Credit Suisse warns of 'value trap' for developers in second-tier cities

The conventional wisdom that developers are smart to build in second-tier mainland cities is wrong because many of these areas suffer from oversupply and low development margins, according to Credit Suisse.

Last year, land with a potential gross floor area of 410 million square metres was purchased on the mainland for building private housing, up 28 per cent from 2009.

Of the 30 first- and second-tier cities it monitored, Credit Suisse identified Hefei, Chongqing and Changsha as the top-three cities with the lowest property development margins. Wuhan, Taiyuan, Tianjin and Dalian will face severe oversupply that will take more than seven years to absorb.

'Most developers tend to buy in second- and third-tier cities with the rationale that land is generally cheaper in such cities compared with first-tier cities and the potential for growth in tier-two cities is huge,' said Du Jinsong, an analyst at Credit Suisse.

As a result of growing developer interest in second-tier cities, land prices in key areas increased by an average of 23 per cent last year, compared with a drop of 2 per cent in first-tier cities, he said. In fact, the pace of growth in land prices there was much faster than residential prices last year, he said.

Land prices in Haikou, Hainan, rose 93 per cent last year compared with a 45 per cent increase in residential prices. Wuhan land prices grew 28 per cent compared with a meagre 7 per cent gain in residential prices.