Two news items today provided conflicting stories on the returns available for investors in China’s emerging cities. First CBRE issued a new research report showing high vacancy levels for office developments in China’s second and third-tier cities, while on the same day, the Evergrande Real Estate Group reported a seven-times increase in annual profit based on its investments in residential real estate in emerging cities.
In the office sector, CBRE noted that China’s office vacancy may rise in some of the country’s less affluent cities as developers overbuild, driving rents down “over the next two to three years.” CBRE’s CEO for Greater China, Chris Brooke suggested that “Hangzhou, Tianjin, Nanjing and Ningbo may be among cities where there may be rising vacancies and falling rents.”
At issue are the plans of many emerging cities to build commercial centres with grand office developments, while many of these cities lack well-developed service sectors, or large demand for commercial services. Meanwhile, developers who are seeing yields compressed and land become less available in China’s first-tier cities are testing out ventures in less developed cities trying to maintain the high levels of return that they formerly enjoyed in Shanghai and Beijing.
On the residential side, however, groups like Evergrande have benefited from the restrictions on housing purchases in first-tier cities as they saw prices surge for homes in third-tier cities in 2010.
According to the Wall Street Journal, Evergrande’s net profit for the year ended Dec. 31 soared to 7.59 billion yuan ($1.16 billion) from 1.05 billion yuan a year earlier, while revenue rose to 45.8 billion yuan from 5.72 billion yuan.
The Journal quoted Evergrande’s Chairman, Hui Ka-yan as saying, “Given that third-tier cities are generally less affected by the macro adjustment and control policies, the room for urban development is broad and the demand and growth potential for housing are immense.”
However, if the fundamentals for office markets are not strong enough to support ongoing development, it would indicate that rising values of residential real estate in third-tier cities may be purely based on speculation on capital appreciation. If there are not enough offices to fill these commercial developments, then it raises some serious questions about where potential residents are supposed to find the income to purchase ever more expensive homes.
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