The Rise of Residential Real Estate and China's New Districts

While there have been no official announcements made, some China observers see a new economic model rising based on revenues from property sales instead of industrial production. Fueled by a surge in housing prices and a dip in new industrial ventures, many cities in China are looking to sales of residential property, rather than inflows of foreign direct investment, as a principal source of revenue. While this model is helping to bridge a shortfall in industrial activity, relying on what many cite as a property bubble may bring its own risks.

Since the beginning of the country's economic reform in the 1980s, the primary driver of China's economic growth has been investment in manufacturing, and much of this manufacturing development was supported by government incentives provided in China's economic development and industrial zones. Because manufacturing investment was seen as a way to bring jobs and tax revenue into the community, local and provincial governments, with encouragement from the central authorities, were eager to stimulate their economies through providing incentives for manufacturing investors in economic development zones, industrial zones and other special economic zones.

The payoffs for the incentives provided in these zones came when manufacturing investments brought in jobs and tax revenue to the community. More jobs meant a richer citizenry who spent money on goods and housing (all of which brought back a certain amount of tax or land sales revenue to the government) and successful manufacturing enterprises would contribute to local coffers through taxes on profits and turnover. So by providing affordable land, stable infrastructure, and tax breaks for investors, governments were able to significantly increase their own cashflow and grow the local economy.

The Struggle to Create Integrated Communities

Particularly in the case of China's best managed economic zones, the goals of the zones' developers have been to create a balanced environment attractive to industrial investors, meaning that they provide not only industrial infrastructure, but also invest in creating commercial, retail, and residential environments in the zone that will provide the services and amenities necessary for the companies in the zone to flourish and provide an attractive quality of life for their team members.

Notably, while many industrial zones have helped to remake their communities by fostering industry and the jobs, education and other benefits that accompany it, even the most successful zones have often struggled with their residential and retail developments.

While commercially the sales of residential units in new zones or districts have been successful, a large percentage of sales have often been to out of town speculators, which has led to a glut of empty homes in prime locations. The impact of these vacancies is most often apparent in the struggles of retail developments in the zones which subsequently lack the local client base to drive their own sales.

One indicator frequently used to judge the healthiness and calculate risk of a nation's property market is to look the housing price to rent ratio. If this figure goes well about 200: 1, one likely possibility is that a housing bubble is forming. Examined by this standard, speculators investing in property markets in many Chinese cities are in danger of losing their investments overnight. The rental price for a 150 sqm apartment in Suzhou Industrial Zone varies from RMB 4000 to 5000/month while the purchase price for such apartments is around RMB1.27 million, which indicates a price/rent ratio of 317:1.

A New Model Appears

However, this model of development based on industrial investment has been disrupted during the last two years as the world economic crisis has led to an acute slowdown in capital investment for industry.

Figures from the Ministry of Commerce indicates that FDI flowing into China by July 2009 dropped by 35.7 percent compared to a year earlier, to $5.36 billion. Although this figure has started to rebound since August of last year, there was still a 10.69% drop in FDI from January to November 2009.

For many local governments, however, the revenues formerly derived from investment in industrial zones has already been replaced by revenue from sale of land for residential developments in new economic areas, new districts and other attempts at creating large-scale multi-purpose developments that combine industrial, commercial and residential development.

Residential Property Looking More Attractive

The incentive for looking to residential property sales for revenues has been created by the surge in prices for homes across China. In Shanghai, residential prices rose by more than 5% in a month during November 2009, and prices in many other communities are rising at similar rates. With apartments in district-level communities such as Kunshan selling for more than RMB 6,000 per square metre and homes in Wuxi going for as much as RMB 15,000 per square metre, the benefits for local governments to strike deals with residential developers are growing by the month.

Surging residential property prices in first-tier cities are believed to stoke developers' enthusiasm for China's second and third-tier property markets. According to Soufun. com, in 2009 China recorded 17 land deals with record transaction prices, of which 12 were in second and third-tier cities such as Chongqing, Nanjing, Ningbo and Foshan. For example, in an auction held in October 2009, Shenzhen-based Zhonghai Property Group agreed to pay a record RMB 3.82 billion for a plot of land in Nanhai district, Foshan,. With a total area of 154,780 sqm, the developer ended up paying a cost per square metre of around RMB 6495, which could push the ultimate retail pricing of the property to over 9,000 upon completion, a premium of 40% over the current market price in the area.