Developing mess?

Check those fundamentals

Too much money chasing too few deals. That seems to be one sentiment in the commercial property market – at least in Shanghai, that is.

Last month, developer China Overseas paid a record Rmb7 billion ($1 billion) for a 142,000 square metre plot in the city’s Putuo district.

Shanghai’s municipal officials are doing their best to capitalise on the buoyant market, by auctioning off more land in city.

This includes a prime plot of land on the Bund – the city’s famous tourist destination. The 57,000 square metre plot on the Huangpu River is expected to sell for Rmb13.5 billion, another new record.

At these prices, you might expect a little buyer fatigue. Instead, property vendors are hoping for a new surge of interest. That’s because the China Insurance Regulatory Commission (CIRC) has announced that state-owned insurance companies are now allowed to invest directly in real estate for the first time.

Mainland Chinese insurers have long been covert property investors, through regulations that permitted ownership of headquarters and branch offices. This meant that many bought up more than they needed, and then leased out the extra space.

Still, the new regulations mean that insurers can diversify from bank deposits and stock investments. Current returns on top-notch commercial property offer annual yields of between 5-8%. So lower than many stocks and funds but a lot better than bonds and bank deposits.

The rule change could lead to $34 billion in new investment, says consultancy Jones Lang Lasalle (JLL). Based on current valuations, that’s more than twice the value of Shanghai’s premium office segment.

The new financial regulations mark a shift from a “foreign-denominated real estate investment market to one where domestic players have assumed pre-eminence,” David Hand from JLL told the Financial Times.

Analysts think that the higher-quality developers will benefit most, as the insurers will focus on well-run properties with stable cashflows. They are likely to avoid residential purchases, which are more prone to speculation.

“Risk control is the primary concern when we explore this new investment channel,” says Wu Yan, President of People’s Insurance Company of China (PICC), the nation’s largest insurance conglomerate.

Most Chinese insurers have been positioning themselves for at least three years in anticipation of the rule changes.

“We are already in contact with several insurers who are seeking proper commercial properties,” Grant Li, director of Savills, told the China Daily back in July.

Ping An, the second-biggest life insurer, has wasted no time in reacting to the rule changes, signing a framework agreement with Greentown Group that promises to invest Rmb15 billion ($2.19 billion) in three years in real estate projects developed by Greentown.

They’ll have to tread carefully, as the commercial real estate market still faces some serious challenges. Too much supply has led to falling rents and high vacancy rates. The situation is worst in key cities like Shanghai and Beijing.

In the second quarter of 2009, Shanghai’s top-grade office market admittedly saw some improvement, with occupancy levels up 14.1%, according to property broker Colliers. But average rents fell 9% over the same period.

Beijing is not faring any better. A third of office space in the country’s capital is empty, says the Financial Times. Prices continue to fall, with total floor space on course to double from 2007 by 2011.

It all makes for a pretty heady mix. On the one hand; the record bids at Shanghai auctions, and a major new investor base seemingly intent on entering the market. On the other; the general oversupply and the weak commercial conditions. Something has to give, perhaps. n

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