In Shanghai this year, negative headlines and poor economic data have weighed heavily on real estate investors. Weakening economic growth figures for China, lower retail sales growth, not to mention stagnation in the U.S. and Europe, have all contributed to a cautious attitude among potential buyers, particularly foreign institutional investors. When we step back and look at this year’s transaction volumes however, things don’t look quite as gloomy. 2012 year-to-date has seen approximately RMB 27 billion in commercial real estate transactions, compared to around RMB 43 billion for the full-year 2011. A slowdown, yes, but certainly not the dramatic decline one might expect.
When we explain the resilience of this market to clients, one of the key factors to highlight has been the surprising strength of Chinese investors in today’s market. So far this year, domestic investors have contributed 69% of total transaction volumes, an increase from 64% in 2011 and just 21% in 2010. It has become clear that the foreign buyers who dominated the market in 2009 and 2010 are no longer the most important players in Shanghai.
Within this group, a key driver has been large Chinese companies buying office space for self-use. Purchasing strata-titled or en-bloc offices has become a key investment strategy for many domestic corporations. Unlike foreign funds that are largely concerned with the rental income from an office property, domestic companies in China are willing to accept significantly lower yields. Taking the space for self-use allows these investors to kill two birds with one stone, enjoying the future capital appreciation of their investment and securing high quality, rent-free office space.
In the long run, the trend of domestic self-use buyers may not be sustainable, however. The Chinese government restricts large domestic corporations and SOEs from making multiple investments in commercial real estate for “self-use” needs, meaning that those companies with enough capital to afford office investments downtown may have already used up their investment potential. A slowing growth environment and flatter sales prices in the office market over the past few quarters may also diminish the appeal of office investment, which in the past was motivated in large part by the potential for capital appreciation.
In the long run, it is likely that demand from corporations looking to buy offices for self-use will be replaced by stronger core institutional investment demand. This does not mean that Chinese investors will become less active in Shanghai. On the contrary, increased transparency and maturity of the market will allow for more domestic institutions, which have traditionally been under-allocated to real estate to invest in commercial assets. Chinese companies from insurance and banking sectors, which have large volumes of capital available, as well as domestic REITs and even pension funds will eventually put that money to work in commercial real estate. Regardless of how this transition actually plays out, it appears that the Chinese investor is here to stay and will remain a key driver Shanghai’s investment market.
