China Cities: 1st Tier = Blue Chips, 2nd Tier = Growth Stocks

Stephen Chung

Managing Director

Zeppelin Real Estate Analysis Limited

April 2007

Quite a few Hong Kong real estate developers have announced big investment plans involving billions of dollars for China 2^nd tier cities such as Nanjing, Chengdu, Chongqing, Hangzhou, and the like. First, these 2^nd tier cities are starting to emerge thus offering good investment potentials, and second, their land prices are still relatively inexpensive compared to the 1^st tier cities. Smart these real estate developers are. However, a smart move for developers does not automatically translate into a smart move for the non-development-orientated real estate investors whose ventures consist of either buying into existing properties OR (at most) taking a passive investor role in development projects handled by experienced developers. Why? Reasons: 

A)     Investment grade properties (trophy real estate) may be few and far between in 2^nd tier cities = bearing in mind investment grade does not simply imply a well-built property, but also it has to be well-designed, managed, located, and maintained. They also may not be for sale unless an unjustifiable price is paid.

B)     Diminishing profit margins from real estate developments in the 1^st tier cities due to high land prices = does not automatically harbor any direct bearing on real estate prices in such 1^st tier cities. Land prices (costs to developers) may not have any direct significance on real estate prices (if there is any significance, it could be the other way round) which in the long run more likely respond to economic, demographic, trade, industrial, social, financial, and the like factors than land prices. [Read our previous analysis on land and real estate prices: http://www.real-estate-tech.com/articles/Simple_read_stuff_200100106.pdf].

C)     1^st tier cities = are like the blue chips in stock markets. You need not sell or promote them as people and investors generally would have some idea and acceptance of them. As to whether one should focus more on the 1^st tier or 2^nd tier, it depends on one’s resources, return targets, and risk tolerance levels. A simple delineation is that the less-than-brave should stick more to 1^st tier. If for whatever reasons one needs to dispose of properties quickly in order to escape certain financial distress, it should be easier to sell off 1^st tier city properties given all things being equal. For one thing, there are only so many (a few) 1^st tier cities whereas there could be dozens of competing 2^nd (and 3^rd) tier cities. 

For investment groups with sizable capital and portfolio, it is difficult to image how one may avoid investing in the 1^st tier cities [read also the first article in our 2Q 2007 newsletter for clues of what may help sell a China real estate fund: http://www.real-estate-tech.com/articles/ret2Q07.pdf]. Ask yourself this question: how many of the most sizable (stock) mutual funds do not include any of the blue chips in its portfolio?

Notes: The article and/or content contained herein are for general reference only and are not meant to substitute for proper professional advice and/or due diligence. The author(s) and Zeppelin, including its staff, associates, consultants, executives and the like do not accept any responsibility or liability for losses, damages, claims and the like arising out of the use or reference to the content contained herein.                                

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