Showing posts sorted by relevance for query beijing housing. Sort by date Show all posts
Showing posts sorted by relevance for query beijing housing. Sort by date Show all posts

Saturday, May 7, 2011

Beijing housing shortage

Typical Danwei-type housing for middle classes

Luxury housing for upper classes

Beijing is one of those boom towns that suffers from a severely constricted housing supply, despite valiant state planning efforts. Whether in a centrally planned economy or an exclusively market-driven economy, though, this is a natural occurrence that comes from rapid economic growth. Rapid growth is hard to plan for, although China has been known to build residential communities in anticipation of growth, sometimes prematurely, such as the Zhengzhou New District.

The Government is encouraging both public and private housing development in an effort to solve the housing shortage. The “which is better, Communist or capitalist housing solutions?” debate was answered a generation ago by Deng Xiaoping, Mao’s second successor and architect of the modern Chinese economic miracle, who quoted a Szechwan proverb that it matters not whether a cat is black or white; if it can catch mice, then it is a good cat. This saying particularly resounds with me, as I have a black and white cat that catches numerous rodents, brings them into the house, and then forgets to kill them. Not a good cat.

"Chairman Meow" - Feline founder of a rodent "catch and release" program -- caught outdoors, then released into the Martin household. In debating communist vs. capitalist solutions to solve housing needs, Deng Xiaoping quoted a Szechuan proverb that it matters not whether a cat is black or white; if it can catch a mouse, it is a good cat. Deng may have been right about many things, but wrong about my cat. Both black and white and catches mice, but fails to kill them. Not "a good cat". Realistically -- is this the face of a mouse-killer?

High housing prices and rents

A joint Wharton/National University of Singapore study found that housing prices increased by 225% in the last 8 years and Beijing land prices increased by 800%.

There are anecdotal reports that Beijing housing prices average 27 times annual household income. Unlike in the Western world, mortgage loans are limited to no more than 50% of value; nevertheless, additional leverage is often obtained from close relatives.

In an American city, housing prices at 27 times annual household income would be a precursor of a bubble waiting to burst, but only because American housing purchases have become highly leveraged investments in which the homeowner can quickly owe more than the house is worth, incentivizing the homeowner to walk away from his home via foreclosure, short sale, or deed in lieu of foreclosure. It’s harder for a Chinese homeowner to walk away from substantial equity or loan obligations to family members.

The Chinese housing model is less dependent upon leverage, while the family residence is considered to be the most secure asset a family can own. This environment also attracts speculators, which the Government continues to try to quell with new policies to curb housing price inflation, most recently tne "Eight National Measures" whose policies include 1) no bank financing for third home purchases, 2) minimum cash down payments of 30% for first home purchases and 60% for second home purchases, and 3) restricting home sales to only "registered residents".

The hukou system classifies citizens by their place of origin, thus limiting their mobility or restricting the right to services in the cities they move to. Preferential treatment is extended to "registered residents". It creates an almost apartheid system pitting rural vs. urban residents. The hukou system of classifying residents limits home purchases in cities with housing shortages to "registered residents" or "migrant residents" who can establish that they have lived and paid taxes in the city for at least 5 years. ("Migrant residents" have become marginalized similarly to illegal aliens in American and British societies.)

The sale of homes held less than 5 years is also taxed. The Central Bank has also raised bank reserve requirements 16 times over the last year and a half to rein in bank lending. Reserves are now required to be 21.5% of deposits.

Residential rental property investments are also priced very high, with sales prices reflecting annual gross rent multipliers exceeding 40 -- even higher than in Singapore or Hong Kong.

The China Daily reports a study by the Chinese Academy of Social Sciences that property prices in Beijing and Shanghai are 30 to 50% above market value. Their definition of market value obviously differs from that of other countries, as "market value" usually represents the price that a property would sell for under ordinary arm's length conditions, a definition commonly used in the U.S. The idea that everything is selling at above market value suggests a different definition of market value than held in the U.S.

With the Beijing housing shortage, the renter is in a particularly difficult position. One computer graphic designer explained to me that he pays about 70% of his monthly income on rent for his Beijing apartment, a rent equivalent to about $1000 USD per month, double what he was paying 5 years ago. He explains that recent college graduates often form groups of 6 or even 8 to rent one apartment, dividing the living room into individual living units.

Those who might consider Beijing housing prices to be a bubble, should take note that most bubbles collapse from falling demand or supply increases well in excess of demand, which so far does not seem to be occurring in Beijing. In American housing bubbles, one can observe that the most supply-constricted markets, such as Manhattan or San Francisco, suffer the least depreciation in economic downturns. One thing that prolongs the Chinese Bubble, too, is the lack of property taxes, which makes carrying costs low for real estate speculators. This is starting to change, now, with the cities of Shanghai and Chongqing instituting residential property taxes, with assessment rates ranging from .4% to 1.2%. This could curb speculation, although Chinese investors have few other choices of investments; Chinese stocks are considered riskier investments than housing and are down about 25% this year.

One interesting twist to the Chinese housing market is that all properties are leasehold. The residential land leases from the government are 70 years in length. As is customary with leasehold properties, improvements must be removed by the end of the lease. This creates interesting repercussions for the Chinese housing market. What happens to resale value after a few decades? Will family heirs have considerably diminished hereditary rights to housing? What resale values are possible for older homes nearing the end of their 70-year leases? It will be interesting to watch this grand housing experiment.

An answer to the overpopulation problem? -- from

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Monday, June 10, 2013

Chinese Housing Bubble

The chart below may explain the reason for seemingly contradictory reports of housing shortages vs. reports of ghost cities of empty new apartments in China. The chart, published on , shows a long-term misallocation of capital towards construction of luxury apartments, whereas affordable housing is in short supply.

In my previous post two years ago on the Beijing housing shortage, , I had spoken to a recent college graduate who described how 6 to 8 recent graduates would have to share one apartment because of the lack of affordability, yet there also media reports, including Leslie Stahl’s 60 Minutes visit to China and interview of Wang Shi, China’s biggest real estate developer, indicating thousands of empty condos in places such as Zhengzhou, Urdos and Tianjin. One memorable irony of this 60 Minutes episode was the sight of poor villagers in Zhengzhou salvaging bricks from the rubble of their modest homes, razed to build new condo towers, while empty condo towers loomed in the background. It was explained that these villagers couldn’t possibly afford the newly built high-rise residences.

In the U.S.A., the sight of so many empty condo towers was the precursor to the bankruptcy of such lenders as IndyMac Bank, whereas it is surprising to learn that in China, these empty towers are actually sold out to small investors. Middle class Chinese investors have very few investment options:

1. Put the money in the bank and earn a very low interest rate.
2. Invest in Chinese stocks traded on the Shanghai and Shenzhen exchanges, in companies that Chinese investors consider to be dodgy and dishonest. (They are restricted from investing in Chinese companies listed on the Hong Kong exchange, which are more trusted because they have to meet higher financial and reporting standards.)
3. Invest in real estate, which has always gone up in value in their lifetime.

This has led to massive investment in residential real estate, and the Chinese government has already taken steps to curb speculative demand for housing with restrictions on loan-to-value ratios for investor-owned housing and the number of units that can be owned.

Nevertheless, when so much money is sitting in empty homes with no renters, the fundamental economic law of supply and demand ultimately forces home prices lower.
Future investors will be dissuaded from investing in these homes with no prospect of income, and sales prices will decrease as a result. This is an inexorable economic law, much as the physical law of gravity, which no society can escape.

The potential result is that millions of middle class Chinese families will lose much of their wealth in an inescapable housing crash, similar to events that have already transpired in places such as the U.S., Spain and Ireland.

Sunday, May 22, 2016

The Growing Worldwide Glut of Luxury Condos

Pavilion Residences One and Two stand largely dark at night behind the successful Pavilion Shopping Mall in Kuala Lumpur's Golden Triangle, yet Phase 3 is now under construction and promises to be more luxurious, featuring serviced suites.  Were Phases 1 and 2 not good enough? Phase One is said to have been sold out to residents from 27 different nations, but few seem to live there.

In my travels in the last year I have witnessed an increasing supply of luxury residential condominium towers in cities such as New York, Boston, San Francisco, Las Vegas, Seattle, Vancouver, Beijing, Shanghai, Kuala Lumpur and my home city of Los Angeles.

In many instances, luxury condo purchases represent foreign flight capital from the upper classes of nations with changing political conditions.  South Americans, particularly Venezuelans, have been attracted to Miami, where a condo glut from 8 years ago has been fully absorbed, with new condo towers now in the works. Western Pacific Coast condos are often being bought by Chinese buyers who want to diversify their investments or feel that they lack safe investment options within China, and some who just want a safe place to store ill-gotten gains now that the Chinese government is cracking down on corruption. 

In many cases, the motivating decision to purchase a luxury condo is the relocation and preservation of capital into nations with secure property rights and stable political conditions, such as the U.S., Canada and the United Kingdom.  Under the present circumstances in Venezuela, for instance, how secure can a high-net-worth individual or family feel when there are riots in the streets and the government is socialist?

As Jonathan J. Miller, New York’s most quoted appraiser, says in the New York Times, “We’re building the equivalent of bank safe deposit boxes in the sky that buyers can put all their valuables in and rarely visit.” These absentee ownership residences become obvious in night-time skylines all over the world, where few interior lights are on in the evening (such as the Pavilion Towers in Kuala Lumpur in the top photo). When preservation of capital is their main motivation, they hesitate to rent such units out and prefer to keep them vacant.
Preservation of capital, though, should not be confused with return on capital.  Those buying luxury condos for rental income will be disappointed, as some of these cities do not have the high income professionals (e.g. Miami, Las Vegas, Vancouver, and Kuala Lumpur) to cover the carrying costs of such condos. I have seen similar disparities in Honolulu.  Tourist cities might be pleasant locations for second homes, but local incomes are generally low, as how much can the local population earn working in hotels, taxi cabs and restaurants?

For those investing for property price appreciation purposes, I fear that the world is running out of multi-millionaires to purchase the swelling inventory, and depreciation is becoming increasingly likely, eventually resulting in fire sale prices. 

What happens, too, when the home country political conditions improve, and the owners decide to repatriate their capital back to their homeland?  Who will purchase such condos at resale?  Chinese and Japanese investors, for instance, have a distinct preference for purchasing new residences, and resales of luxury residences are often marked down. (I remember when the Turnberry was the place to be in Las Vegas in 2008 and have seen considerable markdowns since then.)

The result can be tumbling condo prices, as was seen in Vancouver at the beginning of this century, when Hong Kong investors in Vancouver condos decided it was safe to return to Hong Kong, where the capitalist economy was booming, and then sold their condos in Vancouver.  Now the buyers in Vancouver are from Mainland China. 

The recent regime change in Argentina might similarly entice wealthy Argentineans to return home to a new pro-business climate now that the incompetent Fernandez dynasty of 13 years is gone.  Argentina’s new leader, Macri, made a favorable impression in a recent episode of Sixty Minutes.

Within China there has also been an overdevelopment of luxury condos, as evidenced in the accompanying chart presented by a Chinese government housing official at the MIT World Real Estate Forum last week. The vacancy rate in the luxury residences (defined as Tier 3) is increasing while there is a great need for more “Affordable Housing” (Tier 1).  One young man in Beijing told me of having to share a one bedroom apartment with 3 other graduating college classmates while searching for employment in a country which generates more than 7 million new college graduates per year.  When I attended the OPIE (Overseas Property and Immigration Exhibition) in Beijing two weeks ago, I noticed a luxury condo tower breaking ground next to my hotel, the Metropark Yuantong.

Tier 3 housing has sold well in Beijing, Shanghai, Guangzhou and Shenzhen, but not so well in lesser cities such as Xi'an, where a 27-story high-rise tower had to be recently demolished due to lack of occupancy and deterioration.
Tier 3 Condo Towers in Shanghai

For most of China’s recent history, investment options have been few for local residents, so many have bought condos as a way of saving money with hopes of capital appreciation in the future. Local bank savings accounts offer paltry interest rates, and the Chinese stock market is increasingly viewed with suspicion as Chinese corporations do not operate according to GAAP (Generally Accepted Accounting Principles), but by CRAP (Chinese Regularly Accepted Accounting Principles).


Monday, May 16, 2011

Hong Kong: Lofty Housing Prices, Low Capitalization Rates

As a global financial center, Hong Kong ranks third and is rapidly catching up with New York and London, bringing in expatriate financial workers to fuel the Asian financial expansion, as Hong Kong is clearly the financial hub of the Asia-Pacific region. Its shortage of land also has created some of the world’s highest real estate prices.

In a recent government auction of land, for instance, three sites sold for a combined price of about $700 million. Sung Hung Kai properties, for instance paid $4.49 billion Hong Kong Dollars, or about $577 million USD, for the sloping 3.63-acre former Lingnan University site, equivalent to $1160 USD psf of land or about $3650 USD per buildable square foot, as the maximum allowed buildable area is only about 180,000 square feet. Completed homes, having views due to the slope of the site, are forecasted to sell for over $5000 USD psf.

China Overseas Lands bought a 30,237sf site in Kowloon for HK$578 million, or about $74 million USD, equivalent to $2458 psf of land. They expect to build only ten houses, which will sell at a price of over $3000 USD psf. The price per buildable square foot is $1850 USD.

While these land prices might not seem high by Manhattan standards, when one considers the low density zoning, the price per buildable square foot is much higher than Manhattan.

Real estate prices have been rapidly climbing in sympathy with near-record sales prices, and a high-floor condo near Lingnan University recently raised its asking price to over $3000 USD psf, with other sellers reported to be increasing their asking prices from 10 to 30%.

The highest recent home sale, at 20 Peak Road, was HK$750 million, or almost $100 million USD, equivalent to the highest residential sale ever achieved in the U.S. The average luxury home price psf was estimated by CBRE at HK$21,351, or about $2700 USD per square foot, 14.5% higher than one year ago, and the overall residential property index jumped 24% from one year ago.

Meanwhile, just as in Beijing and Singapore, the Hong Kong government is taking extra measurements to prevent a housing price bubble fueled by speculators, instituting a 5 to 15% tax duty on residential resales within two years of purchase, and lowering LTV (loan-to-value ratios) to 50% on all non-owner-occupied residential properties, in addition to the aforementioned auction of government land (although the balance between supply and demand could have been improved with some up-zoning).

The vacancy rate for the luxury rental market was last measured by CB Richard Ellis at 1.9% and falling as highly paid financial industry workers are imported into Hong Kong.

The highest reported recent house rental was about $25,000 USD per month for a house at The Peak, and the highest flat rentals have been at about $20,000 USD per month. CBRE estimated the average rent psf for luxury flats at HK$37.70 psf, or about $4.75 USD psf. Serviced apartments, a typical housing option for a visiting expatriate, are leasing in the range of HK$44 to $57 psf per month, 13% higher than one year ago..

As for multifamily investment, unleveraged yield rates are now below 3%, fed thus far by ultra-low mortgage interest rates by local banks, lower than 1% until recently, but some lenders are now starting to raise rates, with Hong Kong Financial Secretary John Tsang warning consumers and investors not to count on cheap credit forever. Meanwhile, mortgage interest rates are also increasing in mainland China.

Is the Hong Kong housing market a bubble waiting to burst? Housing prices were actually slightly higher in 1997, before the Asian financial crisis of 1998, which was started by a real estate bubble in Thailand. This time, the Hong Kong government is doing its best to implement measures to achieve a “soft landing”, legislating conservative LTV ratios and short-term gains taxes unheard of in the United States.
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Friday, April 13, 2012

Shanghai's Lujiazui financial district and "Skyscraper Index Theory"

From left to right: Shanghai World Financial Center, Jin Mao Tower, and the intended 2073-foot Shanghai Tower under construction

The last three years has inspired debate about whether China is going through a real estate bubble. Prior to my first visit, I had read beforehand of 64 million vacant Chinese apartments and 50% office vacancy rates in Beijing and Shanghai. When I arrived in China, I did not see this, except for some vacant luxury retail malls in second-tier locations. Perhaps some of these vacancy estimates were inaccurate or even hyped to make China look foolish. Claims of 64 million vacant apartments seemed preposterous when urban Chinese people told me they couldn’t find an affordable one, but to bubble theorists I have found the following chart from Wendell Cox of (My undergraduate degree was in Geography.) If there is a surplus, it is in the construction of luxury housing, which has been built more rapidly than affordable housing.

In the most recent Jones Lang LaSalle global office space count, the picture became clearer about all that formerly vacant office space in Beijing and Shanghai – it has been leased. By JLL's measures, Shanghai and Beijing ranked first and third respectively in the global absorption of office space during 2011.

Focus on Shanghai

I recently visited the two tallest skyscrapers in Shanghai, side by side, the World Financial Center and the Jin Mao Tower, both exceeding 1300 feet in height. Both have Hyatt Hotels atop office towers each with over 75 floors of office space. The building directories both indicate almost no vacant floors.

Despite such apparent success, there has been a recent re-introduction of a “skyscraper index” theory that portends a coming recession that naturally occurs after a flurry of new “world’s tallest buildings”, a theory that has been recently re-introduced by Barclays Capital’s equity research team in Hong Kong. This theory is not meant to imply causation, but instead reasons that having so many “world’s tallest buildings” built at once is but one symptom of a significant misallocation of capital that creates asset bubbles and resultant crashes. The recently published Barclays paper points out that of the world’s skyscrapers under construction, 53% are situated in China, which will be expanding its stock of skyscrapers by 87% by year 2017.

The crane-dominated Lujiazui skyline. The trapezoidal hole at the top of the Shanghai World Financial Center is designed to reduce building sway from high winds at this 1600-foot altitude. The hole was originally designed as a circle by the Japanese developers, which was perceived unfavorably by older Chinese generations as symbolic of the "Rising Sun" emblem on the Japanese flag -- an offensive reminder of the Japanese occupation during the last century.

Origins of the "skyscraper index theory"

The “skyscraper index” theory appears to date back to a 1999 paper by Andrew Lawrence, research director for Dresdner Kleinwort Wasserstein, perhaps in response to the southeast Asian financial meltdown concurrent with the opening of the world’s new tallest buildings of the time – the Petronas Towers in Kuala Lumpur. The southeast Asian region was collapsing in debt much like the current Eurozone crisis.

Some empirical evidence consistent with the skyscraper index theory

Since the beginning of the 20th Century, there seem to be some interesting correlations.

The famous Panic of 1907 coincided with the construction of two new world’s tallest buildings in New York. The 612-foot Singer Building was completed in 1908 while the old Metropolitan Life Tower (not the one blocking Park Avenue) was completed in 1909 at a height of 700 feet. The one year Panic of 1907 led to an approximate 30% decline in business activity and the severe monetary contraction was the impetus for the creation of the Federal Reserve System.

The 791-foot Woolworth Building in New York was completed in 1913 during the two-year recession of 1913-1914 which saw an estimated 26% decline in business activity as well as a decline in personal incomes. The Woolworth Building was just one of many New York skyscrapers completed at that time.

It was not until 17 years later that three new world’s tallest buildings were completed in rapid succession – the 928-foot Bank of Manhattan Trust Building (40 Wall Street) in 1930, followed by the 1050-foot Chrysler Building later that year, followed by the 1250-foot Empire State Building completed in 1931, all while the nation was sinking into the Great Depression.

It was not until more than 40 years later that the records were shattered by the 1368-foot World Trade Center in New York, opening in 1973, and then the 1450-foot Sears Tower in Chicago, which opened in 1974 amidst the worst U.S. recession since the Great Depression. Interestingly enough, you will find no offices built between the years of 1974 and 1980 in almost any American CBD.

The world height record was not exceeded until 1998, with the opening of the 1483-foot Petronas Towers in Kuala Lumpur at a time when southeast Asia was in financial crisis.

One interesting exception to the skyscraper index theory is the opening of the 1671-foot Taipei 101 building in 2003. Economic disaster did not strike.

Last of all, there is the 2717-foot Burj Khalifa that opened in Dubai in 2010 at a time when Dubai was about to default on its sovereign debt and was rescued at the last moment by its UAE neighbors. Perhaps this is the most obvious example of misallocation of capital as this building still stands largely vacant.

What are the implications for Shanghai?

In 2007, the Shanghai World Financial Center was completed at a height of 1614 feet, exceeding the 1381-foot Jin Mao Tower next to it. More auspicious, however, is the adjacent construction of the Shanghai Tower, which will top out at 2073 feet, making it the world’s second tallest building.

It is interesting to observe that the adjacent Shanghai World Financial Center and Jin Mao towers are both fully occupied. Bubble naysayers can easily say, “Look. All that space got built and leased.” The Shanghai Tower could be a game-changer, though, according to the “skyscraper index” theory, as the bubble just got larger.

Thanks to reader Ms. Ng in Chicago for pointing out that the pavement near these skyscrapers, which were built on landfill, is actually buckling. This appears to be some ugly concrete patchwork.

Not to be outdone by Shanghai, the Greenland Financial Center under construction in the Chinese city of Wuhan is considering a redesign that will have it top out at 2087 feet. When towers are built to assuage civic egos or developer’s egos rather than meet financial measures, watch out – a bubble is in the making.

My own “L.A. freeway model” of real estate bubbles

Those of us who have had to commute to distant jobs in southern California spend a lot of time in freeway traffic and often find patterns to get to our destinations quicker. Here is one pattern I learned early on:

When traffic is moving smoothly on eight-lane freeways, one can drive fastest in the “fast lane”, the lane farthest left in societies where traffic moves on the right side of the road. However, when the volume of traffic reaches a certain saturation point, the fast lane is beset with the most sudden decelerations, causing cars behind to hit their brakes even harder, and the fast lane suddenly becomes the slowest lane. It is during these types of traffic conditions that I make the quickest progress by driving in the far right lane where traffic is entering or exiting.

Liken a fast-moving freeway lane to a fast-moving economy, and the point I make is this: the fastest growing economies experience the hardest landings, or “the most sudden decelerations”. I have witnessed it many times before – Texas in the 1980s, southern California in the early 1990s, and recent examples in Las Vegas, Phoenix and Florida. That is why I say, “Watch out, Shanghai.”

For other information or views on an impending Chinese real estate crash, check out
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Wednesday, April 11, 2012


Red Star Macalline Mall on Shanghai's northwest side, from which I took the featured interior photos

In recent posts concerning Perennial China Retail Trust, I have referred to this unique retail mall type, a mall that specializes exclusively in furniture and home furnishings to retail end-users in an attractive, upscale setting. This mall type benefits from the virtues of agglomeration similar to the success of “auto malls” in the U.S. The object is to attract the consumer wishing to make a one-stop shopping trip in furnishing a new home.
This is a property type not commonly available to retail consumers in the U.S. The closest aesthetic equivalent I can think of is Chicago’s Merchandise Mart, which serves as a wholesale showroom mall restricted to buyers from major retailers. What Red Star Macalline does is eliminate the middleman.

Red Star Macalline began as a furniture manufacturer and morphed into an innovator in the sales of home furnishings and design services within a retail mall concept, switching from being a tenant to being a landlord. Founded in the 1980s, Red Star Macalline opened its first malls in 1991 in and sales took off, crowding out the furniture retailing efforts of western furniture vendors not sufficiently attuned to the furniture shopping habits of Chinese consumers. At last count, there are now 100 Red Star Macalline Malls in China.
At a Red Star Macalline Mall, home furnishings shoppers can haggle with individual merchants and also arrange turn-key design services. This is a consumer behavior that Home Depot and La Maison were not sufficiently accustomed to, having had to close many stores in China, but Ikea keeps persevering, even building its own store adjacent to the Pudong Red Star Macalline mall, easily seen during the taxi ride into Shanghai from the airport.

Mona Lisa bedroom set. "Faux Baroque" is said to be the preferred interior decor for China's nouveau riche.

Still, such a duplicative and complementary unit mix is somewhat risky at a time when the Chinese government has been putting the brakes on home lending. Less homes sold means less furnishings sold, and the recent shareholders’ report from PCRT confirms that Shenyang Longemont Red Star Macalline Mall has had its occupancy slip from 92% to 56% for that very stated reason. Existing tenants will be consolidated in one part of the mall while a broader array of tenants will be solicited for the remainder of the mall in Shenyang.

While the Chinese government does not publish data on household incomes, the closest figure it uses to compare city wealth is GDP per capita. Shanghai leads the mainland (excluding Hong Kong, Macau and Mongolia) with $20,000 annual GDP per capita, while Shenyang has less than half, last reported as $9244 per capita.

Sofa alone is priced at over 16,000 RMB ($2500 USD)

The recent slowdown in U.S. housing had severe consequences for the home furnishings industry, with the bankruptcy of such major furniture brands as Levitz and Wickes. While the housing sales slowdown in China is government policy-induced rather than credit-induced, there may be the hope of a quicker turnaround in furniture sales if the government policy is reversed (loosening restrictions on financing and homebuying by investors and “migrants”). In the mean time, China Central Television reported that sales at some home furnishing malls in Beijing decreased by more than 30 percent year-on-year in early 2012. Some small companies were forced out of business.

Side note on the just-published PCRT shareholders’ report for the upcoming meeting

PCRT has been slightly more forthright recently in reporting “independent valuation” results, mentioning this time (in footnotes) that the CBRE valuation is actually based on the assumption that all properties are completed and fully leased. CBRE has even raised its valuation this time. But with Shenyang Red Star’s occupancy slipping so badly, what purpose does such a hypothetical valuation serve other than to mislead shareholders? Would Warren Buffett report to shareholders in such a manner? What is the main purpose of an “independent valuation” other than to be independent and uninfluenced by the very managers whose compensation will be determined by the valuation itself, as disclosed in the IPO?

More on Shanghai soon
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Friday, May 13, 2011


All photos were taken at about 1 pm on a Wednesday afternoon on a sunny day in May.

Having been an appraiser of distressed malls since 1984, I considered New South China Mall to be the Mount Everest of distressed malls. I finally got to visit this mall on May 11, 2011.

Completed in 2005, it is the world’s largest mall with leasable area of 7.1 million square feet, gross building area of 9.6 million square feet, space for 2350 stores, and a 99.5% vacancy rate.

What makes New South China Mall unique is that it has been mostly vacant in its 6 years since completion, and an inspection of the premises indicates that most of the few tenants this mall started with are now out of business. Press releases from the mall indicated that the mall had pre-leasing commitments from 1016 stores and opened with 386 stores.

New South China Mall was developed by an instant noodle billionaire, Hu Guirong, and financed with a billion-yuan loan ($154 million) from the Agricultural Bank of China, which was previously one of the Chinese government's "policy banks", banks that previously made loans based on government policy rather than on economic soundness. This was Mr. Hu's first retail development project, and perhaps he thought that once he had mastered instant noodles that he could master anything.

The mall's feasibility was supported by a study from the SMR Group in Guangzhou, which forecast 203,973 customer visits per day based on the reasoning that building the largest mall in Guandong Province would attract shoppers from as far away as Guangzhou and Shenzhen. This is analogous to building the world's largest mall in Newark, New Jersey, and expecting shoppers to come from New York and Philadelphia.

While I'm not sure if Chinese market research firms have the requisite skills to perform such a study, most feasibility studies, whether in China or the U.S., are typically ordered by developers to justify an over-reaching project and are thus not designed to be objective, any way. (Most lenders are too cheap to order feasibility studies and assume, to their detriment, that the appraiser they hire will automatically determine feasibility for them.)

The Founder Group, a high-tech company created by Beijing University, recently acquired a 50% interest in this property.

People in photo are a janitor and a security guard

Here are some of the factors that have led to the mall's failure:

The mall is situated in the city of Dongguan, 50 km south of Guangzhou and 90 km north of Shenzhen. There is no doubt that the Guangdong Province of China has experienced a population explosion, with the cities of Guangzhou, Dongguan and Shenzhen having a combined population of over 25 million residents.

Dongguan is a sprawling industrial city of 7 million residents and about 900 square miles of incorporated area, more than twice that of Los Angeles. Dongguan does not match the affluence of the cities of Shenzhen and Guangzhou, though. If Shenzhen and Guangzhou were New York and Philadelphia, for example, Dongguan would be Newark, comparing cities based on personal wealth. Annual GDP per capita is $13,750 in Guangzhou, $14,245 in Shenzhen, but only $8187 for Dongguan. Similar to Newark, too, is its reputation for a high crime rate compared to its neighbors.

Of Dongguan’s 7 million residents, 5.2 million are classified by the Government as “permanent migrants”, most of who are young women who have come from rural areas to work in factories – not the sort to hop into a BMW to search for a Louis Vuitton purse at the mall. Most do not have cars. It is estimated that 75% of these migrant workers earns less than $200 per month, and some of that is sent home to even poorer relatives.

Furthermore, the mall is located in the less affluent Wanjiang district of the city, where the factories seem to be low-tech, manufacturing things like cabinets and display shelves and using mostly unskilled labor. (This area was described as farmland at the beginning of the mall's construction in 2002 but is now a fully urbanized area.) Unlike typical U.S. urban form with dying central cities and middle class flight to the suburbs, China's urban central business districts are thriving centers of commerce, and suburbs are for factories and low income housing.

Also complicating mall feasibility is the generally low level of household income in China, estimated to range from one-tenth to one-sixth of U.S. household income (and not officially measured), and the Chinese are known as being savers, too. Too much attention has been spent on the relatively small class of nouveau riche known for its conspicuous consumption. (See my blog post on Macau.) Western-style malls are a recent arrival in China, and seem to work better in the wealthiest cities, such as Shanghai, than second-tier cities like Dongguan.

Despite Dongguan’s recent growth, there are now widespread reports that factory workers are leaving for better paying jobs in Shanghai and other high-value manufacturing cities.

"Strength-accumulating quietness"

Super-regional malls are dependent upon freeway accessibility. For instance, the 520-store Mall of America in Bloomington, Minnesota, is located near the junction of Interstate 494 and Minnesota State Highway 77. The 800-store West Edmonton Mall in Edmonton, Alberta, is located near the junction of the 2 and 216 freeways in Edmonton.

On the other hand, the highways leading to the New South China mall are tollways owned by Dongguan Development Company Ltd (not the government), with tolls ranging from 17 to 25 yuan (about $2.60 to $3.85 -- customary tolls for New York City drivers, but not for underpaid Chinese workers).

There seems to be a lack of convenient public transportation to the mall, too, considering that the mall is not in a central location and Dongguan itself is a sprawling city that has grown without the benefit of rational urban planning. Dongguan has grown without urban planning from 28 factory towns that ultimately grew into each other. With an area of 2500 square kilometers, most Dongguan residents would need to take multiple bus rides to get to the mall.

There is also an inter-city bus station with an entrance approximately one km west of the mall's entrance, but no easy pedestrian access to the mall. Even then, inter-city bus fares are typically more than $15, once again too expensive for the average area resident.

To get to the mall, I took a train from Shenzhen to central Dongguan and then took a 55-km cab ride the rest of the way, having to also pay for the cab driver's 98 yuan in tolls (about $15) for the 110 km round trip. The drivers at the taxi stand all knew about the mall, yet my driver could not find the mall when on the same street and had to call the mall several times before the phone was answered. When a local taxi driver cannot find a mall that has been the world’s largest for the last 6 years, that mall is indeed in trouble.

The mall site is mostly obscured from the main road by its high building profile (4 stories) and minimal signage. The cab driver and I almost passed the mall before realizing we had reached our destination, as the entrance, as seen in the satellite photo, is only about 100 yards wide. The only leased spaces were the ones visible from the main road through this 100-yard aperture.

No anchor tenants
There is no department store currently anchoring this mall, but the official mall web site states that the mall was originally supposed to be anchored by 1) a Causeway Bay department store of more than 400,000 square feet and 2) a KFC (?!). Other intended anchor tenants were OMOMO out of Hong Kong, OBI out of Germany, and Sundan Electronics. I do not know if these other stores ever opened.

In keeping with the mega-mall concepts of the Mall of America and the West Edmonton Mall, New South China Mall is situated around a miniature amusement park with children’s rides and canals with gondolas, like the Venetian in Las Vegas. At the time of my visit at 1 pm on a Wednesday afternoon, there were no shoppers, but several dozen school children in the amusement park. Out of about a dozen tenants, the three tenants doing business at that time were McDonald's, KFC, and Kungfu (a Chinese fast food restaurant with Bruce Lee as its emblem), all visible from the street and also patronized by amusement park patrons.

The theme park concept was said to be inspired by the success of the Window of the World theme park in Shenzhen, but Window of the World is almost 20 years old and was the original theme park in Guangdong province, which now has 40 theme parks, 12 of which were bankrupt as of 2007.

Hark! A customer approaches McDonald's, the mall's leading tenant.

Other Functional Problems

I found it odd that there were no mall maps to be found in the world's largest mall. Any other Western mall one-twentieth its size would have maps.

I was also surprised to find myself trapped inside the mall, too, when trying to exit to the interior courtyard/theme park, which means that the shops are conversely just as inaccessible from the theme park. There are too few entrances to the enclosed shopping area. There were no shoppers or open stores in the enclosed areas I visited, and the entrance to the McDonalds was closed from the interior of the mall.

The design team for New South China Mall visited more than 100 malls worldwide to collect the best design ideas, but they apparently focused only on aesthetics and not on functionality or accessibility. It is an attractive setting, with re-creations of seven different parts of the world, such as Rome, Paris, and Amsterdam, but little thought was made to how customers would find the mall or move around in it once they got there. There is a replica of L'Arc de Triomphe, though.

Retail competition
Having previously lived in America’s most Chinese city for several years (Monterey Park, California – 56% Chinese) and traveled to many Chinese destinations, I have never known a Chinese community to be under-retailed (having a lack of stores); theirs is an entrepreneurial culture. The SMR Group's feasibility study assumed the trade area to be the entire Pearl River Delta (including the larger and wealthier cities of Guangzhou, Shenzhen and Hong Kong), assuming that building the world's largest mall would effective draw away customers from the 15 other super-regional malls (more than 1 million square feet) that were built in Guangzhou and Shenzhen between 2001 and 2003, most of which also suffer from high vacancies. Could New South China Mall be way more retail space than Dongguan needs?

The failure of New South China Mall is also symbolic of a fundamental disconnect between mall development and actual income levels throughout China as empty luxury shopping malls start cluttering the nation. Household incomes are still well below those of more developed Asian states such as Singapore, Hong Kong, Taiwan, Japan and South Korea. The recent decade of mega-mall development in China reflects a naive hubris that presumes that the biggest mall will therefore attract the most shoppers.

PS: For hilarious hyperbole and misuse of the English language, be sure to visit the mall's English language web site The mall is described as "a pacemaker" (perhaps meaning "pace-setter", a pacemaker being the little machine that keeps Dick Cheney's heart from stopping), and "a grand symphonic epic with high tone of traditional wealth revolution, investment revolution, consumption revolution and leading commercial trend of the time and vogue life style",..."highly hailed by experts, scholars, authoritative media and the society, as an international commercial empire". It even discloses that some Chinese economists were initially skeptical of the feasibility of the mall, but now "South China Mall has demonstrated its elegancy and glory, and is bound to be a miracle of commercial history." That was written a while ago. Now the mall is experiencing "strength-accumulating quietness" as the mall president, Kun Liu, has announced another 200,000 square meters (2,150,000 square feet) to be developed in an effort to somehow finally give the mall the critical mass it needs to compete against smaller malls (his opinion, not mine).

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