The government seems to be getting serious about their efforts to cool the residential market and after years of trying it appears to be working – secondary sales prices appear to be dropping in some of the most heated markets, including Shanghai. But the jury is still out on what this will mean for the other real estate asset classes. Some see a turn to office properties but the majority feel that a greater amount of attention will be directed towards retail, with experts ,such and Cushman & Wakefield’s regional CEO Sanjay Kumar, predicting that this will produce car-crashlike results for some but spectacular returns for those that get it right. Currently the largest real estate companies in China are venturing into cinemas, shopping centres and, a very few, into offices.
Strata sales
Office properties in China have been predominantly grade B or lower and become even less attractive to top tier company tenants due to their being sold strata title, which largely precludes uniform and reliable management. Lack of effective asset management and little in the way of comprehensive facilities management has left these properties unattractive to either tenants or investors. However there are a few striking examples that stand out amongst the strata mass. Firstly is the incredible success of the SOHO group, whose model is based on redeveloping properties for high-end strata sales. But it appears that no one else is following their model.
Grade A properties have maintained one owner. Until recently, in a transaction that made headlines. Mori, an international developer that follows the traditional international model of building grade A space to hold and earn rental income from their grade A tenants, recently has started selling off floors in its iconic World Financial Centre(the “Bottle Opener”) in Pudong, Shanghai. Lina Wong, Managing Director, East and SouthEast China, Colliers International was close to the transaction said she was “quite surprised” at their decision to do this. She says it is conceivable that other major title holders will follow suit –the reported USD40mil Mori netted from the sale of a floor would produce a strong incentive to do so.
There will be conditions to these sales. The sales agreement with the buyers of the strata sales floors in the WFC avoids many of the problems of strata ownership. Restrictions on resale and management are extremely strict. For example, they may only sell to an end user not to an investor, if they sell to an investor, explains Wong, they might sub-lease and ruin the reputation on of the building. Additionally occupants are required to adhere strictly to existing management contracts and security requirements.
Wong says that it would have been less surprising for owners of grade A property to turn the building into a REIT, such as have been done by Cheung Kong, of HongKong, owner of several REITs. However REITs in China have been less successful due to an unattractive tax situation unlike in more successful markets like Singapore.
China would be ideal for a REIT market due to its market size, says Wong, but there are problems with remitting currency that would make realising gains problematic. However she concludes “every one wants a listed vehicle” and like many she is watching the unlisted Liuzazhi private REIT that many view as the government’s trial run before opening up a full scale listed REIT market.
For investors in the space there are still opportunities says says Richard David, CEO, China Treasury Trust. While admitting walking away from the majority of deals, he isn’t concerned that he will be forced in to negotiating with multiple owners for strata space. David sees that there are plenty of opportunities with out having to travel down the circuitous path of investing in and reinvigorating a strata title building.
What does it mean for occupantsOnce the commercial experts finish discussing the active investment and retail markets, they get down to discussing the office market in more detail. It’s active. For Cushman and Wakefield the large downtown office-space occupants such as legal, accounting, consulting and services sectors are particularly active.
This indicates increased foreign investment activity as international companies need these firms for every move in China’s complex regulatory environment, C&W’s General Manager, Daniel Wang explains. Internationally listed local companies also require their services as such the sector is booming. Additionally C&W see demand within the health and life sciences companies with sales forces of groups like GlaxoSmithKline growing rapidly and increasing space requirements both in Shanghai and other cities.
Collier’s Wong wouldn’t say that one sector is particularly strong but that it has been strong across all areas and that there has been a much stronger rebound than anticipated. In 08/09 many MNCs in Shanghai wanted to expand but due to a general lock down across the company, HQ would not allow them to do so. Now they have the blessing of HQ and are even more aggressively looking for space.
Financial space
Banks were at the centre of the financial maelstrom two years ago and there are mixed opinions as to how they are expanding now. For C&W they are not at the centre of the action in terms of the big office moves. CB Richard Ellis’ head of commercial, Mark Latham says a number of their recently completed deals involve banks and that the sector is definitely moving, including one large deal for a local financial institution. He points out that when coming to this market the banks are keen to do deals that involve naming rights. they see international banks with neon (or actually LED) displays glittering across the Liujiazui skyline they want a piece of the action. They want, and see that they need, to brand their claim on this real estate too.
Wong tends to agree, with the government having announced that Shanghai would be the financial centre of not just China but Asia she says “banks I’ve never heard of” are moving in. Local Chinese regional banks from far flung cities are taking space in the town and many of them are looking for space in a prestigious office building. As an industry where profit margins can be high they can afford and indeed require this space.
In addition, says Wong, the Economic Cooperation Framework Agreement (ECFA) a preferential trade pact between Taiwan and the Mainland, signed a year ago Taiwanese banks are also looking to expand. So between international financial institutions, the local banks and increasingly local companies looking for grade A space the future is bright for higher end developers.
Problem is that the larger local developers are still not investing in the corporate commercial market. Wong says that to build an office building takes patience and capital. Despite this local developers increasingly may be inclined to do so particularly those listed in Hong Kong. While their ability to deliver residential real estate might be the same if not better than elsewhere their experience with other asset classes is limited at best. But residential real estate might work well for reasons of cash flow it keeps the company short on assets in hand and does not offer the stable income stream of commercial property.
The Retrofitting Model
At the end of the day the size of the market is small says Sanjay Verma, Asia CEO of C&W– with only 5 mil sqm of office in Shanghai compared to four or five times that in cities like New York. With a population of 22 mil, (around as many people as live in the whole of Australia) there is certainly an opportunity for either new build or at least to upgrade existing stock,much of which is still poor quality.
Some experts, such as Peter Churchouse at the Asia Office Space Congress, stated that he believed the only option for some of the poorer quality office buildings was to tear them down and start again. Wong however believes retrofitting will probably come before razing. Take the Cross Building that Colliers have had the luck of being able to sell twice after makeovers.
According to CBRE’s Latham Shanghai is a “city in motion”. A fact few would deny. But there is a mixture of opinions as to what it is moving towards. On the office front different districts are positioning themselves to attract different sectors, he says. Jingan is attracting high end retailers while Huangpu is making a play for financial services companies that do not want to cross the river to the government appointed financial centre in Liujiazui.
Latham says different areas have produced different attractions for tenants with areas growing and developing over time. For example he points out, Pudong was criticised for years as having no options for lunch or other entertainment and being generally a wasteland – this is now changing. Similarly, the more buildings spring up in an area the more the required retail and transportation options expand to accommodate them. He says the Kerry centre in Jingan is an example of a place maker in that district.
As such rather than just analysing what everyone agrees is an interesting retail market he says that its impact on office should not be under estimated. The sophisticated consumers want their offices to be associated with high end retail podiums.
Treasury China Trust is a Singapore listed entity that knows better than many the requirements of the China market. Richard David, its CEO, says that he falls in to the “veteran category”when it comes to investing in the China commercial market. “I’m a real estate hack” he announces before going on to describe his time in China where he was involved with the first en bloc commercial deal in Tianjin in the late nineties.
He claims to be part of an extremely limited group of building owners that hold a portfolio of commercial space and one of very few who buys with the intention of retrofitting, rebranding and releasing to higher quality and, more often than not, fewer tenants.
His take on real estate is equally unique. Rather than being a cyclical market, or a market with short cycles, he says Shanghai does not yet have cycles. The market is just too young. The ups and downs are not just a product of global economic cycles, they are more about a market finding its feet. In Q1 2011 TCT’s majority office portfolio renewed existing or signed new leases at 12 percent increased rents. His is a model that seems to be working.
Having suffered and withstood legal action from disgruntled tenants that have been shown the door the model also has legal feet. Describing their venture as a “private entrepreneurial property company in the guide of a Singapore listed stock” he still emphasises the need for minute to minute coal-face information about buildings, tenants and market activity. People coming into the market looking for investment opportunities “just like at home” are going to be disappointed he says. However, locally he says the interest in the commercial market is picking up and he feels the market is big enough for multiple players.
This is good, because whether the new market entrants choose to get into strata investment, en bloc investment with notions of rennovation or with the view to become an owner occupier the Shanghai market has space to grow. Even if the young Shangai folks prove wrong and the worst of the global naysayers are right about the whole Chinese economy being a bubble waiting to burst, looking locally the growth story exists. Companies will continue to operate, just as they did two years ago. Regardless of economic highs and lows there will always be a demand for quality office space and those who have set out to provide it and know the market for what it is cant help but succeed.
