“If bubbles in residential properties burst, people can still sell them if the sticker price is low enough, because people always need a place to live. But once the commercial property market crashes, nobody is willing to rent a shop that loses money every day”

An urban inferiority complex

Updated: 2013-09-02 07:35

By Wang Chao ( China Daily)

Industry insider points to a problem that is bubbling under the surface

As warnings continue to be sounded about the bubble in China’s housing market, real estateindustry insiders are warning of another, but one that few people are aware of.

That bubble has formed in the market for urban complexes in second and third- tier cities.Urban complexes are modern developments covering large areas that usually bring togetherresidential blocks, offices, shopping malls and entertainment facilities such as cinemas andclubs.

George Yeung, managing director in North China for Colliers International, said so many urbancomplexes have sprung up across the country that the market is almost at saturation point.Colliers International, based in Seattle, is one of the four biggest commercial property servicecompanies in the world.

“If bubbles in residential properties burst, people can still sell them if the sticker price is lowenough, because people always need a place to live,” Yeung said. “But once the commercialproperty market crashes, nobody is willing to rent a shop that loses money every day, whenthere is no customer but accumulating rental and utility fees.”

A report issued at a Chinese commercial real estate conference in Beijing this monthsuggested that the commercial property market in some second and third-tier cities has alreadyshown signs of overheating. In the first half of the year, 4,496 plots of land for commercialpurpose were sold, 53 percent more than in the corresponding period last year, it said.

Urban complexes account for a significant proportion of those sales. In Hohhot, in the InnerMongolia autonomous region, more than 30 urban complexes are being built for an area whosepopulation is only 3 million. The problems that those numbers present become clearer whenyou consider a rule of thumb in the industry: an urban complex can have a direct influence onabout 300,000 residents, which means three or four complexes would be enough for a city witha population of 1 million.

However, mini-cities are also expensive to build: a single urbancomplex requires at least several billion yuan, so if it does notsucceed, the results can be ruinous for investors.What makes theproposition even more challenging is that most of the propertydevelopers investing in urban complexes often have a commonambition: to attract top international brands such as Chanel andGucci to set up shop in their complexes.

“I’m really concerned about whether China’s consumption power cansupport the expansion of so many luxury brands,” Yeung said. “Especially when the new leadership is cracking down on extravagantgovernment expenditure. Previously, 70 percent of these top brandswere bought as gifts to deal with guanxi – a term which loosely means”connections” – and I don’t think the money was from the buyers’ ownpockets”

In addition, the property developers are in a poor bargaining positionwith the top brands and cannot expect them to pay top dollar to leasespace, Yeung said. That is because the exclusive brands realize they have the pulling-power todraw shoppers to a mall, pulling-power the developers cannot do without. That reducesdevelopers to the role of supplicants, willing to pay, even if begrudgingly, large sums torenovate grand stores for the most attractive tenants.

“It’s just like McDonald’s,” Yeung said. “Wherever it goes, it brings a large crowd. So it isimpossible to negotiate a good rent with it. And even if it signs a lease with you, it will not be forvery long.

“But developers need to attract these brands to convince other less-influential brands. Forinstance, other fast-food brands will feel safe once they see McDonald’s is there. Then yourecoup from these brands the money you have lost to McDonald’s.”

Complicating matters for the developers is that even as they are trying to attract big, well-known brands for retail premises, they have to keep a close eye on how much money is comingin from the sale of residential blocks, keenly aware that the cash flow from leased office or shopspace is notoriously slow. In the case of an average five-star hotel it takes more than 10 yearsto break even.

A typical case is Wanda Group, one of China’s biggest property developers, which prefers tobuy land in remote areas and build huge urban complexes. Instead of boasting fancy shopsand international brands, these centers feature pleasant residential blocks with goodsupporting facilities.

“This strategy has been successful in quickly recouping investment,” Yeung said. “But it alsoshows that urban complexes are still not really pulling in the kind of revenue commensurate withsuch big projects.”

Unlike residential properties, whose prices always seem to be rising, commercial property is alot less predictable, given the many variables that can affect the business, industry experts say.The shopping malls at the southern end of Chang’an Avenue in Beijing, which some reckon,seem fated never to enjoy good returns. That lack of optimism is borne out by facts andfigures. In 2010, a high-end shopping mall, MaisonMode, from Hong Kong, closed for lack ofcustom; and while there are more than 30 malls in the northern stretch of Chang’an Avenue,there are fewer than 10 in the southern stretch.

Yang attributes this lack of success to a lack of convenient transport. another. But this is rarelyseen in the “Many things can affect the operation of an urban complex, but the most crucial oneis transport,” Yeung said.

About bambooinnovator
Kee Koon Boon (“KB”) is the co-founder and director of HERO Investment Management which provides specialized fund management and investment advisory services to the ARCHEA Asia HERO Innovators Fund (www.heroinnovator.com), the only Asian SMID-cap tech-focused fund in the industry. KB is an internationally featured investor rooted in the principles of value investing for over a decade as a fund manager and analyst in the Asian capital markets who started his career at a boutique hedge fund in Singapore where he was with the firm since 2002 and was also part of the core investment committee in significantly outperforming the index in the 10-year-plus-old flagship Asian fund. He was also the portfolio manager for Asia-Pacific equities at Korea’s largest mutual fund company. Prior to setting up the H.E.R.O. Innovators Fund, KB was the Chief Investment Officer & CEO of a Singapore Registered Fund Management Company (RFMC) where he is responsible for listed Asian equity investments. KB had taught accounting at the Singapore Management University (SMU) as a faculty member and also pioneered the 15-week course on Accounting Fraud in Asia as an official module at SMU. KB remains grateful and honored to be invited by Singapore’s financial regulator Monetary Authority of Singapore (MAS) to present to their top management team about implementing a world’s first fact-based forward-looking fraud detection framework to bring about benefits for the capital markets in Singapore and for the public and investment community. KB also served the community in sharing his insights in writing articles about value investing and corporate governance in the media that include Business Times, Straits Times, Jakarta Post, Manual of Ideas, Investopedia, TedXWallStreet. He had also presented in top investment, banking and finance conferences in America, Italy, Sydney, Cape Town, HK, China. He has trained CEOs, entrepreneurs, CFOs, management executives in business strategy & business model innovation in Singapore, HK and China.

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