Foreign investors jump on the band wagon but some experts warn it is a big bubble

SHANGHAI - White collar worker Chen Yan is a marketing assistant working in a high-rise building along Middle Huaihai Road, Shanghai's iconic high street.

In recent months, the 30-year-old has been finding he has had to pay increasingly large sums of money for his lunch as many nearby restaurants close down because of high rents.

"Many restaurants have closed recently amid the influx of many top luxury brands in the road," Chen said. Since last year, Louis Vuitton, Tiffany & Co, Cartier, Ermenegildo Zegna and Hermes have begun to open new branches or expand their floor space in premium sites.

"As a result, the cost of lunch has risen from 20 yuan ($3.08) to 35 yuan," said Chen, one of more than 70,000 professionals who work along the road.

However, in the eyes of some heavyweight investors, Chen's complaint sends a strong signal that Shanghai is entering a bullish market for commercial property investment.

Treasury China Trust, a business trust registered in the Republic of Singapore and Ireland's leading property company, purchased Huaihai Mall for 575 million yuan in February. The Irish property investor plans to undertake a total refurbishment and repositioning of the four-story building to double its rental revenue over five years, according to an expert close to the deal.

Huaihai Mall is currently 70 percent occupied, and the rental is somewhat below the market average, leaving substantial room for future increases. "The company successfully renovated Central Plaza, which is located in Shanghai's central business district," said Cindy Ma, manager of marketing and communications with Treasury Holdings (Shanghai) Property Management Co Ltd. After renovation, the building's market value increased 17 percent and the rental surged 25 percent on average, Ma added.

In order to better invest in China's property market, Treasury Holdings quit the Alternative Investment Market (AIM), a sub-market of the London Stock Exchange for smaller companies, and listed in Singapore in June 2010. Currently, the company has all its listed capital in China.

Treasury Holdings is not the only overseas investor in China's commercial property market to believe the next decade is ripe for exploitation after the investment boom in the residential property market over the past decade.

"The Chinese mainland is drawing more attention from foreign institutional investors. In Shanghai, there were seven transactions of commercial properties in the first quarter, totaling 4.6 billion yuan. Of them, 50.4 percent were made by domestic investors, including companies from Taiwan and Hong Kong, while foreign investors took 49.6 percent," said Jack Ye, national director of investment at Cushman & Wakefield China.

According to Ye, offices accounted for 44.5 percent of the total transactions, mixed use was 22 percent, retail was 12.5 percent and the hotel sector was 21 percent.

"These deals show foreign investors are more interested in purchasing commercial properties in China," said Regina Yang, director of research and consultancy with Knight Frank, a global property service provider.

In 2010, en bloc real estate investment reached a record $15.02 billion, up 34.6 percent compared with the year before, a Jones Lang LaSalle report said. This is in sharp contrast with the weakened property market in the United States and Europe, which are still suffering from the fallout of the global financial crisis.

The new investment wave was also triggered by the central government's tough restrictions on residential property trading, which diverted capital into the commercial property market, especially in first-tier cities.

Rather than offering commercial property just for rent, some developers are trying to diversify to increase their profits. Japanese Mori Group, the developer of China's tallest building, Shanghai World Financial Center (SWFC), sold offices separately.

"Since the completion of our building, we have received many inquiries from our clients to buy office space for their own use, and we are delighted to offer such a service," said Pan Bei, who is in charge of Mori Building China (Shanghai) media relations.

Pan told China Daily that at the moment, five floors from the 68th to the 72nd have sold out, each priced between 82,000 yuan and 83,000 yuan per square meter (sq m). The only identified buyer so far is Tomson Group, a property developer founded in Taiwan but which manages most of its assets in Shanghai. Tomson acquired the 72nd floor of SWFC, roughly 3,221.87 sq m of gross floor area, for 267 million yuan.

Considering the total cost to build the skyscraper was 8.3 billion yuan, Mori Building only needs to sell less than half of its office floors to make ends meet, said Lu Qilin, a research director from Shanghai-based real estate agency Shanghai Deovolente Realty.

The 492-meter-high skyscraper has been plagued with a high vacancy rate since clients began to be canvassed after completion in August 2008. After readjusting its strategy, the company behind the iconic building raised the occupancy rate to above 80 percent and strengthened its capital flow as well, according to Mori Building China (Shanghai).

Andy Zhang, managing director of Cushman & Wakefield China, said despite the growing percentage of foreign investors in China's commercial property market, there are still quota restrictions on their investment scale.

"Currently, private equity and funds are the main players in investing in China's commercial properties. However, due to their special requirements for properties, there are not many qualified projects," said Zhang.

According to him, most of the foreign funds and private equities look for projects costing several hundred million US dollars with high quality management.

Even if the investors are willing to make a deal, overseas investors have to wait for a much longer approval time than local rivals. In some cases, the waiting time can extend to 10 months, Zhang added.

"It is more difficult for us to make an investment in the mainland market now," said a managing director at a leading US real estate fund, who declined to be named.

"On one hand, banks have tightened loans to the realty sector. On the other hand, the approval process of a foreign real estate investment will nearly drive everybody crazy," he said.

Currently, foreign investors are more interested in transparent markets in Shanghai and Beijing, but the rapid growth of the second-tier cities of Chengdu and Chongqing make them also premium choices, Zhang said.

Wu Tao, managing director of Wins Investment Management Co Ltd, said its fund will explore investment opportunities in the commercial sector in the near future. The company, which is totally owned by Gemdale, a leading property developer based in Shenzhen, currently manages a joint venture real estate fund with UBS and a yuan-denominated fund.

"The yield of an investment in a commercial property project largely depends on the fund's operating and management capacities," said Wu. "An annualized return of 10 to 15 percent will be quite satisfactory for a commercial property investment, compared with a 20 to 30 percent return from a residential development.

Domestic players who traditionally focus on the residential sector also sense good returns in the commercial real estate especially after the central government showed its determination to cool the residential market.

Cushman & Wakefield predicts that as the restriction continues in the residential sector, more domestic and foreign investors will pour into commercial real estate. A growing economy will bring about more opportunities for office leasing and trading, most investors believe.

During the latest fiscal year report, major Chinese developers China Vanke Co, Poly Real Estate Group Co Ltd and Gemdale Co sent clear messages that they were ready to develop commercial properties. Beijing-based SOHO China Ltd has purchased seven commercial projects in Shanghai since 2009.

However, the oversupply of commercial properties is also looming on the horizon, experts warn. "There is a saying that the bubble in commercial properties is even bigger than that in the residential market. Although I cannot confirm the saying, the lavish spending on commercial properties may pose a threat to the investors' portfolios, too," Zhang noted.

The development of commercial properties should match the pace of the economy, and it's necessary to monitor any investment risk, Yang said.

Hu Yuanyuan in Beijing contributed to this story.

China Daily

(China Daily 05/30/2011 page16)