KEY POINTS
- The urban landscape of Tier II cities is being transformed to meet international standards.
- Location, income level, and core industries will give certain cities more opportunities than others.
- Each Tier II market is different and must be understood qualitatively before statistical metrics can be applied.
A fundamental shift has occurred in the China property market over the past couple of years as investors and developers have begun looking towards Tier II cities for new opportunities. This trend has been expected as an inevitable step in the country’s macro-level development, but what seems less certain is the precise pace and manner in which each interior market will develop. In fact, not only can different cities be at different phases of maturity, but different sectors within a particular city may be at different phases of maturity relative to the Tier II market as a whole (Figure 1). To help the prospective developer make more sense of what is indeed a very heterogeneous market, certain key opportunities are identified for the high-end residential, Grade A office, and prime retail sectors.
Relative States of Tier-II Markets
| High-End Residential |
High Cost |
Nanjing, Hangzhou, Dalian |
| Middle Cost |
Tianjin, Qingdao, Chongqing, Wuhan, Chengdu |
| Low Cost |
Shenyang, Changsha |
| Grade A Office |
Rising Cost |
Hangzhou, Nanjing, Chongqing, Xi'an, Dalian, Chengdu, Qingdao, Tianjin |
| Low Cost |
Shenyang, Wuhan, Changsha |
| Prime Retail |
More mature |
Nanjing, Wuhan, Hangzhou, Shenyang, Dalian |
| Less mature |
Qingdao, Changsha, Tianjin, Chengdu, Xi'an, Chongqing |
Source: Jones Lang LaSalle
High-End ResidentialResidential construction has been fierce across China. Nationwide, the total sold area of commodity housing for the first five months of 2007 rose by 15.2% compared to the same period a year ago. A number of important drivers have contributed to this trend: migration to urban areas, the desire of increasingly affluent Chinese to upgrade their living environs, and new infrastructure and growing car ownership that has improved accessibility to commuting neighbourhoods.
Dalian exhibits these trends clearly. Demand has been so strong that the amount of residential floor space sold exceeded that which was completed in both 2004 and 2005. Capital values have increased steadily in the last couple of years, and average transaction prices have already surpassed RMB 10,000 per sqm in the Xinghai, Hutan and Fujiazhuang districts of the city. The city’s reputation for having the best living environment in Northeast China and its popularity with Korean and Japanese businessmen bode well for the continued expansion of its luxury residential market.
Similarly, Chengdu and Hangzhou also enjoy strong reputations for offering some of the best living environments in their respective regions. Chengdu saw a 22% rise in capital values between 2005 and 2006, and rents have been increasing for the past couple of years as foreign workers follow MNCs into the city. For Hangzhou, the draw is multi-faceted: not only is the city famed for its natural scenery, it also boasts an enviable location near Shanghai and is the provincial capital of Zhejiang, the the province with the highest per capita disposable income in China. If the currently stalled magnetic levitation railway project connecting Hangzhou and Shanghai sees completion, Hangzhou will become a possible bedroom community for wealthy workers in Shanghai.
Changsha is also a strong opportunity that shows many indications of flowering. Due to its location between the regional hubs of Wuhan in the east and Chongqing in the west, Changsha has not attracted a great deal of high-end residential development in the past few years; however, as developers move towards new markets, Changsha should stand to benefit greatly. Some important factors to keep in mind about the city’s residential market include the over 10% price appreciation in each quarter of 1H07, the relatively low quality of the current high-end stock, and the relatively low ratio of average high-end housing price to annual household disposable income. Although some large projects are planned, few will be competing for market share in the next three years.
Grade A Office
The prime grade office market in Tier II cities in China began at roughly the same time as the growth in high-end residential development. Driven by attention from big-time developers, the entrance of MNCs, and the push by local city governments to create more attractive CBDs, the Grade A office market has taken root in some Tier II cities and is expected to expand rapidly in the coming years (Figure 2). Growth, however, is expected to be unevenly distributed, as the large corporations that demand Grade A quality will tend to cluster around certain cities.
Figure 2: Office Supply Statistics
Source: Jones Lang LaSalle
Figure 3: Tier II office Rent Range
|
RMB/sqm/mo on GFA
|
Starting Number
|
Height of Blue bars
|
|
Shanghai
|
188
|
148
|
|
Shenzhen
|
120
|
40
|
|
Chengdu
|
80
|
60
|
|
Tianjin
|
72
|
69
|
|
Nanjing
|
97
|
40
|
|
Qingdao
|
96
|
24
|
|
Hangzhou
|
91
|
59
|
|
Xi'An
|
85
|
55
|
|
Dalian
|
75
|
70
|
|
Chongqing
|
70
|
90
|
|
Shenyang
|
65
|
55
|
|
Suzhou
|
65
|
20
|
|
Wuhan
|
50
|
20
|
|
Changsha
|
40
|
20
|
Source: Jones Lang LaSalle
One example of a market with potentially healthy growth is Dalian. While overall ‘local Grade A’ vacancy is currently about 26%, vacancy rates for the best buildings are under 10% due to the strong demand for ‘true Grade A’ space. The rental range and top-level rents in Dalian (Figure 3) are competitive in comparison to other cities’. Because of the recent focus on developing the Dalian Hi-Tech Industrial Zone outside the city, the majority of current ‘local Grade A’ stock originates from before 2004. Incoming MNCs that want to locate in the downtown area often face a choice between settling for Grade B quality offices or setting up away from the city center. A true Grade A development would receive strong demand, given that the city is considered highly desirable for its good port and welcoming natural environment, in addition to being a popular stronghold of Korean and Japanese firms looking to do business in China.
Changsha is a smaller market, but offers a good opportunity nonetheless due to the early stage of its Grade A office market development. As of mid-2007, there are only eight buildings that can be considered suitable for ‘Grade A’ designation, and the market is only about half the size of some of its Tier II peers. Demand, however, has risen steadily as MNCs have begun moving into China’s interior, and occupancy is forecasted to remain between 80% and 90% over the next couple of years. Since Changsha has begun building a core precinct around financial services and real estate firms and is considered to be one of the next targets for expanding MNCs, it is expected that there will be continued demand for Grade A space in the years to come.
Prime Retail
As disposable incomes rise and more luxury brands enter the regional markets of China, many of the Tier II cities will devote a greater portion of centrally-located land to retail space, encourage the growth of suburban shopping centers, or re-develop current retail areas to meet a higher standard. Thus, the retail sector is expected to undergo significant change, especially as the ‘shopping mall’ layout becomes more commonplace.
Figure 4: City Map
Source: Jones Lang LaSalle
Among the Tier II cities, Wuhan stands out as one of the well-primed locations to benefit from retail development. Although there are currently no true shopping malls in the city, Wuhan’s department stores enjoy prodigious amounts of foot traffic and are concentrated enough to provide a similar effect. Along Jiefang Avenue, for example, five large-scale department stores exist within 2,000 meters of each other. Although total prime retail space is expected to double by 2010, occupancy is still expected to be close to 90%, and rents are expected to rise by 10% y-o-y. In addition, there is plenty of room for growth both in the Wuchang CBD area, an aging but still popular neighborhood with few currently planned projects, and in the Wangjiadun area, a currently vacant former airfield proposed by the city government as the core of the city’s new CBD. Considering the current paucity of luxury brands in Wuhan relative to Tier I cities or even some Tier II peers, future demand for retail space in the city is expected to be robust.
Chengdu also offers a good opportunity due to its strong strategic location as the retail hub of south-western China. As the entry point into that part of the country for many international brands, Chengdu currently attracts luxury consumers not only from its own province, Sichuan, but also from Kunming, Chongqing, and many other cities in the west. While competition may be fierce with nine shopping malls being built since 2004 and the entrance of developers like Wanda Group and CapitaLand into the market, many of the new retail properties are not considered to have the highest quality construction or management, leaving room for top-notch developers who can position their products effectively.
Figure 5: Chengdu Fortune Centre Photo
Picture: Jones Lang LaSalle
Conclusion
In the past few years, Tier II real estate markets in China have finally launched into their long-awaited transformative phase. The rise in rents and capital values in spite of the large supply increase indicates that demand is very robust at the moment. But while the rising macroeconomic tide is likely to reach each city in China eventually, it most certainly will not do so evenly. The cities mentioned in this report are a sample of the sorts of opportunities in the current market that merit some consideration from developers. The list is not exhaustive, but it should provide a starting point for understanding the nature of some Tier II markets and help lay down the first step towards earning those sought-after profits.
Report by Weijia Yu - Jones Lang LaSalle
Last update : Friday, 19 October 2007
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