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News Release

Shanghai

Strong Market Fundamentals Create a Healthy Environment for Real Estate Investment in China

Jones Lang LaSalle’s white paper analyses changes and opportunities for investors


Mainland China’s real estate investment market is experiencing on-going structural change, according to Jones Lang LaSalle’s latest research report <Ebb and Flow: The Changing Dynamics of China’s Real Estate Investment Market> released today. The past year and a half has seen many changes, including a shift in the composition of market participants and the introduction of new regulations. The report highlights significant changes and opportunities such as:

• Renewed activity from foreign investors, particularly in retail and office property;
• The implications of China’s insurance companies commencing real estate investment;
• The status of Real Estate Investment Trusts (REITs) and RMB funds; and,
• Strong market fundamentals creating a healthy investment environment.

 “Foreign investors are once again aggressively chasing the momentum and the undeniable opportunity that lies within China’s retail and office property markets.” says David Hand, Head of Investment for Jones Lang LaSalle China, adding, “At the same time as international capital re-emerges strongly, local developers face mounting challenges to finance their development programmes as a result of a government-inspired cocktail of tightening measures.”  Hand believes, “Opportunities will emerge for foreign capital to acquire, to finance, and to partner with local developers across all sectors of the property market.”  With a nod to the ‘Chinese characteristics’ that are often applied to domestic versions of international trends, Hand added, “Official encouragement for directing capital into ‘socially attractive’  sectors such as developing more affordable housing, aged-care facilities, and for investment into other social infrastructure such as higher-education and health care, will inevitably result in increasing investment opportunities in such areas.” He also foresaw in the future that, “This new direction may even be given further impetus by innovative new investment vehicles such as a ‘china-style REITS’ and RMB funds. For now, however, the main story remains the insurance companies that are busily ramping-up their real estate capabilities, and we will soon increasingly experience their market presence domestically and hopefully internationally as well.”

Foreign buyers return: Following the global financial crisis, 2010 saw foreign institutional investments rebound significantly, accounting for 41% of all en bloc real estate investment transactions. With Asian-based investors making up the bulk of foreign transactions (34%, or USD 5.1 billion), those from Hong Kong and Singapore, in particular, aggressively pursued investments across China. US- and European-based investors took a more cautious view, concentrating on Shanghai, a city with limited trading stock. Without broadening their horizons, future opportunities will be harder to take advantage of.

Domestic investor climate: After a surge in domestic investor activity during 2009, mainly driven by state-owned enterprises, 2010 saw a 7% decrease in volume. This was partly due to a change in government policy. With tighter lending controls, domestic investors are facing difficulties in securing funds. Unlike mature markets, domestic capital markets are limited in providing funding alternatives, putting domestic investors at a disadvantage. Wary of asset price inflation, they are being encouraged to pursue investments with ‘Chinese characteristics’, such as affordable housing and senior care facilities.
 
In September 2010, Chinese insurance companies were finally given the green light on commercial real estate investment. With an investment cap of 10% of total assets, these giants can potentially dominate the market. Despite total assets standing at just over USD 770 billion in 2010, and with a steady yearly growth of 20%, significant activity has yet to appear. Many challenges must be met, due to a lack of:

• real estate investment management talent,
• Investment-grade assets,
• internal infrastructure, and
• asset management capabilities.
 
Insurance companies see real estate as an ideal long term asset to offset long term liabilities, so their significant participation in the market is inevitable.
 
In the current financial climate, REITS are no closer to being approved. REIT-like structures are instead being touted to finance low-rent housing, with the government determining yields or margins by setting land price and rents. With a steady income stream guaranteed, risk lies in a developer’s ability to manage construction costs.

RMB Funds remain legally ambiguous, but pilots are being run in Shanghai, Beijing and Tianjin, with active participation from prominent foreign fund managers. Although uncertainty remains for foreign investment, fund managers still have plenty of opportunities from huge untapped domestic capital.
The positive underlying market fundamentals in commercial real estate have created an environment where Asian-based foreign investors are eager to acquire assets in China:

Office: The market in China’s Tier I cities remains strong, having enjoyed record net take-up in 2010. With investors facing a lack of tradable assets in CBDs, some are now turning to investment grade stock in peripheral areas, whilst others are upgrading or “greening” existing portfolio buildings. Within Tier II cities, where whole new CBDs are under development, developers are turning to the strata title market; relatively low capital values may offer long-term investors such as China’s insurance companies, attractive options.

Retail: Terrific market fundamentals in the retail sector continue to attract interest, as government encourages increased consumption and rises in urban incomes. Investors in retail are pursuing well located assets nationwide, not just in Tier I cities. With an asset that evolves over time, such as a shopping centre, needing to be adapted in line with market conditions, opportunities remain for experienced managers to capture market share.

Residential: As government policies suppress demand and restrict pricing, opportunities for investors will arise from tighter lending controls. By the end of 2011, banks must reintegrate off-balance sheet lending, which will cause a reduction in liquidity and create demand for investment capital. With government focus on affordable housing, developers are expected to target lower income buyers, resulting in squeezed margins from the increased land prices. This will lead to opportunities for equity joint ventures and the availability of commercial assets from residential developers’ portfolios.

Looking ahead, there are clearly opportunities for foreign and domestic investors given the strong market fundamentals. Lower investment yields, along with limited investment grade stock, will lead to new opportunities for raising capital from domestic investors destined for overseas real estate markets. China’s real estate investment market promises to be as dynamic as ever in the years ahead.