Another day, another negative article on China. One might become seriously depressed reading the Western press if your job was to invest in China. The tone at the recent PERE Asia conference was also dispiriting as fund managers grumbled about investors' aversion to buying China. Baron Rothschild said, “Buy when there's blood in the streets….” While we do not believe it is or ever was that dire in the country, it is time to invest in China.
It is easy to understand the perception that there is blood in the streets. Growth has certainly slowed. That said, China is still growing at rates that make developed economies envious. Given the current large base, even mid-single digit growth in the country is more growth on a nominal basis now than double digit growth was eight years ago (6.9 percent growth in 2015 was $675 billion on a nominal basis, compared to 14.2 percent growth in 2007, which was $457 billion on a nominal basis).
However, China remains the world's global source of manufacturing and given population disparities, it is not likely that this will change drastically in the near future. Also, China still has a significant amount of urbanization to occur, with an additional 230 million people expected to move into the country's cities by the year 2030, based on a report from Chinese Academy of Social Sciences. These people need places to eat, sleep and work, which will mean greater demand for retail, residential and office real estate. Employment remains strong and the middle class continues to grow rapidly at an estimated cumulative annual growth rate of 15 percent over the next 10 years, according to McKinsey Global Institute.
Another positive change benefiting the Chinese real estate market has been the government's effort to limit the growth in residential prices to maintain affordability. In fact, affordability is actually better today than it was 15 years ago, as wages have risen faster than residential prices. According to Capital Economics, the wages to price ratio has increased by 40 percent from 2000 to 2015, thanks to a number of restrictions that the Chinese government imposed on demand from mid-2010 to early 2014.
The malaise that the residential market suffered during late 2014 and 2015 has notably eased. Inventories across China have dropped from an average of 18 months at its peak to 13 months currently, based on SouFun data. Much of the pickup in the residential market is attributable to the Chinese government removing some of the restrictions on demand, along with easier credit. Now, in early 2016, inventories have dropped and land purchases and construction have picked up. In fact, in Tier 1 markets, the recovery has been too robust, partly driven by volatility in the stock market, and the government has begun to increase restrictions on demand in Tier 1 markets again.
On the commercial front, rents continue to climb in Tier 1 cities and vacancies are staying tight – ask anyone who has tried to find a significant block of space in a Tier 1 city recently. Admittedly, commercial opportunities in non-Tier 1 cities are still a bit soft.
Opportunities continue to exist in residential development as mid-sized developers remain liquidity constrained and many established developers do not, or no longer have, access to traditional sources of financing. However, investors must keep their focus on markets, and even micro-markets, with proven demand. A particular city or area may suffer from high inventory levels, but those levels may be skewed toward a particular section of that city or area. Commercial properties in Tier 1 cities remain a safe bet but are expensive and unlikely to provide opportunistic returns; a number of fund managers are instead targeting such assets for core-plus and value-add investments. There are also opportunities to invest in the country's under-developed property types, such as logistics, senior housing, student housing, self-storage, and business parks.
In the pre-GFC 2000s, investors thought they could invest anywhere in China and ride the growth without much thought. That is clearly not the case anymore. Identifying markets in China with sustainable growth and discernible sources of demand is crucial. If investors can exercise the appropriate due diligence and caution – and ignore the generalized negative view they read in the mainstream press – there are plenty of opportunities, right now and to come, in China.