Thursday, January 24, 2008

Volatile Stock Markets and China Still Rocking

Let's take a quick look at the daily headlines regarding China's stock market over the last four days:

Asian stocks rise on hopes worst is over (January 24, Agence France Presse)

Asian Markets Rebound After Fed Cut
(January 23, AP)
Chinese shares follow world markets down, sink 4 pct at middday
(January 22, Xinhua)
Asian Stocks Plunge In Global Selloff On US Recession Fears
(January 21, Market News International)

In an article from two days ago, Kevin Rudd, a journalist for Australia's popular "The Advertiser" wrote the following, "It may be the Chinese and Indian economies and their demand for Australian minerals, meat and grain, which determine the direction of the world economy, not Wall Street."

China's Statistics Bureau today released figures for 2007 National GDP growth - not surpisingly it was a whopping 11.4%! The breakdown by level of industry was primary (agriculture) 3.7%, secondary (manufacturing) 13.5%, and tertiary (service) 11.2%. However, the real growth in manufacturing is closer to 18.5% ( The latter represents what is known as the "Total Value-added Industrial Growth" (

So, despite all the rhetoric that China (and India) are the new centers of the global economy, the outright economic shift to Asia has still not taken full effect. However, the effects of the recession we are headed for are bound to influence the shift and in my mind it will only expedite it.
There are three major factors that contribute to this convergence:

1) Lowered interest rates in the US
2) Higher commodity prices
3) Appreciating RMB
4) Higher bank reserve ratio in China

1) Lowering the interest rates in the US is traditionally done for one reason: increase consumer spending. The problem with this logic in January of 2008 is that 2) Higher commodity prices have forced consumers into high levels of debt and spending based on increasingly higher cost goods. Since the last time the Fed cut rates in the early part of this decade, gas is up from an average of $1.40 (some points as low as $1.20) to $3.09 in December of 2007. 500 Kilowatt Hours (KWH) of Electricity cost you $48 in 2001. It's now up to $60 as of December 2007. Even the cost of 1 dozen eggs has jumped from $1 to $2 in that time period. ( While many other commodities, such as fruits and bread have grown in step with inflation, the energy shocks are enough to wreak havoc on our economy.

3) The steadily appreciating RMB is causing China to make leaps and bounds in two related ways: A) Slowly the Chinese are able to buy more heavy equipment from Europe, the US, Taiwan, and Japan. Simultaneously, they are quickly building new roads, infrastructure, and factories in the hinterland to keep their economy relatively competitive with poorer development manufacturing countries in south Asia (India, Pakistan, Bangladesh), Mexico, Africa, and South America. This will offset many of the price pressures that they are facing. Here's an example. We know of a factory in the western part of Shandong where they are paying workers $0.40 an hour to do the same labor that was being done 10 years ago in Shanghai or Guangzhou for an even higher hourly wage. How can this be? It is because that region is so poor, that the workers can accept that low wage and still live comfortably. Meanwhile, the central and local governments have dramatically increased the port and road infrastructure at Rizhao Port and Lianyungang Port, a mere 3 hours drive from the factory.

4) China raised the central reserve ratio for its banks to 14% last week. That's high, but not high enough. According to experts, the prediction is that they will continue to raise it until it reaches 19% later this year. What this does is reduce the amount of money that banks can loan out to their customers. This in turn reduces the amount of money to start new businesses, buy homes, and get credit cards. It makes the economy much tighter and more secure. They are doing this to prevent a meltdown in their banking system. Given the amount of cash they have in the central bank, it is going to be possible that they will not need banks to lend to continue building roads and creating factories. The central government will effectively "fill in" as projects are short on cash.

All of this has led to not only predictions of a stronger China, but as you will see in the following quotation from George Soros' speech to the World Economic Forum in Davos, Switzerland, the dollar's day as king has passed us by...

“ 'The current crisis is not only the bust that follows the housing boom, it's basically the end of a 60-year period of continuing credit expansion based on the dollar as the reserve currency,' Mr. Soros said in a debate today at the World Economic Forum in Davos, Switzerland. 'Now the rest of the world is increasingly unwilling to accumulate dollars.' The dollar's share of global foreign-exchange reserves fell to a record low of 63.8 percent in the third quarter as demand for U.S. assets waned after the collapse of the U.S. housing market, according to International Monetary Fund data. The greenback accounted for 65 percent three months earlier. The euro's share rose to 26.4 percent from 25.5 percent. IMF quarterly figures go back to 1999, the year the euro was introduced..." (Bloomberg)

Sunday, January 20, 2008

Update on China Real Estate Investment

Before I get into a succint analysis of the latest data on China's real estate market, let me first begin by saying that it is astonishing how quickly Dubai has stolen Shanghai's (and all of China's for that matter) thunder. I recently received an email from my brother that was entitled "This is what $100 Oil Can Do: Why Steel and Construction are Correlated to Oil." Lest you be scared off by that pretentious and academic-sounding title, this was no economics paper abstract. Rather, the email blasted off 25 pictures of Dubai then, now, and in the future. They included renderings of the Burj Al Ajam, a 480-meter hotel, the Burj Dubai, expected to be over 800 meters and 140 stories upon completion, the Al Burj, expected to be over 1200 meters and approach 200 stories upon completion, the Palm, the World, Trump International Hotel and Tower, Dubailand, and (in my opinion the coolest of them all), Hydropolis - the world's first underwater hotel. How they emergency exits in that are going to work is far beyond me, but hopefully the civil engineers have consulted with...I don't know - who would you consult on that? The old deep water submarine engineers?

Anyways, the bottom line is that now that much of the international real estate world's rapt attention has been taken away from Shanghai and shifted toward the Middle East, it is time for China's major markets to mature and pave the way for the second and third-tier markets to really take off.

With that, a quick comment on the first 2008 report by a major real estate broker and consultancy, none other than Colliers International ( For those of you reading this that are not familiar with the landscape in China, almost all of the major international consultancies are there. CBRichard Ellis, Jones Lang Lasalle, Cushman & Wakefield, Colliers, Savills, and Knight Frank Petty are the six majors that really dominate the foreign corporate world. There are hundreds of local brokers as is to be expected in such a major market, but the international companies really rely on this six brokerages unless they are going in with their independent real estate advisors, who no doubt will have relationships with one of these companies at least.

Now, let's tackle some of the more interesting stats that appeared in this report.

1) Beijing's office rental vacancy rate is 14.63%! That seems quite high in the buildup to the Olympics and on top of this, over 1,000,000 square feet were added in the fourth quarter alone! Maybe all of that action going on next door in Tianjin is keeping vacancy rates higher than they should be. What's more, there is another 1,200,000 square feet to come on market next year and that should lift the vacancy rate to a near 20%! By comparison, Shanghai's office vacancy rate is peaked at 7.5% in 2004 hit a nadir of below 3% in 2006, and is on the rise again and scheduled to hit 6% for 2008.

2) New residential supply in Shanghai in 2007 was estimated at a shade over 2000 units, well below 2005 and 2006 totals. However, 2008 is poised to see that total jump to nearly 4,000 units. Vacancy will remain steady around 20%.

3) Guangzhou office supply in nearly quadrupled from approximately 180,000 square meters in 2006 to over 650,000 in 2007. Although vacancy rates followed suit and approached 20% from 10% in 2006, the experts at Colliers predict a return to 12% vacancy in 2008. It only occurs in developmental years of a young economy that such gross fluctuations in capacity can be absorbed so quickly from one year to the next. That where the tremendous opportunity is.

4) The Shenzhen migration from Hong Kong continues. Shenzhen OFFICE supply is continuing to surge. In 2006, nearly 350,000 square meters of new supply can on line nearly double 2005. In 2007, supply was up another 33% to 460,000 square meters. 2008 growth should cool, but the prediction is for still another 520,000 square meters. Shenzhen RESIDENTIAL capital values also continued their surge that started in 2006. Midway through 2006, the average per square meter value of housing in Shenzhen was $1500. By the end of 2007, it was nearly $4000! Unbelievable! Colliers predicts it will level off in 2008.

5) Chengdu residential supply and demand were about even in 2006 and it looks like the same occurred in 2007 at 900 new units in each. The vacancy rate there remains quite low at 3% and should not rise above 4.5% in 2008. Average prices there are still quite modest at 13,570 per square meter.

6) Finally, it looks like Hong Kong is in for a huge increase in office supply in 2008 after a very modest 120,000 square meter increase in 2007. This year, nearly 450,000 square meters are due to come online, almost quadruple the total for 2007. Consequently, the vacancy rate is expected to more than double to 7%.

So, where would I suggest putting your money (even though my opinion for you is totally irrelevant given the clamp on foreign investment into the real estate market in China)? Of the majors mentioned here, no doubt Chengdu is the best market to be in for long-term appreciation. As for cap rates, well, most cap rates across China are quite low, averaging in the 1 - 6%, but there are great deals to be had in the Lianyungang and Rizhao Port facilities for industrial space as well as the Nanhui area of Shanghai. Finally, Tianjin is going to boom for years to come so whether you invest in one of the old houses there, new office space, or industrial, you'll do well.

Finally, I think the rush to the third tier cities is on and I have stated before that Nantong, Wuhu (Anhui Province), and Qingdao are all places you want to be looking. Finally, it is still so early to invest in Sanya, which is incredible given how nicely they've built out Yalong Bay and other parts of the city. However, the key factors there are population and employment. There are not even 1,000,000 full time residents in Sanya. In 1950, the population in Florida was 2.77 million (Floridians for Sustainable Population). Today, there are over 17 million. By 2030, there are expected to be 30 million (Census Bureau). In 1940, there were 7 million people in California. Today, there are over 35 million. And in Arizona, in 1950 the population was 750,000. Today, it's nearly 5.5 million. What those numbers show are a minimum population increase of five times over a fifty year period in warm weather climates in the United States. Now, what do you think it would take much for the population to reach 2 million in Sanya? How about 5 million? 10 million? But this is a much longer debate for a different post.

Make it a great week!