China50 – Investment Markets of the Future?
Jones Lang LaSalle’s recent ‘China50’ study points to an increase in institutional investor interest in commercial real estate across 50 key secondary and tertiary cities in mainland China, as volumes of tradable assets increase. Though this interest may ebb and flow with risk appetite and liquidity, the report anticipates that investor focus will be on the retail and logistics sectors that capture the dynamics of rapidly growing consumer markets.
Over the past three years, China has emerged as a major commercial real estate investment market, with direct investment volumes doubling from USD 8 billion in 2008 to over USD 17 billion in 2011. China now ranks as the world’s sixth largest market, only behind the US, UK, Japan, Germany and France, an impressive growth story given that an active investment market only started to build in 2005.
Whilst investors are predominantly focused on China’s core Tier 1 cities—Shanghai and Beijing —interest in the China50 has been steadily growing, although it has fluctuated with economic conditions and sentiment. In 2006–2007, the China50 accounted for 10% of total national investment activity, but this fell back in 2008–2009 as investors retreated to Tier 1 cities during a period of global economic crisis and risk reduction. In 2010–2011, activity has recovered strongly with transaction volumes increasing fourfold in the China50, to account for 20% of national activity.
Within the China50, the majority of transactions have been in Tier 1.5 cities such as Hangzhou, Dalian, Chengdu, Tianjin and Shenyang, the most liquid and transparent markets. But deals have also been struck further down the hierarchy in Tier 2 cities such as Zhengzhou, Changsha and Xiamen.
A supply-demand imbalance in some occupational markets may dampen investor appetite over short periods of time, but this will also provide new opportunities for investors to enter a long-term growth market.
We expect investors to focus primarily on the retail sector to tap into the China50’s growing consumer markets despite the challenges of securing retail assets and achieving scalability. More funds will also be available for logistics, but activity will be constrained by a limited number of standing investments.
Investors will favour Tier 1.5 cities, such as Chengdu, Hangzhou, Suzhou and Nanjing; i.e. those cities that have the most internationalised and diverse economies, with strong corporate bases, dynamic consumer markets and an emerging critical mass of tradable assets. In reality, however, investors will need to be opportunistic, and we will see them move deep into the China50 in order to secure scarce assets.
The Rise of the Domestic Developers
The development of investment-grade commercial property has traditionally been and continues to be dominated by Hong Kong and Singaporean developers. In recent years, a few Chinese-based national and regional players have emerged and are likely to become formidable players over the next five to ten years. Not only have these players developed, or are on the cusp of developing high-quality assets, but some have come through with stellar track records in marketing, leasing and managing commercial properties.
Local and regional office developers, predominantly those with close affiliations to local government entities, are emerging with strong investment-grade assets located in premier office cores across the China50. These firms, with advantages in acquiring the best sites in a city, have built up strong portfolios and therefore dominate the office landscape as developers of some of the key top-quality projects in each city. Players such as Finance Street Holdings in Beijing, the Lujiazui Group in Shanghai, Harmony Group in Suzhou and Golden Eagle in Nanjing are leveraging their competitive edge, particularly in terms of their superior knowledge of the tenant base of the city. This particular group of developers could also someday benefit from having an additional viable exit strategy – geographically focused REITs.
Domestic players are still lagging behind their international counterparts, but if recent developments in China’s residential sector is a guide, whereby a few projects capture an outsized share in any given market, then we should soon expect a handful of domestic players to rise to the top and perform on a par with, or even possibly outperform, their international peers.
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