These are busy days for Pan Shiyi and Zhang Xin, the celebrity couple behind the property developer SOHO China. Not only is the duo in a courtroom battle with Fosun – China’s largest privately-held conglomerate by revenues – over a piece of land in Shanghai’s Bund area, the two are also having to field questions about why SOHO’s net profit has dropped 65% in the first half of the year.
The developer explained that it completed fewer projects during the period, which meant profit fell to Rmb613 million ($96.4 million) from Rmb1.75 billion a year earlier.
Investors were also left to mull a major shift in strategy too, as the company announced it will move into a ‘build-hold’ business model for its office and retail assets. That means SOHO will no longer sell prime commercial projects it develops in Beijing and Shanghai, instead trying to generate revenues as a landlord.
The reason? “For build and hold, there will not be many surprises because you’re holding the buildings for lease,” Zhang, chief executive of the Hong Kong-listed company, told analysts. “The leasing market is more stable than the sales market. When we do build and sell, the capital market doesn’t always understand.”
In layman’s terms: “If in the past our business was to make flour from wheat, then what we need to do today is to produce cakes from flour, creating even greater value,” Pan, an avid microblogger, wrote on his Sina Weibo. “Our properties will be like hens that never cease to lay eggs.”
Analysts are generally supportive of the change in strategy. With office rents in Beijing and Shanghai on the rise – estimates from real estate specialist CBRE suggest that they have risen 73% in Beijing and 18% in Shanghai over the past 18 months – the new business model means SOHO takes more advantage of the potential for further appreciation at its premier locations.
“SOHO China’s core strength is in developing projects in prime areas in Shanghai and Beijing with high margins. However, these resources will become increasingly scarce, so if they only sell, how do you ensure future earnings?” Li Jing, a senior manager at First Shanghai Securities, told Caixun.
According to SOHO, investment properties will bring in almost Rmb4 billion ($628 million) of annual rental income in three years. In contrast the company earned Rmb76 million in rental income in the first half, while income from sales of properties was Rmb1.2 billion. Under the new plan, SOHO will hold a total of 1.5 million square metres (16 million square feet) of office space in Beijing and Shanghai.
Other property developers have taken this approach too. Dalian Wanda, one of the largest property developers in China, usually sells a small part of its new developments while leasing out the rest. That model ensures that Wanda has more control over tenant quality, as well as how its buildings are managed.
Indeed, the change also aims to deal with criticism of SOHO in the past. “Previously SOHO China’s build-and-sell model maximised the developer’s profits. But for investors in the property, the return is not high,” says Wang Yongping, founder of the China Commercial Real Estate Association.
For example, Qianmen SOHO and Jian Wai SOHO have been criticised for poor occupancy and weak investment returns. This is because, once fully sold, the developer no longer has a strong incentive to ensure the building is well-managed or tenanted with suitable clients. Under the new strategy these incentives will be in place.
But the change has a downside too: SOHO now says that it won’t be able to meet the Rmb23 billion sales target initially set for this year, reports the China Daily.
Originally, the company intended to sell two projects – SKY SOHO and SOHO Century Plaza – in the second half of 2012. Instead it will retain them as investment properties. That’s sacrificed near-term revenues. So no surprise, perhaps, that after the announcement investors sent SOHO’s shares down by 8.6%.
© ChinTell Ltd. All rights reserved.
Exclusively sponsored by HSBC.
The Week in China website and the weekly magazine publications are owned and maintained by ChinTell Limited, Hong Kong. Neither HSBC nor any member of the HSBC group of companies ("HSBC") endorses the contents and/or is involved in selecting, creating or editing the contents of the Week in China website or the Week in China magazine. The views expressed in these publications are solely the views of ChinTell Limited and do not necessarily reflect the views or investment ideas of HSBC. No responsibility will therefore be assumed by HSBC for the contents of these publications or for the errors or omissions therein.