China Luxury Residential Real Estate: Identifying the Right Reasons for Optimism

Stephen Chung

Managing Director

Zeppelin Real Estate Analysis Limited

July 2007

(Written for Luxury Properties Magazine)

Your humble author assumes that readers of this column and magazine would have some knowledge of China and its asset markets, real estate included. He is also certain readers to have heard of all the usual reasons for investing in China, such as the immense population (if every person buys this…), impressive growth rate (10% + pa), huge cash reserves, strong exports, and so on. While there is some truth in all these, they are not always the right or sufficient reasons for investing in (really) luxury residential real estate. Here’s why:

A)  There is NO NEED to have all 1,300,000,000 people, or roughly 400,000,000 households, wanting and being able to buy real estate for the luxury real estate markets to become prosperous = because this is practically not possible, even the most matured and developed economies, like the USA or UK, do not have complete homeownership. Some families will always be lacking in resources while others are frequently on the move making ownership a less urgent need. The point is that a high home ownership rate in itself does NOT automatically spell a vibrant and viable luxury residential sector. It may or may not exist. Curiously, a high homeownership rate may mean overall lower home price and vice versa. Read this analysis of ours on USA home markets: http://www.real-estate-tech.com/articles/SRS050701.htm.

Instead, what we really need are a few outstanding markets (cities) which will offer outstanding return in the long run. Given statistically there are some 667 cities (urban areas) in China, selection is key. Not all of them will prosper or to the same degree, and some will be more equal than others, to coin a phrase from Animal Farm. Using developed economies as hints, your humble author expects the (really) luxury residential sectors to be concentrated in and around several selected China markets and cities, just as one would find the mega$ homes concentrated in only a few cities and areas in the USA. While the luxury residences need not be right in the city center, and many are not, they tend to be within and connected to the metropolitan economy, or more technically, the Standard Metropolitan Statistical Area (SMSA). Notwithstanding these acronyms and concepts, the point is a significantly scaled and competitive economic system (city) is required to generate the sufficient return and money to create a significantly scaled luxury residential sector with mega$ homes, be these expensive condos or mansions.

As to how to assess and select the better or most suitable luxury residential markets, there are no hard and fast rules, and much depends on one’s aspirations for return AND risk among other factors. Despite some observed correlations between different real estate markets, each city also harbors its own economic characteristic, rationale for growth, price structure, and cyclical behavior. Eventually, the task for an investor is to find market(s) with the least risk given any level of desired return given all other factors being equal. Nonetheless, it is also felt that investors with a preference for low return and low risk may not find China, being an emerging economy, to be a good match i.e. investors need to accept at least medium risk prior to entering China. Note also that while collectively it appears that high return do come with high risks, an individual investment opportunity may offer only high risk but not high return. Here are links to analyses we have written earlier for further thoughts:

China Real Estate: 1^st tier cities = blue chips, 2^nd tier = growth stocks

http://www.real-estate-tech.com/articles/SRS040701.htm

China Villa Sector

http://www.real-estate-tech.com/articles/SRS030705.htm

Food for thought: some of the world’s largest real estate development or investment groups do not become so by being all over the place but instead focus on specific regions, markets, sectors, or real estate types.  For (really) luxury residential market sector investors, ask these among other questions: where do and shall we see the biggest concentrations of millionaires in China? Or for that matter, which markets or cities would have better capacities and the economic engines to create millionaires-billionaires?   

B)  Overall GDP growth rate means little = and higher disparities in regional growth rates and income levels may actually be good news for luxury residential investors in China. Because this means differences in income levels are higher, thereby luxury residential properties in some markets or sectors may see higher than usual prices, even for comparable luxury residences. Naturally, one does not wish to see such disparities becoming too immense as overly regional imbalances will lead to other challenges and non-economic problems which in turn increase risks tremendously.

Food for thought: the investment market appears to be optimistic of Europe, in particular the western portion of it. One reason touted is that governments, from the UK via France to Germany, have in the last 20+ years come out of the immensely socialist mode (usually smaller imbalances) and have embraced freer market economy and capitalism (generally larger imbalances). Hence, ask these among other questions: will such regional disparities in the China economy and income level narrow down, remain the same, or even become more pronounced in future?  

C)  Administrative restrictions on the luxury residential developments are actually one reason for paying attention to the sector = as insufficient supply may be unintentionally created somewhere down the line in certain markets, which in turn may mean a windfall for investors. Signs to watch for include 1) smaller-size residential units are designed to merge easily with one another to form a bigger residence; 2) the price per floor area (Yuan / m2 in the case of China) for larger residential units are way higher than those for smaller (and older) units, and this can be observed in the Hong Kong market where ordinary residences command on average approximately HK$5,000 / ft2 whereas (newer) larger residences can get on average HK$10,000 /ft2; and 3) there will be a tendency to call most new residential developments “luxury” thus your humble author’s emphasis on “real” luxury residences. These signs appear to confirm a lack of sufficient luxury grade residences to meet the demand for better and larger properties.  

Very roughly, your humble author has the feeling that overall China does not have a vast oversupply of new residential units in terms of numbers i.e. versus number of households etc. If anything, it may have a mismatch of supply and demand, i.e. the suppliers (real estate developers) collectively are building too many over-sized over-priced over-furnished residential units which collectively the prospective buyers find out of their financial range. Hence this may also explain in part the quick sales seen in some economic-housing projects targeted for the lower-middle strata. Perhaps the administrative measures are not so much against luxury residential units but against a bias in the real estate development community for developing luxury residential units (at the expense of the mass private residential sector).

Food for thought: China as an emerging economy is still on a growth path despite ups and downs along the way. As such, and given its huge population, millionaires-billionaires are now being and will be created in future. It is only natural that demand for luxury residences will increase. Investors may wish to seek markets-cities hit hardest by the administrative measures yet harbor some of the best economic engines.  

We may go on further to discuss other reasons for optimism on the luxury residential sector, yet your humble author thinks these suffice for the moment. One thing though, some of these present and future luxury residential properties are being and will be developed in relatively new neighborhoods, and new neighborhoods do NOT automatically turn into prime neighborhoods merely by having many expensive homes in them. Some will prosper while others may falter as newer and better ones are developed. Notwithstanding there are a few techniques to evaluate the prospects of such neighborhoods, yet only time can tell which ones will become landmark.  

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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