China: China

Guide to the Risk and Opportunity Ratings

At the end of each country profile, we have given a risk rating and an opportunity rating. These ratings are a summary of our analysis indicating the levels of risk when investing in a market and the level of opportunity to profit from it.

The ratings themselves are simple. Both work on a scale of one to five. The opportunity rating is indicated by the $ symbol. A single $ equals a low opportunity whilst 5 of them ($ $ $ $ $) equals the highest opportunity ranking.

For risk we have used the * symbol. A ranking of * equals a low risk rating whilst * * * * * equals a high risk rating.

Introduction and why this is a good place to buy

To many, investment in China may seem like a difficult prospect. Apart from language and cultural differences, concerns may range from laws and regulations which may not be transparent, to complicated bureaucracy. However, China has made huge progress since it joined the UN and embraced a market-oriented economy in the late 1970s. The country is opening up to trade, has an increasingly liberal global trade regime, and labour costs are a fraction of what they are in the West. China also showed its openness to progress and development by joining the World Trade Organisation (WTO) in 2001.

A key element of China’s new-found economic freedom has been the introduction of property rights. These property rights include laws which state that the government may not confiscate property without payment of compensation, and allow for claims to be made against the Chinese government (although this is on a reciprocal basis – if the home State of the claimant allows Chinese citizens to make claims this will be allowed, if not it won’t). China also has dual taxation agreements with 78 countries, including the UK (further details of these agreements can be found at www.chinatax.gov.cn/ssxd.jsp).

Due to these developments, China is seeing extraordinary economic growth (averaging approx 9.4% per year between 1978 and 2001). In 2004, the Organisation for Economic Cooperation and Development (OECD) predicted that the Chinese economy would grow by 9.3% in 2005, rising to 9.4% in 2006 and 9.5% in 2007. The total GDP between January and June 2005 reached 6.7 trillion Yuan Renminbi (RMB) (£466bn), a growth driven by exports and largely private sector investment. This is one of the largest growth rates in the World. To complement this, the Chinese currency is undervalued – the World Bank estimated the currency to be 75% undervalued in 2000. Until July 2005 the Yuan was pegged at 8.28 RMB to the US dollar, a fact which enabled China to build up a huge trade surplus. On July 21 the People’s Bank of China announced the adoption of a more flexible exchange rate system and a 2.2% appreciation of the RMB against the dollar. The likelihood of further appreciation, along with the aforementioned economic growth, has helped to drive investment interest in recent years. Straightforward currency purchase would appear to be the best tactic to take advantage of these factors, but the Central Bank of China maintains strict controls over the RMB, an untradable currency. The Bank has imposed a limit of $50,000 a month on the buying of the RMB, and once bought, it is extremely difficult to repatriate funds or to convert the currency back into foreign denominations. Funds can, however, be taken out of China through investment in a business or in property, and the commitment required to run a business in a foreign country means that property investment is the simplest and most advantageous way to benefit from the opportunity that China offers.

Price history

China’s property sector began to take off in 1998 (when the Chinese began to be allowed to buy their own homes), and has been growing at an average rate of 22% a year ever since. The investment boom in 2003 raised growth to 32.5%, an unprecedented level. In Beijing, statistics from the Beijing Land Bureau show that the revenue to investment ratio of high and medium-grade housing has reached as high as 30% to 40%, compared with around 5% in Europe and the USA. The consistently high returns on property investment have meant that money is pouring into the property market, and according to research by Morgan Stanley, up to $2 billion in foreign capital will flow into Shanghai’s property market in the next few years.

The massive appreciation has caused fears that this amount of investment is unsustainable, and that a property bubble is being created in China. In response to this the Chinese government took action in 2005 to raise taxes, interest rates and deposit requirements, also imposing restrictions on certain types of sales. The residential property market has slowed as a result, whilst the commercial sector has gained ground, continuing to return impressive rental yields and capital appreciation figures. The government is continuing to keep an eye on the situation, and is ready to provide stricter controls if necessary, a fact which means that a bubble is unlikely. Over the longer term the government’s action should inspire careful and sustainable investment, rather than short term speculative investing by investors looking to make a quick profit. The real estate market therefore looks set to remain in a sustainable price increase curve for a number of years to come.

Where taxation is concerned, this is currently under the control of the regional governments and is periodically adjusted in moves designed to stabilise the economy. Capital gains tax is floating and varies between 0% and 30%, although as the government is currently looking at stabilising their taxation systems, this should only be of concern to short-term investors.

Which type of property should you go for?

All property in China is under a ‘land use right’ system, similar to the western leasehold concept. There are three types of lease on land: residential, which is run on a 70-year lease; commercial, which is on a 50-year lease; and industrial, on a 40-year lease. At present, due to the relatively recent nature of this system’s creation, what happens at the end of this period is uncertain, although the government is likely to create possibilities for renewals of leases similar to European models.

The recent drop in prices in the residential sector, combined with the sustained strength of returns in commercial properties, means that institutional investors are now more certain than ever that the Chinese commercial property sector is the one to become involved in. Investors are aware that prime office space in China’s main cities is in relatively short supply, allowing owners of such properties to charge ever increasing rents as demand increases, and domestic purchasing power in many Chinese cities is also increasing, meaning that businesses are able to pay higher rates for retail space. The residential market is also by no means finished; in fact Chinese residential property probably offers one of the best long term investment opportunities around.

The securest investments currently on offer, however, are most likely those available in the serviced apartment sector. The demand for apartments and hotel accommodation is rising rapidly in major cities such as Shanghai, Beijing and Guangzhou, especially in areas close to the financial and business centres of these cities. The great advantage of these properties lies in both guaranteed rental schemes (an example of a property currently available has a guaranteed rental averaging 8.9% of the purchase price over an 18-year agreement) and in a capital appreciation rate of, in many cases, around 10% per year. A number of new developments are also available with their full lease period intact.

Buyers this market will appeal to

Buyers in China will come from various fields and backgrounds. As stated above, many institutional investors are buying, including big names such as Morgan Stanley, Citigroup and Goldman Sachs. These investors prefer to invest in office complexes and brand new retail units and spaces, as these are likely to be in short supply in future and they are able to purchase substantial amounts. However, there is space for the private investor as well, and many of those who are hoping to break into the investment market will be able to purchase property in the major cities. This is due to the fact that there are an extremely wide range of properties available in the commercial sector, and options include low-cost cash purchases, financed properties and properties with guaranteed rentals. There are also opportunities for those wanting a long-term investment as well as those wanting a shorter-term project, although it is advisable to keep ownership of a property for three years or more to avoid paying a resale tax. China therefore offers something for everybody wishing to make an investment.

Hotspots

There are a number of different regions attracting investment in China, and each region has slightly different legal requirements and benefits with regard to property investment. The major cities on the scene are currently Shanghai and Beijing, although it is also worth considering Guangzhou. Due to rapidly rising local wealth, domestic tourism is also taking off in China. As a result it may be worth considering investing in either ski or beach resorts here. Shanghai and Beijing will be concentrated on here.

Shanghai

As home to the powerful Shanghai Stock Exchange, Shanghai is one of the world’s most significant centres of trade and finance and is the world’s second-biggest container port. The city is becoming more important all the time, being ranked alongside New York, Tokyo and London. The city showed a GDP increase of 10.2% in 2004, bringing it up to $60 billion, and the Shanghai government contributed approximately 25% of the tax payment for the whole country. Thousands of international companies have relocated to Shanghai, including the regional headquarters of the World Trade Organisation, due to the growth in worldwide significance of the city’s financial district. The resulting influx of people has driven demand for property to far outstrip supply.

Considering the city’s current status, the price of property here is extremely attractive – you can purchase here at a fraction of the cost of other world financial centres, and at half or even a third of the prices in Hong Kong or Taipei. This means that the potential for capital growth is substantial, and prices are likely to rise very quickly over coming years. It is estimated that commercial property prices in the Pudong financial area will increase by 50% until the year 2007, which will probably affect the demand for private property and leasing as well.

The local government has recently relaxed both the housing loan market and foreign home ownership policy (there are now no restrictions on foreigners owning property in Shanghai). Currently mortgages are available for up to 70% of the purchase price and 70 year leases are now available to foreign property purchasers, with experts predicting this will soon change to freehold property ownership being a right for all. It is still extremely difficult to find property with guaranteed rental in Shanghai, though when these are found, rental returns currently stand between 6 and 10%. As rental costs are comparatively high, they may not rise in line with property prices, meaning that there may be a drop in yields to 5-7% against future prices, which is nonetheless a healthy return.

Shanghai is growing at an unprecedented rate, and is therefore likely to be considered an investment hotspot for some time to come.

Beijing

The Beijing market is proving increasingly attractive to foreign investors. Colliers International noted in a report released in March 2005 that several international real estate funds are looking to gain a presence in the market, attributing the demand to the booming economy, the expansions of multinational companies in China, the improvement of Chinese investment regulations and the 2008 Beijing Olympics.

Since 1990 Beijing has built 5.1 million square metres of premium office space. At the end of 2004, Morgan Stanley purchased the north tower of R&F TwinTower in Beijing, and in March 2005, CapitaLand agreed to purchase two office buildings in the Central International Trade Center complex in Beijing Central Business District (CBD) for RMB 1.84 billion. The Colliers International report revealed that rental demand for Grade A office space in Beijing remained quite firm during 2004, despite the overall slight downward trend since 2001. The data showed that the average rental in Beijing CBD outperformed the overall market with an increase of 5.7% during 2004 due to a shortage of high quality Grade A office space.

Beijing is also an attractive investment market for other reasons. The city is a centre for tourism in China, a fact which means that the serviced apartment and hotel industry is always a good buy. This sector is also likely to benefit greatly from the 2008 Olympics, when thousands of visitors are expected to flood into the city. The Olympics have also led to a massive programme of infrastructure development, a fact which should keep the value of property rising even after the Olympics have ended.

Overall, Beijing offers good prospects for potential investors, although it is a good idea to consider your overall aims before buying. If your aims are principally short-term, the Olympic Park area would seem to offer the best potential. For the medium- to long-term investor, however, it would be wise to remember that once the event is over, although theoretically transport links to the centre from the Olympic Park will have been improved, interest is likely to shift away from this area and property prices will stabilize. It is probably more advisable, therefore, to invest closer to the Beijing CBD, as this sector is more likely to continue to develop after the Olympics have finished.

Future opportunities

Anne Kalifa, Head of Research for Beijing at Jones Lang LaSalle, noted that there is a high probability that in the future, investors will begin to show an interest in second tier cities such as Tianjin, Qingdao, Shenyang, Nanjing, Xi’an and Chongqing. Many Singapore and Hong Kong developers are already active in these cities, and large amounts of foreign capital are expected to flow into the market in coming years. Wherever you decide to invest in China, it is worth conducting some independent research, as specific rules regarding property ownership and purchase are likely to vary depending on the region you are interested in.

Key risks and opportunities

Donald Greenlees, of the International Herald Tribune (IHT), has stated that there is a frontiers feeling to the Chinese property market, and, as on all frontiers, there are numerous risks and unimagined traps, as well as a worrying lack of information and legal security. Concerns include security of title, financial disclosure, governance of listed real estate companies and zoning and building codes. In its 2004 Global Real Estate Transparency Index, Jones Lang LaSalle ranked China 39th out of 51 countries for transparency. However, there has been a fundamental shift over the last couple of years, and China has taken steps to improve the transparency of its property market. More reliable information and professional advice have become available to support investors’ decisions, especially in the major cities such as Shanghai and Beijing.

Another risk lies in the fact that no land in China is freehold, and the government is legally allowed to expropriate land if needed for commercial purposes. According to the constitution, they are required to pay compensation which is likely to be market value, especially where foreign funds are concerned.

As always, it is wise to procure reliable legal and tax advice when investing.

Purchase process

Before a property can be sold in China, certain checks (such as exact measurements of the property) must be made on both the property and the owner. In some cases there is a need to apply for government and public security bureau approval. During the purchase process itself, a number of legal documents must be signed and require legalising by the Chinese consulate. Some of this documentation must be completed in China, but this can be done through an agent and a power of attorney arrangement.

Before deciding to buy it is a good idea to look into loan applications or financing, if required. A number of foreign banks will provide mortgage facilities for those wishing to purchase property in China. It is also necessary to open a local bank account and to register this with the appropriate authorities. This bank account will be the base for any transactions, such as rent payments, to be made with regard to the property. A bank with internet and telephone banking is a recommended option for this process, as buyers are thereby able to keep track of transactions and funds.

To book a property it is necessary to pay a small reservation deposit. The buyer and seller will then enter into an ‘official sales contract’, which in the case of foreign buyers must be notarised. At this stage, another deposit is made, typically 20 or 30% of the purchase price. Application will then be made to the government Deed and Title Office for the deed transfer from the seller to the buyer, on payment of the relevant taxes and fees (which will typically amount to around 5% of the purchase price). Before this transfer can be made the seller must have paid off any existing mortgage on the property. The ownership certificate is then issued and the buyer pays the outstanding balance on the property and takes possession. This payment schedule also varies depending on the developer.

Opportunity rating

China is set to be the biggest economy in the world by 2020. Demand for property is growing enormously both locally and internationally, and the country has possibly the strongest underlying fundamental reasons for property price growth of any country in the world.

Rating: $ $ $ $ $

Risk rating

There are many perceived risks in China, predominantly related to politics and the protection of private property. However, private property rights are protected in the Chinese constitution and China’s recent accession to the WTO should continue to ensure that the government maintains an investor-friendly approach. In some cities, prices have increased rapidly in recent years, creating fears of a bubble, however while in the short term there may be some price deflation, these locations still present good medium to long term opportunities.

Rating:* *

© Vacation Work 2005

“Where to buy a property abroad – An investors guide”, First edition 2006 David Cox, Ray Withers, Kate Godfrey.

Reproduced with the permission of Property Frontiers.

Further information on this topic can be found in “Where to buy a property abroad – an investors guide” 1st edition, by David Cox, Ray Withers and Kate Godfrey.

This book is available from all good bookshops nationwide at a recommended retail price of £12.95 or can be ordered directly from www.aninvestorsguide.com for £10.95 including postage and handling (to UK addresses only).

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