China’s commercial property market is thriving even as residential property lags and the overall economy slows

Foreign investment drove the growth in China’s commercial property in 2018, and domestic buyers look likely to join in the trend in 2019
While the office and retail sectors have borne the brunt of the fallout from the government’s deleveraging campaign, demand for warehousing space is surging

Nicholas Spiro

Published: 2:01pm, 25 Feb, 2019

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For some time now, the residential property market has topped the list of vulnerabilities in China’s economy. In the latest sign that the slowdown in the housing market is gathering momentum, data published by the National Bureau of Statistics last Friday showed that new home prices in 70 major cities tracked by the government decelerated in January for the third straight month, expanding at their weakest pace since last April.

Softening price growth is just one of several cracks that have appeared in China’s once-red-hot housing market. According to a survey produced by Professor Gan Li at Chengdu’s Southwestern University of Finance and Economics, more than 22 per cent of China’s urban housing stock is currently unoccupied. The vacancy rate excludes homes yet to be sold by developers which face severe funding strains. More than 80 per cent of Chinese real estate companies covered by Moody’s, the credit rating agency, which forecasts a contraction in Chinese home sales this year, have “junk” ratings.

Yet the gloom enveloping the residential market contrasts markedly with the solid performance of China’s commercial property market.

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A report published by CBRE, a leading property adviser, last month showed that commercial real estate investment transaction volumes in China last year reached 251.7 billion yuan (US$37.6 billion), up 4 per cent on the previous year and a record high. While purchases by domestic investors fell 10 per cent year on year, foreign-funded institutions invested more than 78 billion yuan in Chinese commercial property, a 60 per cent increase compared with 2017.

However, CBRE expects purchases from local institutional investors to pick up this year as looser financial conditions support fundraising. The adviser notes that the sharp drop in government bond yields is “likely to accelerate investment in alternative assets by Chinese insurance companies”.

People cross a bridge at Pudong financial district in Shanghai. Overall growth in the commercial property sector in 2018 came despite the struggles of China’s coastal cities, which rely heavily on trade. Photo: Reuters

To be sure, China’s commercial real estate industry is not immune to the slowdown.

In the occupational market, the office and retail sectors have borne the brunt of the fallout from the government’s deleveraging campaign and the escalation of the trade war. New demand for leased office space last year fell significantly in coastal cities, which are reliant on trade, leading to a 12 per cent drop in the net absorption rate – the difference between tenant move-ins and move-outs over a given period – in the 17 cities tracked by CBRE. A gush of new supply over the last several years has pushed up vacancy rates, with the average level in the 17 cities set to exceed 20 per cent this year, putting downward pressure on rents.

Rental growth is also lacklustre in the retail market due to a combination of slowing domestic consumption and oversupply risk in a number of cites, notably Chongqing. CBRE notes that “operational expertise” has become increasingly important in generating rental income, with shopping malls operated by major listed developers outperforming the rest of the sector.

However, China’s commercial property market is being propelled by the megatrends driving the country’s economy and modernisation.

Nowhere is this more apparent than in the industrial and logistics market. The combination of surging demand for high-standard warehouses from e-commerce companies, third-party logistics providers and manufacturers, coupled with a scarcity of land in major urban centres and tight land-use restrictions, has led to strong absorption of warehousing space.

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Vacancy rates in “prime logistics assets are low or zero in Tier 1 cities”, according to a report published by Colliers, a property adviser, last month. Jones Lang LaSalle, another real estate consultancy, noted in a report published earlier this month that prime logistics rents in Beijing surged by more than 8 per cent quarter on quarter in the last quarter of 2018, the highest quarterly rate since it began tracking the market in 2004.

The logistics sector, moreover, is set to benefit from new infrastructure spending as Beijing ramps up its stimulus measures. CBRE notes that the spillover effects of demand for modern warehousing in China’s super-city clusters will benefit neighbouring cities, creating regional logistics hubs. Data from the adviser shows that land purchases by e-commerce firms over the past two years were concentrated in central and western cities, notably Changsha, Shengdu and Hefei.

Tier 2 and Tier 3 cities are also set to benefit from more demand from logistics investors given the scarcity of tradeable assets in Tier 1 cities. CBRE advises its clients to seek partnerships with e-commerce companies that are aggressively developing warehouses in major secondary and tertiary cities where infrastructure is being upgraded and investment yields are above 6 per cent, compared with the adviser's forecast of sub-5 per cent in Beijing by the end of this year.

While China’s slowing economy leaves no room for complacency, the strong fundamentals of the country’s logistics property market – buoyant demand, rising rents and severe undersupply – provide a welcome counterbalance to the gloom surrounding the residential market.

Nicholas Spiro is a partner at Lauressa Advisory

This article appeared in the South China Morning Post print edition as: Fundamental logistics

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