By Harry Tan* (pictured)
The recent volatility in financial markets, both in China and globally, has obscured the enormous changes in China’s commercial real estate markets. Investors should position themselves for the globalisation of the reminmbi within their alternatives portfolio. Here are 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 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 per cent of Chinese households owned stocks, with their share of overall market value at less than 5 per cent 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 marks 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 per cent to 60 per cent 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 the 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).
This 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 per cent 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 US$6,700 in 2015 to over US$16,000 in 2030. In 2012, there were 36.6 million households with incomes of between US$35,000 and US$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 USA (68 per cent), Japan (61 per cent) or the EU (50 per cent). At 83 per cent, 93 per cent and 74 per cent 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 internationalization of the renminbi in their global alternative asset portfolio.
*Harry Tan is Head of Research, Asia-Pacific, at TH Real Estate