Navigating China’s Real Estate Sector

This article was published in the summer 2024 edition of the German Chamber Ticker. Read the full issue online here.

By Bjarne Bauer, SIOR , Managing Partner China at NAI Sofia Group Shanghai .

For the first time in over 30 years, China’s residential property market is experiencing an extended nationwide downturn. The retail, office, hotel and even industrial property sectors have been affected as well, although the extent of their respective downturns is mixed.

The changes are partly caused by a broader economic slowdown that is impacting the profits of many foreign businesses, making it all the more important for companies to seize opportunities and dodge potential dangers that the property market is creating.

China’s Real Estate Crisis: How We Got Here?

Residential prices have dropped chiefly because of excessive new supply coming to market in many regions, as well as government efforts to cool down the sector. The most forceful of the latter was the “Three Red Lines” policy of 2020, which pushed most major developers into a state of severe financial distress or outright bankruptcy.

As a result, some developers became unable to complete projects where units had been pre-sold, and a sense of unease spread among potential homebuyers. Meanwhile, pandemic-induced economic uncertainty and geopolitical tensions further dampened homebuyer appetites.

Home prices finally slowed their decades-long rise and began to drop in many cities, as reflected in the chart above. The figures show the national average price dropping slightly, and a more pronounced drop in Shanghai, where for decades the notion of a sustained drop in prices was deemed impossible.

The New Office and Retail Markets?

The current downturn in the national economy is also affecting demand for office space to some degree, but the primary reason why office rents and prices have flatlined, or, in many places, dropped, is excess new supply. Shanghai, for instance, added 1.106 million square meters of new office space in 2023, a year-on-year increase of about 30% (NAI Sofia Group, 2023).

In some districts in Shanghai, drops in office purchase prices have been more dramatic than drops in rents, as?factors such as capital access barriers and a murkier overall economic outlook play a role.

These new price trends have set off a fierce battle among landlords to retain existing tenants and attract new ones. Their chief weapon is offering meaningful and sometimes imaginative incentives: Longer rent-free periods, lower renewal increases, units custom designed to tenant specifications and fully furnished, and so on.

Demand for retail real estate, meanwhile, remains strong, generated chiefly by segments such as F&B, entertainment and education, while classical retail – apparel, cosmetics, accessories – has largely moved online. However, as in the office market, supply has outpaced demand in many areas, and retailers of all types are being impacted by the economic slowdown.

Another trend in retail consumption with potential real estate implications is the “trading down” phenomenon, where consumers are turning to cheaper options within a product category. This may have arisen out of?economic necessity, but it also has cultural roots, with sentiments such as “Save resources, save the environment”, “Be patriotic and buy domestic”, or “Invest in experiences rather than items” becoming widespread and seeming to echo the post-materialism of 1990s Western Europe.

Industrial Property Market Relatively Stable

Comparatively, owners of industrial real estate are doing well, with both factory rents and purchase rates rising in most cities, at least in prosperous provinces such as Guangdong, Zhejiang, Shanghai, Jiangsu and Beijing.

The picture is more mixed when it comes to logistics properties. The darlings of investors for the past several years, they’re now feeling the downward pressure on their purchase prices and rents, because of new competition in many areas of the country.

Despite the buoyancy in industrial property prices, the larger economic slowdown means that local governments are under intense?pressure to attract foreign investment for tax generation, job creation, and overall economic activity. As a result, some local governments and landlords are offering unprecedentedly generous incentives.

Strategies for the New Era?

In most of China’s commercial real estate market, conditions now favor occupiers over landlords. As such, it is often possible for the former to win not just a cheaper rent or purchase price, but significant material concessions as well. What tenants can ask for depends on the business and property in question, but examples include: The right to expand into neighboring units, the right to extend the contract, a commitment to install additional electrical capacity later on, if needed, etc. The old saying “Those who don’t ask, don’t receive” should be kept in mind.

The current situation provides great opportunities for German manufacturers as potential anchor tenants, benefiting both landlords and local governments. The landlord may have a KPI for a certain amount of tax?generation, and the local government may have a KPI to meet for the amount of new foreign direct investment. Both will likely see the German firm as a magnet to attract other high-quality manufacturers, especially to a new industrial park, and thus be willing to offer significant support: A free shuttle bus for one’s staff perhaps, an additional designated entrance to the park, or paying for an expensive new power transformer station. Retailers might wish to consider whether the “trading down” trend has any pertinence to their property choices – could a smaller and simpler space actually be more appealing to consumers? After all, some of the most elite luxury brands deliberately sell their wares in tiny, inconspicuous shops, the lack of ostentation being central to their image.

Dodging a New Danger?

Many of China’s developers and landlords are now under considerable financial strain, and tenants must be aware that?their landlords may become unable or unwilling to properly maintain their buildings.

If a tenant believes such an event is possible, it would be wise to prepare by limiting investments in renovations and upgrades, and having a plan B ready in case of sudden lease termination. If possible, it is also advised to pay one month’s commission instead of the usual three.

Examples of Recent Tenant Benefits in China?

To illustrate the benefits that tenants can now expect, below are three cases among NAI Sofia’s recent projects.

1. ?A large company rented a 40,000m2 manufacturing space. The local government agreed to subsidize 75% of real estate costs for the first 10 years. It is also helping to cover the costs of equipment and relocation through tax incentives and other policies.
2. A Mittelstand company rented a 3,000m2 assembly space. The government is subsidizing the real estate cost by 50% for the first eight years, contributing to equipment purchases, and providing other preferential treatment.
3. A trading services company rented around 600 m2 within Shanghai’s inner ring road. The government support is minimal in this case and the floor area of the new space is slightly smaller, but the company benefited from accessing a nicer, more centrally located building with direct access to the metro at a lower rental rate than what it had been paying. Additionally, the landlord agreed to a prolonged rent-free period of eight months.

Affordable Housing: New Opportunity?

Every nation has its own approach to ensuring affordable housing for lower- income earners. In the US and Europe, where governments tend to prefer free market solutions, one recent trend is the development of co-living spaces, where young urban professionals take up tiny units for rent and then share many community spaces, kitchens and living rooms. In Singapore, where, according to its Housing and Development Board, 77% of residents live in public housing, the government actively develops and subsidizes housing for people in lower-income brackets. China has recently started to experiment with a concept that is something of a combination of both, with a twist: Affordable apartment units that cannot be bought but only rented. Developers that invest in building this type of project are allowed to do so on industrial land, which, at only 2%-5% of the cost of residential land, makes attractive profits a possibility for developers.

What the Future Holds for German Construction in China?

Of all the German companies in China, the most affected by the big changes in the real estate landscape are suppliers to the construction industry. While the new affordable housing projects mentioned above may represent one area of future growth?for them, at this point, construction activity is still believed to be down by about 50% overall — a massive blow to their revenue.

With fewer opportunities for new real estate projects, suppliers will likely want to refocus their marketing efforts on promoting property upgrade activities such as renovations, energy-efficiency projects, building safety and well-being enhancements, and so on. In the past, German suppliers may have viewed these areas as secondary market segments for their business, but now they may become their lifeline.

Bjarne Bauer, SIOR serves as the Managing Partner in China at NAI Sofia Group Shanghai. He has been working in the commercial real estate industry for 23 years: Four in Germany and 19 in China. During this time, he has successfully negotiated over 300 factory and office acquisitions, including some purchases and many leases. Bjarne can be reached at +86 21 6230 1919 ext. 808, or at [email protected]

NAI Global is a global commercial real estate brokerage firm with more than 300 offices worldwide.

The German Chamber Ticker is the business journal of the German Chamber of Commerce in China. This free English language?magazine is published four times a year and features quality content from member companies and those with Sino-German expertise. Readers benefit from practical and in-depth cover stories, features and op-eds on a range of economic, social, technological, environmental and governance topics. The Ticker has a readership of over 35,000.

The Ticker is prepared by the German Chamber's communications team.