exploring opportunities in niche sectors. All of these avenues are becoming more attractive to investors looking to maximize exposure to China’s real estate space.
En-bloc transactions are yet another capital force in China flexing their might. In 2017, en-bloc commercial property transaction volume reached a record high of RMB230 billion [$36.4 billion]. We see supportive monetary policy trends and robust demand by developers and institutional capital leading to another active year on this front.
Are premium office markets, such as Shanghai, still favored by investors?
Reflecting the maturity of the economy, Shanghai is no longer the barometer for the health of China’s national office market. Viewed holistically, the entire office investment market in China will remain active in 2018. Specifically, investors will continue to show strong interest in decentralized areas and emerging submarkets in first tier cities with solid fundamentals. Prime assets in core areas of growth cities such as Chengdu, Hangzhou, Nanjing, and Wuhan have come into favor and will likely emerge as more sustainable recipients of capital.
Having said that, Shanghai remains a stable office market, but we expect to see decentralization to brew as an office market trend in not only Shanghai, but across Greater China. For example, in Shanghai and Hong Kong, where footprints of financial sector tenants are usually larger, we will continue to see banks and other big financial institutions relocating some of their back-to-middle office operations to more cost-effective submarkets outside of the central business districts (CBDs). As a result of some oversupply, a mild rental decline in Shanghai could be on the cards, but this will in no way dent the longer term confidence in the market, particularly as industries such as finance continue to evolve.
What kind of firms relocate away?
Office leasing demand will remain stable in 2018, with activity expected to be driven by tech and domestic financial firms. Encouragingly, Asian corporates will dominate as new industries and sources of demand continue to emerge.
Oversupply pressure will persist in China. For Shanghai specifically, this will mean some compression in rents which will bring some firms back into the fold. Longer-term, the fast expansion of the tech sector in the Chinese mainland and Taiwan will drive strong demand for decentralized office space in both first and second cities.
One major theme we follow and expect to see more traction in comes from the national expansion of technology, media, and telecom (TMT) firms. Both domestic and MNC names are traditionally centered in Beijing, Shanghai, Shenzhen, and Hangzhou, but we see the mix changing. Since 2015, the distribution of the leading 100 internet companies has also extended to other cities. Demand for office space in Chengdu, Wuhan, and Nanjing is testament to this fact, as well as the appetite of TMT firms to capitalize on the next phase of China’s commercial property story and tap into new pools of local talent.
This interview has been edited for clarity.