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Commercial real estate in limelight, yet again

Commercial real estate are in limelight, yet again with China adding to the stories of US and Dubai. Bubbles in Chinese real estate were specualted for several months; debate is intensifying; those in denial are gradually acknowledging the problem. Above all, data speak plenty.
Unbelievable growth of Chinese public infrastructure has helped creation of large commodity production capacities in-house over years. A big part of government stimulus last year went into accelerating this growth even further; imports and domestic capacities grew even more and are seeking continuous feed of demand. While several of the newly built world-class infrastructure could be utilised in future, analysts argue that Chinese commercial real-estate capacities are in well excess of their current demand. Rising property market has left large loans on bank’s balance-sheets, several retail property investors seeking quick returns and low occupancy ratio. This seems repetition of history –Japan in 1990 and US in 2008 showed similar series of events which went beyond control of administration and eventually burst out. Analysts are worried and so is Chinese administration. Rising buying power of common man is the only solace; this, however, doesn’t dissipate the issue.
Chinese real(i)ty
Some analysts argue that about 60% of new loans in 2009 in China were directly or indirectly put into property and stock markets. Property sales rose about 75% in value and 42% in floor area in 2009. Pushy lending efforts and cheap money had to find ways into asset markets.
Andy Xie, ex-chief asia economist, Morgan Stanley calls it a bubble. He finds difficult for demand to continue rising and loans to remain cheap. Andy, based in China, points out that many properties are bought for investment and are now left vacant, rental yields are low (3-5% pa) – all this point to a bubble. James Chanos, Newyork based hedge fund manager and keen investor in real estate sees China as a “monumental property bubble” which will be difficult to deflate gently. He compares Chinese property bubble as 100 to 1000 times of Dubai.
Chinese commercial property floor under construction has risen more than 200% in last one year despite Beijing office vacancy rates as high as 22.4% in Q3 2009. Analysts assess that available commercial property floor area will rise another 13% in 2010. With currenct occupancy ratio about 50% and rent yields at low single digits in Beijing, Jack Rodman sees a business opportunity in China. Jack is president of Global Distressed Solutions and has made money by selling distressed property loans.
The history of Japan and US tells us that rising demand for properties result into astronomical rise in land prices; China isn’t different. Standard Chartered Bank has expressed their concern on rapid land price rise in cities; they foresee pains in 2010-11. Bank’s research suggest that land prices rose 2-4 times in Chinese cities in 2009; this is eye-popping.
Several overseas investors have been visiting China from time to time and have written about their findings. Most of them have depicted a scary picture about the property market. Hugh Hendry of Eclectica Asset Management visited China in early 2009 and observed unprecedented glut of commerical real estate in city’s business metropoli. Stephan van der Mersch, fund manager, shared his observations from his visit in July 2009 and made interesting comments about possible rationale for this rise. Patrick Chovanec, associate professor in an internatioanlly reputed Chinese University draws a parallel with Japan and finds risks too big to handle. Several developers too have warned of unsustainable prices.
Policy reversal?
Local / City governments in China have made fortunes in property boom. In 2009, they earned 40% of $1 trillion stimulus by selling land to willing developers. Land sale in China rose 44% in 2009. Greed to capitalise on the boom has put local governments in conflict with central government. However, with tighter policies and strict compliance, this should change.
In December 2009, China re-introduced nationwide 5.5% sales tax if property is sold within 5 years. Further, it raised reserve requirements for banks by 1% in last one month.
Chinese housing prices rose 9.5% y-o-y in Jan 2010 showing another month of sequential growth. The prices rose 3.9% in Oct09, 5.7% in Nov09 and 7.8% in Dec09. Looking back, in 2007/8 government tightened monetory policies aggressively when rate of house price rise peaked around 11%. Housing price rise were arrested as a result. Given higher leverage and larger scale, the pattern could repeat even more forcefully and hence a tight rope walk for administration.
China has built enormous capacities across industries and infrastructure asset classes; a rapidly growing economy should do this. Since these capacities are built for use in future, they could appear excessive to current needs. Chinese property market could be such case. History is full of examples of several of such cases turning into bubble burst; this scares economists. However, despite similar talks of bubble in 2007, China has proved otherwise so far. Two reasons could possibly explain this. One: Product and service outsourcing from China has kept domestic business booming. Property price rise has thus kept pace with wealth effect of Chinese and thus properties remained within affordability limits. Two: the scale of speculation and volume of transactions remained at low scale (relatively). Thus at every dip, by-standees flocked in.
The fact that western counterparts are still struggling to stand on their feet, has kept export growth contained. Due to this, property price rise has gone beyond affordability of common man/businessmen in China; several blogs (news are filtered) indicate this. In the ongoing boom, the scale of transactions have grown enormously, creating new records. This indicates that involvement of people in the boom is higher than those in 2007. This has features of a bubble and hence worrying comments from Jim Rogers, Marc Faber and Goldman who refrained from acknowledging the problem so far. What looks certain for most of this year is that Chinese policy decisions will be driven by property market conditions – tightening will have several surprises. Gentle moderation needs to be manufactured to avoid a pop-out; the world is watching this scape for its obvious implications.

Disclosure: None