Rebalancing China's economic mix away from capital investments and more towards consumption is at the very heart of Beijing's economic strategy for the next five years. But in the retail sector itself, wildly over-optimistic expectations of rising consumer spending have led to massive over-investment in new premises. 'China is overbuilding shopping malls,' explains Jing Ulrich, chairman of China equities at the investment bank JP Morgan. Few stand any hope of ever trading profitably and most owners will surely end up losing money. Yet bizarrely, building shopping centres remains a lucrative business. Despite the recent imposition of government restrictions on land use and on new investments in real estate projects, there are few signs that developers' enthusiasm for throwing up new shopping malls is abating. In the end, this anomaly will only magnify the size of the inevitable financial losses. The problem is that while Chinese retail sales are now growing at a healthy clip of around 15 per cent a year, the amount of new shop space is expanding at a rate many times faster. According to Morgan Parker, Asian president of US mall giant Taubman, China has built 300 shopping centres in the past three years. 'The vast majority are completely underperforming,' he says. 'At least 90 per cent of the malls built in the last three years lack any economic rationale for their existence.' In developed markets, government building regulations and bank credit assessments together act as a check on new developments. In China, however, local governments tend to actively encourage developers to build malls in order to boost local headline economic growth and enhance the prestige of their city. Banks, meanwhile, lend money based on relationships, rather than any analysis of a project's future yield. The result, says Mr Parker, is a glut of new shopping centres built opportunistically by inexperienced and under-capitalised developers in response to the ready availability of land and bank loans. Many are in poor locations. Often they lack the necessary supporting infrastructure and few have locked in long-term anchor tenants. But building shopping malls can still be a profitable business. So ingrained is the belief in China's coming retail boom that developers are able to divide up malls into hundreds of individual shops which they sell 'off-plan' to small investors even before construction begins. The developer pockets his money on the day the mall opens, pays off his bank loan, clears a handsome profit of 30 per cent or even 50 per cent and promptly begins building another one, possibly right next door. The individual shop owners, meanwhile, often struggle to find tenants. Mall management is generally poor, co-ordination between owners non-existent and further capital expenditure impossible to obtain. The consequence, says Mr Parker, is a blight on China's urban landscape of shoddy shopping centres with empty upper floors, escalators that do not work and shops that open and shut at different hours. Economic occupancy - the proportion of space let at a profit - he estimates is below 50 per cent. And still construction continues. With generous grandfathering provisions available to defer the application of new rules and little or no enforcement of regulations at the local level, Beijing's latest round of administrative measures designed to restrict new real estate investments appears to be having little effect. For the time being the party can continue, sustained by the flood of foreign real estate investors entering the country and by small-time local investors' conviction that if they just hold on, the expected retail boom will materialise. Few are prepared to get out now and crystallize a loss on their investments. In time the market must mature. Developers will begin building and managing malls in response to retailers' demands in order to generate a yield, rather than in pursuit of short-term capital gains. But the process will take years, if not decades. In the meantime China's cities will be littered with unwanted and ugly shopping centres. And for the large part, it will be China's ordinary real estate investors left carrying heavy losses, says Mr Parker. 'It will be the mom-and-pop investors who will end up bearing the costs,' he warns.
