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One of the most oft-used strategies amongst major property developers in the past year has been to acquire land, get financing from the capital markets, and then to acquire more land. Stanley & Partners Investment Management Co., Ltds most recent report shows that since the beginning of 2007, only a few developers have invested in reserved land banks in second and third-tier cities, with a total investment amount of 120 billion RMB in over 20 million m2 of land.
However, the industrys situation has seen certain changes recently, with the aforementioned strategy ending up as a death-knell for many developers, stranding the already-invested capital in these second and third tier cities.
Rearranging the Cards
The 120 billion RMB invested in and 20 million m2 of reserved land banks reported by Stanley & Partners report only accounts for larger, national-level property developers such as Vanke, Greenland, Sino-Ocean Land and international investors such as Capitaland, Goldman Sachs, and Singapores Guoco; which are only a small portion of the countrys developers.
The report indicates that 55% of the second and third tier city land banks were concentrated in Chongqing, Chengdu, Hangzhou, Wuhan, and Shenyang. 60% of the developers involved were major domestic brand-name developers, including Gemdale, Vanke, and Country Garden. A further 30% were Hong Kong developers. Most of the remaining 10% overseas developers were Singaporean.
Many developers that have entered second and third tier cities cite a couple similar motivating reasons: too much competition in first tier cities causing incredibly high land costs; greater room for growth in second and third tier cities with their strong economic development and the increased purchasing power of their citizens; faster development and growth; constant improvements in infrastructure, attractive government policies, and a less mature market with less competition.
The second and third tier cities previously referred to include Chengdu, Tianjin, Wuxi, Nanjing, Changchun, Guiyang, Lanzhou, Shaoxing, and Xian; covering the entire nation.
Stanley & Partners Samson Chan commented, As the economies of these cities have continued to grow, many developers have also began to expand the range of their land acquisitions. Lanzhou, Xian, Guizhou have all become major markets for these developers. Most of these developers choose to acquire land on the primary markets through an auction process. Some developers, however, will prefer to buy land through stock acquisitions of project companies.
When asked about the motivation to enter second and third tier cities, many officials in large-scale property companies answered that the competition in first-tier markets is becoming far too strong, pushing land costs too high. Moreover, second and third tier cities have greater room for development, with increasing activity and strength in their economies. Also, development speed is much faster in these cities, with greater market potential and expansion. Other reasons include, the attention on infrastructure development, the friendlier government policies, and the weaker competition.
The report also stated that average profit margins in second and third tier cities could reach 30%, while in first tier cities it could only reach 15%. The search for profit maximization will naturally lead capital to enter second and third tier cities. Often, developers dont adjust to the markets movements fast enough.
120 billion compared to the capital developers have in store for second and third tier cities is just the tip of the iceberg. The actual number should be many times greater than 120 billion, remarked Shanghai Shengji Groups president, Zhu Yong Ming.
Stay First-Tier, Forgo Second, Third Tier?
Samson Chan commented that once everybody began to focus on second and third tier cities, the competition would also naturally increase, becoming a hidden risk to the entire market.
Stanley & Partners predicts that the new entries into the second and third tier markets by both national and international developers and investors will rearrange the markets current make-up. With the increased competition as movement away from first-tier cities into second and third tier cities becomes the norm, smaller companies will inevitably get muscled out of the market.
Currently, Everbright Securities research teams analytical investigation of Jiangxis Nanchang market indicates that the Nanchang market is a good representative of all second and third tier city markets, with 2007s enormous growth putting significant pressure down on the supply side, possibly delaying a full market recovery.
Before 2007, Nanchangs residential market had been in a steady expansion phase. Then 2007 saw a 50% explosion in sales volume growth, with average prices rising 22%. With the credit crisis, the market in the last quarter of 2007 was mostly frozen. But since Marchs traditionally active sales season, parts of the center city have begun to show higher sales. Still, this years first quarter, primary market sales were considerably less than the same quarter in 2007. Marchs sales volume was only half of March 2006s. The markets recovery may have to wait until 2009.
The situation isnt isolated to Nanchang however. Large developers in all second and third tier cities who have swallowed up land at peak prices have to question these markets. Many developers have stopped swiftly acquiring new land reserves, focusing instead on dealing with the land they already have on hand.
Stanley & Partners reports that the entry of new real estate capital into the markets will increase the competition in these second and third tier cities. The real estate congestion will only cause land and house prices to rise faster. And since the markets are limited in their capacity, projects will most likely come across difficulties in sales.
At the same time, second and third tier cities still cannot be considered mature. Local regulations are constantly changing, and developers from other cities may encounter management risks. At the beginning, they may have met with very friendly government support, but now, local political attitudes might no longer promise the same enthusiasm. For example, Zhejiangs Dmegc property developer company ran into unacceptable government conditions in Jiangxis Jiujiang when auctioning for a project.
Some major developers claim that under the current pressures, not a small amount of real estate companies will be choosing to stay in first tier cities and abandoning hopes in the second and third tier, a turn of events that escalate the crisis in those markets even further.
--------Century 21 Economic Report |
