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China's commercial real estate woes

(chinadaily.com.cn)
Updated: 2009-10-09 16:39

Cheaper to rent

Commercial real estate rents began declining in Beijing and Shanghai in the third quarter of last year, says Macdonald. Leasing prices ("headline" or "face" rents) have dropped on average from 189.8 yuan ($27.80) per sq m per month to 147.9 yuan($21.66), down 17.2 percent year-on-year. "That's quite a sizeable correction," he says.

But in an effort to keep tenants and woo new ones, many landlords are signing leases offering 12 or more rent-free months on a five-year lease, so that net effective rents are down 40 percent to 50 percent in Beijing, according to Rodman. From his office window, which faces the heart of Beijing's business district, he can point to at least six empty high rises, most of which have been ready for leasing for months, if not years, but have yet to be put on the market by developers.

Beijing retail rental rates, meanwhile, have dropped by roughly 20 percent, "which is quite big," says Zha, although she believes some developers are deliberately holding prices up even as retailers try to insist on low rents.

In Shanghai, rents are "falling to levels not seen since the second half of 2006," says Hu. "We are beginning to see tenants position themselves to take advantage of market conditions and implement longer term occupation strategies."

Hold those prices

The problems began in the boom years of 2003 and 2007, says Rodman. Developers had easy access to bank loans and market leasing rates at the time were 200 to 250 yuan ($29.30 to $36.60) per sq m per month, supporting building values of 25,000 to 30,000 yuan ($3,660 to $1,545) per sq m annually for Class A space. But when the bottom dropped out of the rental market, landlords did not draw up leases that reflected the drop, and prospective tenants, many of them from foreign firms that were feeling the squeeze from the financial crisis, were unwilling or unable to pay the prices developers were asking for.

Rodman believes two reasons explain why developers have been keeping leasing prices at pre-crash rates. "One, they are under no pressure from banks to repay their loans, ergo no motivation to lease at today's current rates. And two, writing a lease at half the rent that supports the valuation … could trigger a writedown, incurring losses for the banks. (Meanwhile, there) has been a lack of transparency and reliability, and a lack of veracity in market information that the brokerage community made available to owners, developers and tenants," he says.

Developers also haven't been very market savvy, says Zha, particularly among those who moved into commercial real estate from residential. "In residential … they can hold the price and wait it out, eventually selling at a higher price. In retail, it's different. When a mall has been on the market for too long, it's not hot anymore. Also in retail you spend more money on maintenance and retailers won't wait for you. In the beginning, they didn't really get it. But now more and more developers understand."

High residential land price has also into play, says Hangzhou developer Wu. City governments dictate commercial and residential areas, and the current high land prices placed residential land out of reach for many developers, who turned to commercial property. "They then shift it to some kind of special apartment space later on," he says.

Knock-on effects

The economy is affected in a number of ways, says Rodman. "We ignored the problem with collateralized mortgage obligations (CDO and CLOs) in America. Everybody knew about it. It blew up on us. Not only did it blow up on us; it blew up on everybody else."

What's more, "the rest of the world recognizes that they have a huge problem with commercial real estate rents coming due," he says, noting warnings from financial experts like Warren Buffett of $3 trillion to $4 trillion of real estate loans coming due in between 2010 and 2012. "(China) is the only market in the world that doesn't think it has an oversupply or that commercial real estate values have not declined," he says. "Yet there are no transactions to support it. We've only had three commercial office building transactions in Beijing over the past year, and two of three buildings were sold to Chinese insurance companies."

The biggest banks in the world are Chinese, he points out. If they're carrying loans on their books that the collateral (i.e., the property) doesn't support and there's a change in regulation or in the economy, "then you would have a real loss of confidence in the financial system," he says.

A crash in this case would require a government bailout, pushing up debt until it started to resemble Japan's. With the highest debt-to-GDP ratio among the world's developed nations, Japan "ignored (the problem) from 1986 to 1990 and it has never recovered."

What the future holds

Finding occupiers for future retail property projects in Beijing during the current financial situation will be difficult, says Hu. But the government's stimulus efforts to boost domestic consumption will help ease the problem. In Shanghai, the 70 million visitors expected for the Expo will also help. "However, forecasts including future prime retail projects for 2009 show that both Beijing and Shanghai will have a relatively larger supply compared with the last several years, with an estimated 1.39 million sq m for Beijing and 722,000 sq m for Shanghai," she says.

According to Savills' Macdonald, office-building vacancy rates in Beijing are expected to continue rising, exceeding 25 percent by the end of this year. "Net take-up recovered in the third quarter to levels comparable to 2007," he says. "However this is not enough to absorb the new supply."