Developers Bid Adieu to First-Tier Markets

[Click for Chinese Version]

(Caixin Online) Legislators returning home in March from annual conferences in Beijing hardly had time to unpack before reports from the capital threw light on a critical issue they'd left unfinished: skyrocketing real estate prices.

This year's legislative sessions of the National People's Congress and the Chinese People's Political Consultative Conference failed to produce the kinds of government curbs for real estate sought by many consumers concerned about affordable housing and economists who've warned about runaway property bubbles.

Meanwhile, many developers reacted to the legislative inaction by finding more reason to tap real estate markets in smaller cities and turn away from China's sprawling first-tier cities – Beijing, Shanghai, Guangzhou and Shenzhen – where soaring prices have crimped business opportunities for all but the industry's dominant "land kings."

Developer interest in second-, third- and fourth-tier cities also rose a notch shortly after the legislative sessions ended when, on March 15, three state-owned developers broke land auction records with the highest bids ever in Beijing, offering a combined 12 billion yuan for three building sites.

The record bids further stoked price fears. Pan Shiyi, chairman of leading developer SOHO China, called the auctions "bizarre."

Another market twist came three days later, when the State-owned Assets and Supervision Commission (SASAC) said it had been "forced" to issue "emergency orders" to 78 state-owned enterprises (SOEs), telling them to abandon the property business. SASAC Director Li Rongrong gave the companies, for which real estate is not a focus, 15 business days to begin an orderly exit.

SASAC's step, record land auctions in Beijing, and the lack of action by national legislators are just a few of the developments pointing to trends that may strengthen the strongest real estate developers by giving them better access to resources in first-tier cities and challenge their smaller rivals.

Some say SASAC's move may have been designed to further restrict the supply of land available for development, thus intensifying a scarcity of urban development land and squeezing out all but the largest developers.

New Tiers

Even before the latest events, though, many developers were amassing property reserves in second- and third-tier cities, which include provincial capitals and regional hubs in areas such as the Yangtze River Delta, Pearl River Delta and Bohai Rim. Fourth-tier cities have attracted attention, too.

Developers are expanding land holdings as well as deploying sales teams in these new growth areas.

For example, Longfor Properties Beijing's marketing director, Wei Jian, recently relocated to Changzhou in Jiangsu Province, a third-tier city where housing demand is growing. Wei's company in January won an auction for two villa sites in Changzhou totaling 385,000 square meters by bidding 2.29 billion yuan, or 5,939 yuan per square meter.

"People in southern Jiangsu are wealthy, and urban construction is good," Wei told Caixin. "The local government is welcoming us to build there. Not only is there a branding effect, but (construction) also can stimulate local consumption."

Wei said developer competition in Changzhou is limited to regional companies. Most buildings "are constructed by local developers," he said. "There are relatively few well-known developers and high-end developments."

According to a Centaline Property report, second- and third-tier cities comprised 81 percent of the land reserved by 10 leading real estate companies last year. The companies had 41 million square meters in first-tier cities and 175 million square meters in other cities, the report said.

But even second-tier cities may be beyond the grasp for some businesses. Some developers say housing prices are already quite high relative to income levels in second-tier locales such as Hangzhou, Tianjin, Chengdu and Changsha.

"Right now, developers are looking to get into a lot of these cities, but they can't," said Pan Jun, president of developer Fantasia Holdings Group. "Only in third- and fourth-tier cities can land be acquired (at prices) that guarantee profits."

Some industry experts who have declared the country's largest markets out of control are also starting to raise similar fears in smaller urban areas.

Yi Xiaodi, CEO of the developer Sunshine 100, recently declared first-tier cities overheated and warned that fire hoses should be turned on second-tier cities before developers fan the flames higher. In third-tier cities, he noted, local governments are going all-out to attract investment and drive up housing prices.

Indeed, Yi said, bubbles are emerging and growing in different ways in cities of all sizes across the country.
 
Development Factors

Some second- and third-tier cities that sensed growth potential started building so-called "new towns" two years ago, whetting the appetites of hungry developers who are now getting busy.

One example is the Shijiazhuang City Comprehensive Project in the capital of Hebei Province. China Metallurgical Co., the parent of MCC Real Estate, last year invested 50 billion yuan in the project. MCC is participating in first-stage development, urban infrastructure and subsidized housing in Shijiazhuang's new town.

For developers, the most attractive aspect of second and third-tier cities is that local governments can offer a relaxed policy environment. But that means real estate companies have to be self-disciplined, because some may be tempted to buy large swathes of land before looking realistically at development, funding and staffing issues.

"Developers coming to second- and third-tier cities should be looking at potential and prospects, the most important of which are transportation and infrastructure construction, followed by local economic growth, income levels and purchasing power issues," said Zhong Wenhui, a China Index Academy researcher.

The rush to smaller urban areas has raised questions about possible land hoarding, as well as whether developer funding chains and management capacity are strong enough.

Ministry of Land and Resources (MLR) Chief Inspector Xu Shaoshi recently warned about the importance of overseeing real estate companies and real estate development money that's started flowing into second- and third-tier cities.

Yet some developers learned how to beat MLR's supervision system, which relies on satellite images to enforce rules against hoarding. Developers who sit on vacant land can use MLR insiders to tip them to upcoming fly-overs, then hire temporary laborers to pretend to build on the land when a satellite camera passes overhead.

"MLR's satellite can only scan one area at a time," said a lawyer familiar with the hoarding issue. Developers can find out "when they want to scan a city's land ahead of time. They send out a few vehicles and pretend to dig. Once the satellites have moved on, the vehicles are called back."

Regardless of individual tactics, developers in general appear convinced that shifting away from high-priced, first-tier cities is the next big thing for the industry.

Ren Zhiqiang, president of developer Beijing Huayuan Group, said his company in the future would focus on second- and third-tier cities. His firm was defeated in the recent mega-bidding for Beijing land, dropping out after offers soared above 10,000 yuan per square meter – prices Ren called "unaffordable."

1 yuan = 14 U.S. cents