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An Overview of Real Estate in China – Scratching the Surface

by Ziv Magen on June 1, 2012 · 2 comments

  
Asian property - China

It’s a common view that Japan is considered to be Asia’s most “alien” environment, as far as cultural norms, cuisine and business/work etiquette goes – (don’t worry, we’ll get there soon ;)) –  while China, at least on the surface, seems far more familiar to the foreign investor. US nationals, in particular, feel comfortable around the Chinese, if only due to the vast amount of Chinese migrants present in the USA (as well as in almost any other country in the world) – some of them dating their original pilgrimage two, three or even five hundred years back, making them, alongside the Indians possibly, the most common and well-assimilated Asian ex-pats in almost every “western” society.

As a result, many foreigners also believe that doing business in China is a viable, profitable, easily exploitable option – after all, so many of the world’s movers and shakers have told them “That’s Where It’s All Happening Now” (whatever “it” may be, depending on the conversation and participants)– and after a lifetime of haggling over the price of vegetables with their local Chinese grocer, buying home-decor Chinese lucky charms and sampling all of the popular, familiar dishes in Chinese restaurants world-wide – venturing further and doing business with the Chinese, in China, seems like a natural choice.

The government, while (cough, cough) communist, seems to be very international business-oriented, much like the “average Chinese” one meets in the course of doing business or on the street, and the vast size of the land, its population and economy all but dictates endless opportunity for those willing to venture that far.

And, theoretically, this is all very true. There are several huge “howevers”, (however), which we’ll delve into more deeply into in the second part of this article. For now, though, let’s consider -

 

“The Numbers”

One should bear in mind that private real-estate ownership has only been allowed in China in the last dozen years or so, is government lease-based(as opposed to freeheld) for 70 years at a time, and any information regarding market performance in previous years is non-existent. Naturally, as a result, our ability to look back at historical trends and analysis is severely limited – it also means that, from a foreign investor’s perspective, China’s property market is virginal and highly volatile, for better and worse. Governmental “iron-fist” regulation has maintained a VERY steady rise in property value since late 2001 – average value up 75% in the last decade, exactly the same as in Singapore, but without the pesky and opportunistic roller-coaster dips and curves evident there – Singapore being a tiny market, any change in policy has immediate and sharp effect, whereas the sheer size and magnitude of China’s property market tends to act as a regulator for any such fluctuations, making the big picture seem far more stable when viewed from afar – this is highly misleading, however, as China’s real-estate market is beset with surprises, policy about-turns and, increasingly in the last two years, even violence and civil unrest – but more about that later.

The last two years have seen a relative plateau with a slight downwards curve, as a result of (you guessed it!) yet more government intervention, enforcing stronger financing laws regarding additional home purchases – as a result, the minimum down payment now required is 30%, banks (wholly owned by the state) do not approve mortgages for more than the first two properties purchased, and other such control measures – measures that have achieved the desired effect and slowed down price rises to a (purely temporary, in most analysts’ minds) reverse trend. These measures have, in fact, been so effective, that in the last two months sales have begun to pick up, likely due to tax reliefs and easing of limitations for home buyers.  A recent rise in borrowing interest rates (also manipulated by the government, and in sharp contrast to China’s GDP expansion slowdown) has also done its share in this artificial forced slow-down.

Rent return in the bigger cities (Shanghai, Beijing) is paltry, even compared to other metropolis’ around the world, and is now at an average of just under 3%, which many consider to be the early warning signs to the forming of a Chinese property price bubble. The only internationally recognizable spot exhibiting healthy rent returns (an average of 8-9% p/a) at this point in time seems to be the fast-developing metropolitan hub of Chengdu, in the heart of the country, and the last major city as one heads west, towards trouble-stricken Tibet.

While this doesn’t sound too good in theory, one must bear in mind that these numbers are relevant to central metropolitan centres, and all-but-new developments or close to it. Due to the size of the land and a huge variety in prices (from $50K in the more rural areas to the mid millions in the heart of the city), extensive deal-mining is possible – but watch out for local municipality taxation by-laws, and China’s infamous “land grabs” (more on that next week).

(Figures mainly taken from globalpropertyguide.com and “The Economist”, re-checked & confirmed with local industry professionals, as always)

 

The Foreign Investor

Real Estate Asia

The first procedural challenge all foreigners must deal with when considering the purchase of Chinese commercial property (residential investment property, as well, is considered commercial by Chinese law, unless owner-occupied by a legal resident) is the fact that it’s illegal for non-residents to own Chinese property. This can be circumvented by the setting up of a Chinese company (JV – Joint Venture, or WFOE – Wholly Foreign Owned Enterprise), but this requires legal and financial representation, and incurs expenses that should be taken into account beforehand.

Taxes vary across China, with different local municipalities taxing at varying rates, but general rules of thumb are –

* Income tax on rental income is normally a flat 20%

* Property tax is a whooping 12%(!) for out-right commercial property, 4% for rented-out residentials

* App. 25% in CG-related taxes (20% plus an additional 5% business tax, on all sale-related profits)

* Shanghai (pictured in it’s full smoggy glory, above and to the right) is far more investor-oriented, with app. 5% for both income and CG-related taxes

* Taxes can be further reduced for smaller residential apartments/landless properties, and with creative accounting and familarity with local taxation laws, in similar fashion to most other countries.

Again, as this is largely region-specific, local advice is highly recommended. The big cities have a multitude of English speaking financial and legal reps, but these aren’t cheap, so as with the costs related to a forming of a company, above, should be estimated and WILL affect profitable investing budget minimums.

If all of the above isn’t formidable and complex enough, it gets much more so– next week we’ll do a quick review of recent history and unique environmental issues (mostly related, as you may have already guessed, to Chinese government policies and control), speculate on what this means for future investments (aka “Crystal-balling”), and try to summarize the general pros and cons.

Looking forward to your comments!

Ziv

Images: 1- Canal in China - Dainis Matison, 2- Shanghai’s “Blue hour” – Robert S Donovan

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{ 2 comments… read them below or add one }

Chris Teed June 11, 2012 at 7:51 am

Ziv appreciate your reads on China. But I have to disagree with many of the rationales and reasons you have offered, though your bottom line is absolutely true – be very careful doing RE in China today, the rose has bloomed.
I don’t know how many BP members reside in China, I might be the only one, and given the lack of response to your well-intentioned efforts, it would appear the BP membership is secure in remaining blind on China’s RE market.
With that in mind, I will make a few quick points (between you and me).
You wrote: One should bear in mind that real-estate sales data, as well as any other type of business data, has only been made available internationally in the last dozen years or so…
This is due to the fact that private ownership of ANY real estate was only permitted then. Has nothing to do with “business data” per se
You wrote: Governmental “iron-fist” regulation has maintained a VERY steady rise in property value since late 2001 – average value up 75% in the last decade.
A property purchased on the 4th ring road of Beijing (near the edge of “downtown” in this humongous city) in 2001 could have been had for 6000/metre. In 2011 that property sold for 30,000/meter. I know because it was mine. Help me understand your math?
You wrote: …been so effective, that in the last two months prices have begun to rise again,…
Prices have not risen, or even stabalized, but sales volume has risen. This is most likely because prices have fallen notably and the government has taken steps to ease mortgage eligibility for first time owner occupied properties. Add a little dose of the Chinese still hard-fast belief that prices only rise and a pinch of help from developers (deferred down payments) and you get a jump in sales.
You Wrote: Taxes vary across China, with different local municipalities taxing at varying rates, but general rules of thumb are –
The general rule of thumb in China is all property taxes can be avoided or negated in large measure. What we have is more properly called a sales tax and the amount of which depends on the city and how “clever” your agent is. There are only two cities where what is called an annual municipal property tax in the west is levied, though it is being suggested for further roll-out.
Don’t mean to call you out on this, though expect that is how it reads. But as I am sure you know Ziv, don’t trust much of what you read about China, least from official sources, and absolutely don’t believe a word the real estate agents here say in any public way.

Reply

Ziv Magen June 11, 2012 at 10:37 pm

Hi, Chris, and many thanks for taking the time to reply with such detail – I don’t feel like I’ve been “called out” at all, I was very much hoping a Chinese ex-pat would pipe up actually, since as you well pointed out, information for the non-Chinese speaker is scarce and unreliable, and every bit of fine tuning is more than welcome in this regard, as it helps the main purpose – to educate (myself first and foremost but then also) the readers

So first off an apology, I should have delved far more deeply into why it is that property market data regarding sales and prices hasn’t been made publicly available, particularly considering China’s unique regime (unique, that is, to us, living under different philosophies in different countries) – the fact that private ownership has not been allowed in previous years was known to me (as you can probably tell from my statement that the market is virginal and volatile), but I didn’t make that connection when looking at sales data, and for that I apologize profoundly, that was sloppy of me – I’ll correct the text accordingly.

The same goes for your second comment, you’re absolutely correct, it’s sales that have picked up, and not prices yet – not sure if I misread or mistyped, but will correct this as well. Still, I believe this may very well signify the start of a new, if somewhat more moderated, rise in price. (Regardless of that, I don’t like to crystallball, and certainly not to mislead, so will amend the text at once).

As for capital gain in the last decade – while I congratulate you on the great profit made on your home equity, the fact remains that China as a whole has shown price growth of app. 75% – again, this is OVERALL and since 2001, not in Beijing particularly, and not from 2006.
To verify this (I hope Joshua approves), you can have a peek at this link – http://www.economist.com/blogs/dailychart/2011/11/global-house-prices

As I pointed out immediately after stating this number, though, and to “explain the math” of your Beijing purchase, this reflects nothing of the local price insanities that have been going on in pinpointed regions and periods of time, since the vast size of China’s population and property market acts as a regulator on the bigger picture, as evident in the link above – and while Beijing, Shanghai or any other region’s prices may differ from the larger picture, it’s exactly this (fake) moderation in the overall curve that further leads me to believe prices will continue to rise in the near future – again, this is speculation only of course, and relates to China as a whole, and not to particular regions therein, so we’re really comparing apples with apple trees, if you will – I’m not sure there’s much point to continue and argue this point.

As to how (or if, really) to purchase property in China – what you politely call “clever” agents, I call “connected” or “associated accordingly”, and someone even less polite may call “agents well placed with corrupt government officials”. I guess cleverness and total familarity with local and national laws, bylaws, loopholes and ways to create new loopholes all falls into what we’re both trying to convey to the reader, so again, I don’t really see that our thoughts are very different on that point. The same relates to taxes – I was trying to get the point across that extreme familarity with local markets and related taxation laws, which may vary greatly between regions in China, is essential to avoid the pitfalls, of which there are many. I haven’t meant to delve into the particular differences, types of taxes and/or particular regional issues, as this would require far more than the scope of this series means to , or can reasonably hope to achieve.

I hope these main points were communicated successfully (if anyone was reading ;)) – as you pointed out, this doesn’t seem to interest too many people as much as the Singapore posts – I do hope Hong Kong and Japan, which are coming up next, will be of more interest – I’d certainly feel more comfortable purchasing in Japan and Singapore, personally, so I guess I can see where they’re (not) coming from.

If you have any insights into HK, btw, I’d love to hear them, here or in private communication – an eye over my shoulder while I try to research this information, considering my limited lignuistic skills, would be much appreciated. :)

Thanks again for your comments!

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