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[This is Part 4 in a series about China’s property market. See here for part 1, part 2, and part 3.]
When thinking about China’s property market, the image that often springs to mind is that of the endless seas of residential towers one sees when flying into Beijing or Shanghai. And indeed, the demand for investment in residential housing has been a tremendous catalyst for growth in China and around the world. But there is another part of the property story about which less is known. The nonresidential real estate market consists of mainly office buildings and retail property like shopping centers and hotels. Nonresidential makes up approximately 30 percent of China’s real estate market in terms of investment, and total sales of the nonresidential market account for about 20 percent of the total (see chart 1).
Chart 1. Total Sales of Commercial Versus Residential Buildings (rmb $bil)
Source: Wind Economic Terminal
The commercial property market, similar to the residential market, is highly differentiated by city tier. As shown in our previous post in this series, the prices per square meter in the major cities in Beijing and Shanghai differ substantially from that of national average (see chart 2 below). Pricing data for property is hard to come by but using aggregate sales and floor space data you can obtain an overall price per unit for this market.
Chart 2. National Price Index for Nonresidential Property (Feb 2002 = 100)
Source: Wind
Within the commercial space, an important factor that is not such an explicit concern with residential property is rental yield. While buyers of residential property naturally consider the rent they pay relative to the costs of financing the purchase of a similarly valued property, the property has more intrinsic value to a household looking to actually live in the property. Commercial property firms such China Vanke Co. are more sensitive to the volatility of the property cycle as businesses that set up in office buildings on short-term leases are less “sticky” customers than a newly-wed couple who just put down 40% of their home’s value down in cash. Thus, commercial developers’ success or failure depends on their ability to accurately assess the future value of not just the land and building, but also the changes in funding costs and demand.
Commercial space in Shanghai has continued to increase but the availability of office space has has grown steadily at around 9 percent over the last couple years. The same can not be said for the tier 2 cities where supply continues to outstrip demand, driving up vacancy rates to 40 percent in cities like Chongqing, Chengdu, Shenyang, Wuxi, and Changsha. The central government has not applied as many counter-cyclical policies for the commercial market as it has with the housing market, so the commercial property market is more sensitive to the broader easing moves of the PBoC such as interest rate cuts and cuts to banks’ reserve requirement ratios.
The data for the commercial real estate market shows mixed signals. Recently there has been an uptick in nationwide supply of commercial real estate. From 2005 to 2009, we take a look at the difference of commercial building starts versus the amount sold two years later. During that period, the amount sold was a nearly equal to the amount of starts. However, from 2010 to 2014, starts exceeded sales by an average of 670 million square meters annually, totaling 3.35 billion square meters more starts than sold over the five year. One limitation is that commercial building starts are likely overstated as some will be in the planning stage or some may be postponed projects. However this large of a difference suggests that there is a significant oversupply of commercial floor space. And with the amount of floor space sold at the same level as last year, and a high amount of starts last year, this oversupply will be maintained.
Looking at floor space for sale in the last few years, a measure of inventory, shows a continued rise of cumulative unsold floor space of commercial buildings, and an especially steep build up during 2013 (see chart 3). Even while the growth rate slowed in 2014, it still averaged around 25 percent. However, currently the cumulative amount for sale is around 650 million square meters, and since the average annual amount sold over the past five years was nearly twice that at1.15 billion square meters, the current amount of inventory is not a dangerous level.
Chart 3. Unsold Floor Space of Commercial Buildings (lhs - million sqm, rhs - percent)
Source: Wind
One worrying indicator is the total sales of commercial buildings, including office building and commercial business buildings. This indicator tracks the total amount of revenue from buildings sold, and while commercial business buildings have been near a zero percent growth rate lately, office buildings have been in the negative for over a year (see chart 4). What this tells us is that while floor space sold has still been strong, prices have dropped off notably for part of the nonresidential real estate sector
Chart 4. Sales of Office and Commercial Buildings (ytd, yoy)
Source: China’s National Bureau of Statistics.
A closer look at the data for office buildings shows that completions have maintained a strong growth rate recently (see chart 5). This likely signals that in the near term prices for office buildings will stay low. The data for starts has been volatile lately, however dropping negative for the year to date, another trend likely to continue due to low prices and increased supply.
Chart 5. Starts and Completions of Office Buildings (ytd, yoy)
Source: Wind
China’s real estate market is an important driver of China’s economy, but oversupply in mid-tier cities is driving prices down and an adjustment is taking place. As China’s economy shifts into a lower gear, it may take longer for the commercial real estate market to turn around, and this may affect smaller cities the most. This data indicates that the slumping commercial property market may have a small but notable effect on GDP growth. What we’d like to see happen is a slowdown in commercial starts, which will also show up as slowing investment, but as completions and sales catch up, investment can pick up again.
