The coronavirus outbreak could bring China’s property investment market back to earth

The disconnect between China’s investment and occupier markets has become less sustainable since the outbreak hit an already vulnerable economy, though some investors will take heart from the prospect of more aggressive stimulus measures

Nicholas Spiro

Published: 4:00pm, 10 Feb 2020

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One of the buzzwords in global capital markets these days is “disconnect”.

Asset prices, and sentiment in stock markets in particular, have become detached from underlying fundamentals. The most conspicuous example is the persistent rise in the benchmark S&P 500 equity index – which currently stands at a record high – in the face of the economic shock from China’s draconian efforts to contain the rapid spread of the deadly new coronavirus.

In China itself, the disconnect within the country’s commercial real estate market is just as pronounced, if not more.

Long before the coronavirus outbreak grabbed the headlines, the Chinese commercial property investment market and the occupational market appeared to be in parallel worlds.

In the Chinese investment market, transaction volumes last year reached just over US$45 billion, a 21 per cent rise year-on-year, and one of the main reasons investment activity in the Asia-Pacific region reached a record high of almost US$169 billion, according to preliminary data published by JLL last month.

Indeed, in the first three quarters of last year, Shanghai was the third-largest recipient of foreign investment among the world’s most actively traded real estate markets, helping boost Asia’s share of cross-border investment in the global commercial property market to 34 per cent, up from 14 per cent in 2009, data from JLL show.

What is more, China’s retail real estate market has bucked the global trend of declining investment activity. According to Real Capital Analytics, Beijing, Shanghai and Tianjin all registered significant increases in retail transaction volumes in the first nine months of 2019.

However, in Chinese occupier markets, sentiment has deteriorated sharply. The double whammy of Beijing’s deleveraging campaign and the trade war has led to a collapse in demand in the office sector. Last year, net absorption of office space in Tier 1 cities plunged 25 per cent year-on-year, the main reason for the 19 per cent drop in the Asia-Pacific region, data from CBRE show.

The sharp fall in leasing activity has been exacerbated by oversupply, especially in Shanghai. In a report released last month, Savills noted that in 16 major mainland cities, a further 6.7 million square metres of Grade A office space was added last year, an increase of more than 40 per cent. This has pushed vacancy rates up to levels last seen during the global financial crisis, causing prime rents to decline.

Even in the more resilient retail sector, shopping centre rents fell in most major cities last year due to a combination of acute supply pressures and retailers’ more cautious expansion.

The disconnect between the investment and occupier markets has become even less sustainable since the coronavirus outbreak delivered a profound blow to China’s already vulnerable economy, causing a growth scare and fuelling concerns about the outlook for the global economy.

While the virus’ mortality rate is significantly lower than those of previous epidemics, it is likely to prove more disruptive economically. The tougher the measures to contain the spread of the disease, the bigger the hit to growth. The infection rate is still rapid enough to allow only a partial reopening of Chinese factories. Last week, JPMorgan slashed its estimate for growth in China this quarter from 4.9 per cent to 1 per cent.

A sudden and unexpected collapse of the economy will increase the sensitivity of real estate investors – particularly foreign buyers who have become the main driver of transaction volumes – to the worsening fundamentals of the occupational market, hastening a flight to safety that was gathering momentum last year.

Savills notes that Tier 1 cities – which, although suffering from oversupply and weaker demand to varying degrees, are more liquid and transparent – accounted for more than 70 per cent of transactions last year, up from roughly 50 per cent in 2018.

Investors in Chinese commercial property must now contend with a severe disruption to economic activity that could last a lot longer than most analysts anticipate, particularly given the all-encompassing nature of the shock, with domestic demand, trade and travel all affected.

The retail property market is most at risk as footfall and sales plummet at shopping malls, which are cutting rents and shortening their opening hours. Major brands, such as Ikea and Apple, are closing stores across China. In a report released earlier this month, CBRE noted: “Entertainment, F&B and fashion retailers will be most impacted as households curtail activities outside the home...”

Even the more resilient logistics real estate market – which is more insulated due to the dominance of e-commerce and the shift towards omnichannel retailing – is vulnerable as supply chains are disrupted, exacerbated by Wuhan’s status as a major transport and manufacturing hub.

To be sure, investment in Chinese commercial property is driven by long-term trends, such as urbanisation, technological change and the shift to consumption-driven growth. These drivers remain intact. Moreover, some investors will take heart from the scope for more aggressive stimulus measures to help revive growth.

However, while financial conditions – in China and abroad – are likely to become even more supportive of further investment, the severe strain on occupier markets calls for caution. The coronavirus outbreak should serve as a sharp reality check for investors.

Nicholas Spiro is a partner at Lauressa Advisory

This article appeared in the South China Morning Post print edition as: Time for reality check

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