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THINK China: An overseas investor’s guide to the risk and opportunities

In its latest research report, TH Real Estate provides a flavour of the real estate investment climate in China and highlights the leap in risk appetite required by overseas institutional investors seeking to penetrate the market.

China is arguably the epicentre of mass urbanisation, experiencing relentless growth in its middle classes, and symbolising the shift in economic power from the West to the East. Its economy is predicted to continue to expand more rapidly than the rest of emerging Asia over the next fifteen years. As a result, further seismic demographic and social shifts are underway. As the economy progresses along the value chain, from production to consumer, and financial and business services, immense opportunities will open up for real estate investors. Urbanisation has already been accompanied by the development of major new office markets with the biggest cities experiencing massive job growth. In addition, as China becomes richer, growing financial security will lower precautionary saving and underpin further rapid expansion in consumer markets.

The main focus of the report, however, is to highlight the elevated levels of risk in accessing real estate investment opportunities, in particular for overseas institutional investors.

Andy Schofield, Director of Research at TH Real Estate, comments: “The current backdrop in China remains one of economic imbalance. Aside from the stock market gyrations that dominate the financial headlines, the medium-term test for the government will be to restructure debt and rebalance the economy from investment to consumption. Success will require significant financial and social reform. We need to remain mindful of these ongoing issues as we assess real estate investment risk.”

The report explains the hurdles and challenges in accessing market opportunities and considers the risks of investing relative to competing global markets. US and European investors have accounted for a small share of total overseas volumes over the past decade, with investors from Hong Kong and Singapore constituting the lion’s share. Owner occupation is high and when core stock does become available, the competition can be fierce. Domestic state owned enterprises have access to easy credit, and overpay to prevent assets going offshore. Market transparency is also a major issue for overseas investors and income risk is compromised by short leases. Restricted land use rights add a further uncertainty that can seem insurmountable to an institutional overseas investor.

Schofield continues: “Rental growth expectations are supporting frothy capital values in some locations, but these are likely to be challenged by excess supply. Over-development is encouraged by local governments who use land as collateral for loans raised through local government financing vehicles. As a result, swathes of new development will not only dampen rental growth, but pose additional risk of locational obsolescence. A potential correction in capital values over the medium term remains a significant risk.“

The report concludes with brief portraits of the retail and office sectors across China’s Tier 1 cities, emphasising the importance of local knowledge to potential overseas investors.

Please see the attached report.

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