Headwinds and opportunities - China property market outlook 2019

Savills recently published “China Property Market Outlook: 2019”. The report discussed the key trends in the real estate market and analyses the main asset classes of 11 leading Chinese cities.

Grade A office: Guangzhou and Chengdu look to be in a better position, while most others are faced with growing pressure  

The total Grade A office supply of the 11 cities tracked in this report fell by 37% YoY in 2018 with excess stock being gradually absorbed resulting in average vacancy rates falling 2.3 ppts YoY.

Among the eleven cities, only Beijing and Guangzhou recorded vacancy rates below 10% by the end of 2018, at 7.0% and 4.3%, respectively. Guangzhou vacancy rates are now at its lowest level in over a decade. Despite economic challenges, Guangzhou has demonstrated strong corporate appeal thanks to its comparatively low rents and maturing business environment.

Among the seven second tier cities, Nanjing has maintained the lowest vacancy rate over the last two years. Nevertheless, this might be more a factor of limited supply (120,000 sq m over two years) than strong demand, with Nanjing’s net take-up only 11% of Chengdu’s. While Chengdu’s vacancy rate remains relatively high at 21.0%, it has been falling for four years and is now very close to the average of other second tier cities (20.2%). Confidence remains high for another strong year in 2019.

A slowing economy and rising supply will mean that 2019 will be another challenging year. Supply for the eleven cities is expected to more than double in 2019, and almost all cities are forecasting rising vacancy rates—with the exception of Hangzhou—as a number of projects are likely to be for self-use.

With more established operators adopting more flexible spaces, the impact of Workspace-as-a-Service (WaaS) is likely to be more profound, broader and longer-lasting than previously envisaged. The adoption of WaaS comes at a time when economic growth is slowing but the pace of change in the corporate world is accelerating. In these times of dynamism and uncertainty, to tie a corporate to a long-term lease with only limited opportunities for expansion or contraction of headcount would be nonsensical.

Retail: Overall rent remain stable as low-preforming projects continued to be expelled from the market

Similar to the office market, retail supply of the 11 cities included in the report saw a decrease of 27% YoY, with average vacancy rate falling 1.0 ppt YoY.

Nine cities saw their vacancy rates fall below 10% with most recording a decline in rates year-on-year. However, the headline figure disguises the fact that a number of underperforming projects have been driven out of the retail market as a result of the increasingly competitive environment in which only quality projects can survive.

Shenzhen and Xi’an recorded the lowest vacancy rates on the mainland at 1.2% and 3.8%, respectively. Despite of receiving 1.2 million sq m of supply in 2018, which is highest among all cities, Xi’an witnessed one of the lowest vacancy rates as the majority of the new supply is of international standard, bringing a significant boost to the local market.

Retail supply for the eleven cities is expected to increase by 19% YoY in 2019 with Shanghai and Wuhan receiving the most, with over 1.0 million sq m retail space coming to both markets. Shanghai is also expected to receive another bumper crop in 2020 of around 1.0 million sq m.

As wages continue to rise and returns on fixed investment diminish, it was hoped that the consumer market would usher in a new era of economic growth for China, moving towards more international norms where household consumption accounts for roughly 50-70% of the economy from its current level of 35-40%. However, as housing prices increase, and debt servicing takes up an increasing amount of households’ disposable income, this limits households’ ability to consume products and services.

Despite slowing retail sales growth rates, new opportunities continue to emerge, and domestic brands are meeting changing consumer needs, especially in the affordable range with the likes of many specialty coffee brands and electronic brands such as Huawei and Xiaomi. New business models are created that offer comparable quality to existing brands but with significant cost saving.

Residential: Stabilising price and rational expectation

China has been trying to cool the market and wean itself off its reliance on the residential property market in recent years. This comes with the now standard range of policy tools including restricting mortgage availability, house purchase restrictions, control over pre-sale permit pricing and tightening up land auction processes and requirements. The hope is to cool price appreciation and therefore maintain or improve housing affordability as incomes continue to rise while avoiding a price correction which would see household wealth shrink. While price appreciation is controlled, transaction volumes are still supported to enable developers to monetise their investments and either pay down debt or reinvest and generate continued economic growth and employment. 

The latest iteration of property cooling measures has taken an extra twist with the support of the development of the residential leasing market, which, while started in 2016, gained significant momentum in 2018. The leasing market is expected to improve the supply of affordable housing, increase mobility and encourage individuals to invest in alternative asset classes which contribute to the real economy—like equity markets or business start-ups—and, at the same time, create employment and make more efficient use and absorb current vacant residential stock. As the leasing market matures, there is the potential for a more diverse, multifaceted leasing market that caters to specific communities such as student housing or senior housing. 2019 is expected to see another year of stabilisation in the sales market and a consolidation of the leasing market.