China’s property market has grown in pace with the country’s boom but well known commentators have recently warned of an asset bubble and Beijing is taking its own precautions by prevent the property market from overheating.

Famous short seller and predictor of the Enron demise, Jim Chanos, founder of Hedge Fund, Kynikos Associates Ltd., dominated China news headlines recently sparking concern of a China bubble. In a widely publicized talk at a conference in London, he said there are about 30 billion square feet of space in construction in China’s commercial property sector and called China, “Dubai 1000 times over.”

Chanos is not the only pessimist about China’s real estate sector. Zhang Xin, CEO of SOHO China, a residential and commercial property developer caused some nail biting in the market recently when she criticized government stimulus for creating the framework for a real estate bubble. “Real estate prices should only go up because people want to actually use the space, but at the moment we see more and more empty buildings across the whole country in every real estate segment,” she said. “The rising prices are a direct result of so much money coming from the banks and the Chinese banks should be very worried.”

China’s real estate sector set several new records in 2009. Nearly 940 million sqm of properties sold, and the average price hit 4,695 yuan ($687) per sqm, China’s National Bureau of Statistics (NBS) revealed in January. Consequently, Beijing is curbing lending for new developments and reducing incentives such as discounts on loans. In January, Chinese banks were ordered to increase their reserves in an effort to prevent a surge in credit following a flood of lending last year to support stimulus projects.

The banking industry’s top regulator, Liu Mingkang, said in January that Chinese banks are expected to scale back lending to about 7.5 trillion yuan ($1.1 trillion) this year after handing out 9.5 trillion yuan ($1.4 trillion) in 2009. Concern of a bubble has also spread to other realms of the real estate market such as industrial and commercial. China’s biggest bank, ICBC, said in a statement in early February that it will “strictly control” lending to real estate and industrial projects deemed too dirty or energy-intensive and those outside government development.

Certainly Chinese banks are in a much healthier position than U.S. banks were prior to the mortgage crisis. For one thing, with Federal Reserves in the range of $2.4 trillion, they have plenty of cash. Chinese home buyers are also much less leveraged than U.S. home buyers, in most cases putting down payments of more than 30%. Nevertheless the government is concerned about reckless lending and hoarding of vacant land or properties by developers. While there is also an attempt to provide more affordable housing for the masses, Beijing wants to discourage speculation in the residential market.

Policy versus reality
How will tightening of credit in the residential market affect the commercial and industrial sectors? “The commercial and industrial sectors have different fundamentals,” says Stephen de Kyper, Managing Principal of CresaPartners, a commercial and industrial property consultancy. “Residential property is more speculative. Lenders and developers look at commercial and industrial properties with a longer view.” One caveat about the recent policy talk is that there is often a large gap between policy directives and actual implementation.

“While the law may not make much distinction between different elements of the property sector, the intent is to cool down the residential market,” says Michael Cole, Managing Director of Right Site Asia, a web portal aimed at bridging investors, developers, industrial zones and consultants in the property sector. “On the basis of this, I would expect the new measures to be implemented more leniently for commercial projects, and especially for industrial projects.”

Echoing DeKyper’s emphasis on the differences between residential and commercial, Wei Wang, Assistant Director at Mapletree Investments Pte., a Singaporean commercial and industrial property developer noted that “The residential sector overheated due to the pressure of demand on limited resources, whereas the other sectors cooled down due to the financial crisis.” Wang does qualify that “if there is an impact on the commercial and industry property sectors, I’d say it will be more difficult for investors to raise funds.”

Raising funds will be especially difficult for foreign developers. “Western developers are facing difficulties to raise funds for China due to the crises in their own countries,” says Arnaud Sebban, Commercial Director for GSE China, a design and engineering and construction firm which builds large scale industrial properties. “Money is coming primarily from China and Singapore” “There are still a number of foreign REITs and other funds, especially Asian investors, who have significant appetite for commercial projects in China,” says Cole of Right Site Asia.

Another consideration is that much of the financing for real estate developments comes from cash rich state owned enterprises (SOE’s), looking for revenue growth and opportunities to make bigger profit margins. These SOE’s are paying premium prices for land and property, often outbidding private developers.

An example is State-owned Shanghai New Huang Pu Real Estate and Shanghai New World which won a joint bid for a prime parcel of land for commercial development in Shanghai for just under US$500 million. The 13,709 square-meter site, near the Nanjing Lu shopping district has a potential gross floor area (GFA) of 65,743 square-meters.
These SOE’s are less accountable to shareholders and don’t necessarily rely on banks for funding. They also have strong “guanxi” with local governments and can more easily acquire land and licensing for their projects.

Market recovery
Certain industry segments, such as retail, will face no trouble finding funding. Jones Lang Lasalle (JLL) sees retail, driven by Chinese domestic consumption, creating increasing demand for commercial and industrial space all over China, but especially in second and third cities and Western China. JLL, along with the other brokers also see a turnaround in the commercial property sector. According to Greg Hyland, Head of Investment at JLL in Shanghai, “In Pudong, overall market vacancy is at 11.1%, down from over 20% a year ago. Yes a lot of developments are underway, but 40% of supply is sold to preleased and owner occupiers.”

Contrary to Chanos’ warnings, many developers, brokers and consultants in China seem optimistic that what we are experiencing is not a real estate bubble. China’s Economy expanded significantly in January and all indicators are it’s going to be a good year. With a focus on IT and software related property projects, DeKyper, of CresaPartners is experiencing strong interest from his clients in upgrading and expanding on their commercial and industrial space in Shanghai.

In their recently publicized 2010 market outlook, Jones Lang Lasalle, bullish on most areas of China’s property market, sees domestic consumption as the primary growth driver. “Lending will be tighter than what it was last, but it will be accommodative,” says Hyland at JLL. Along with JLL and others, Sebban at GSE has his eye on the tier one cities and western China, “Most logistic developers are targeting Tier 1 cities but we see interest and opportunities in cities like Chengdu, Chongqing, Wuhan.”

Eric Ng, Head of Direct Investment (China) at IMCPAA, a port facilities and commercial property investor and developer out of Hong Kong and Singapore is similarly focused on second and third tier cities, with projects underway in Chengdu, Southern China and Qingdao. “In some segments there might be a bubble, but overall, no,” says Ng. “Even with high vacancy rates in cities such as Shanghai, things will be different in two or three years. Also on an individual level, real purchasing power of Chinese is much higher than commonly believed.”

Whether or not there is money to be made in commercial property development remains to be seen, but it seems unlikely that the money pipeline for the right real estate projects will stop. Even with restricted bank lending and government control, the trend we are likely to see in China is ongoing development.