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The bigger picture in China and the role of real estate


The recent volatility in financial markets, both in China and globally, has obscured the enormous changes in China's commercial real estate markets. Harry Tan (Head of Research Asia-Pacific) discusses the opportunities and risks.

'Made in China' is a phrase that describes much of the recent volatility in global financial markets. Investors have been unsettled by two (minor) devaluations of the renminbi, the failure of the authorities to prevent brutal sell-offs of shares and macro-economic indicators that point to a slowing in real economic activity.  

Investors have also been concerned by the very high levels of debt within China's financial system, notwithstanding that most of this is held domestically, and not by foreigners. 

None of this is really surprising, given the various structural trends that have long been underway in China. Those trends include the maturing of industries and the shift from export-focused investment to domestic demand. Meanwhile, there has been a steady rise in real wages and the consequent changes to consumers' spending patterns.  

Urbanisation: the demand for new housing is expected to continue to grow 

In short, we think that the swings in financial markets (less than 10% of Chinese households owned stocks, with their share of overall market value at less than 5% or less, according to the China Household Finance Survey, 2013) have obscured a number of really big and positive changes that are taking place in China's commercial real estate markets.  

The arrival of the year of the Monkey marked the largest movement of people this year, with 700 million people travelling around China to be with their families and friends. The figure has been boosted by migration from rural areas to the cities: many people no longer live where they used to. About 20 million Chinese migrate into cities each year and China's 10 largest cities increased their combined populations by 35 million people over the decade to 2012 (Oxford Economics, 2015). 

And this trend has a long way to run, as workers look for much higher wages in urban areas. The percentage of the population which lives in a city is likely to rise from 50% to 60% over the eight years to 2020 (Oxford Economics projections from 2015). The process of urbanisation will be boosted by the liberalisation of the Hukou system, which had previously restricted the social benefits available to people from the countryside who had migrated to cities for work. The relaxation of the One Child policy also points to a structurally positive demographic-driven demand for housing in the coming decades.  

A lot more white collar workers: a lot more offices needed? 

Meanwhile, the rise in services is an important element of the transformation of China's economy. Some 24.3 million net new jobs were created in business and financial services alone in the period 2005-14. Over that period, the number of office jobs in Beijing and Shanghai doubled (Oxford Economics, 2015). 

The trend also underlies the improving quality of the workforce: according to the China Statistical Yearbook, close to 7 million new university graduates entered the workforce last year and by 2020, China will have a total of nearly 200 million college graduates in the labour force, compared to the projected 170 million in the United States. 

The trends will continue. In Beijing, office employment is a higher share of total employment than it is in London or Paris. It will grow to 40% by 2030 - with the result that another 2.7 million jobs are created (Oxford Economics, 2015): that is more business jobs than currently exist in London's metropolitan area. 

Big spenders will likely become more numerous and more discerning

The swings in China's share markets obscure the fact that a lot of people are becoming (a lot) richer. Oxford Economics estimate that real disposable income per head is expected to rise from $6,700 in 2015 to over $16,000 in 2030. In 2012, there were 36.6 million households with incomes of between $35,000 and $70,000 per annum. Such households should quadruple in number by 2030. 

Over recent months, a lot of publicity has surrounded the government's clampdown on corruption, which has temporarily restricted the most conspicuous consumption. Such publicity misses a more crucial point. Sophisticated shoppers, who are able to pay a premium for quality and purchase discretionary goods, will increasingly dominate the retail scene, providing opportunities for owners of designer outlet malls in China. 

The rebalancing of the economy has favoured consumption. According to World bank, consumption spending has accounted for about one third of overall GDP in recent years  which is a lot less than in the US (68%), Japan (61%) or the EU (50%). At 83%, 93% and 74% respectively, urbanisation rates are much higher in the other places. The point is this: consumption spending will likely grow faster than the overall economy as the process of urbanisation continues. 

The opportunities are not without risks

Foreign investors who can see the bigger picture and the opportunities will still need to bear in mind cyclical and structural risks in China's commercial real estate markets. Such risks include misguided policy changes and the lack of a deep investable and liquid market outside Shanghai or Beijing. Commercial lease lengths in China are shorter than in other countries: this may compromise income security. That said, we believe the case for investing in China's real estate market remains strong. 

Secular prospects aside, institutional investors will do well to position themselves for the internationalisation of the renminbi in their global alternative asset portfolio.

This article is intended solely for the use of professionals and is not for general public distribution. Any assumptions made or opinions expressed are as of the dates specified or if none at the article date and may change as subsequent conditions vary. In particular, the article has been prepared by reference to current tax and legal considerations that may alter in the future. The article may contain "forward-looking" information or estimates that are not purely historical in nature. Such information may include, among other things, illustrative projections and forecasts. There is no guarantee that any projections or forecasts made will come to pass. International investing involves risks, including risks related to foreign currency, limited liquidity particularly where the underlying asset comprises real estate, less government regulation in some jurisdictions, and the possibility of substantial volatility due to adverse political, economic or other developments. Past performance is no guarantee of future performance. The value of investments and the income from them may go down as well as up and are not guaranteed. Rates of exchange may cause the value of investments to go up or down. Any favourable tax treatment is subject to government legislation and as such may not be maintained. The valuation of property is generally a matter of valuer’s opinion rather than fact. The amount raised when a property is sold may be less than the valuation. Nothing in this article is intended or should be construed as advice. The article is not a recommendation to sell or purchase any investment. It does not form part of any contract for the sale or purchase of any investment. TH Real Estate is a name under which Henderson Real Estate Asset Management Limited provides investment products and services. Issued by Henderson Real Estate Asset Management Limited (reg. no. 2137726), (incorporated and registered in England and Wales with registered office at 201 Bishopsgate, London EC2M 3BN) which is authorised and regulated by the Financial Conduct Authority to provide investment products and services. Telephone calls may be recorded and monitored. COMP201600056

Harry Tan

Harry Tan

Head of Research, Asia Pacific

Harry's biography