Shanghai land sales push commercial rates higher, the last thing the regulator wants

Implications: The recent record land sale in Shanghai's prime Nanjing Road will set a new benchmark for the city's commercial real estate market raising expectations for other developers and pushing up costs for end users. This comes at a bad time for the regulator who for the last 4 years have been issuing edict after edict aimed at slowing the market

Analysis:

Following Shanghai’s latest land sale (Rmb67,000 per sq. m. accommodation value for a site on Nanjing East Road) one can’t help but sympathize with the regulators over their efforts to restrain the property markets. They have thrown pretty much everything they can easily throw at the market and still someone is willing to place a massive bet that commercial (retail and office) space on Nanjing Road will be worth Rmb100,000 or more per sq. m. in 3 to 5 years time. I wouldn’t mind taking that bet myself, after all I have forecast residential prices to double over the next 5 years, but just imagine how disheartening this sale must be for those given the task of slowing the market down.

Truth be told, there will always someone willing to take a punt like this and historically, if we conveniently forget about 1997 to 2000 office market downturn, they have always won (jury still out on the deliriously priced Tomson Riviera). One could even argue that the nature of last downturn will not be repeated since it was supply led and any new oversupply will have less effect on a mature that the last glut did on an immature and much smaller market. A future market downturn must surely be led by economic factors but no one seriously mentions China and economic recession in one sentence. Not such a crazy gamble perhaps.

If the developer chooses to lease the building, after allowing for construction, tax and contingencies on top of the land cost and assuming average rental income of Rmb10 per sq. m. per day (today’s prices) I calculate a return of 4% based on developers cost including financing on 50% of cost. If he chooses to sell, based on a completed sales price of Rmb100,000 per sq. m., which is more or less double today’s prices, my envelope spits out an after tax return of 8% which increases to 16.5% if he finances out of his own equity, although this of course excludes opportunity cost. The developers gamble of course is that the upside is stronger and presumably higher than can currently be imagined by anyone else in the bidding hall.

This auction result does achieve two other things however. It goes someway to answering the fears mooted some months ago of a Japan like meltdown affecting China, prices will have to see their way to late 1980’s Tokyo levels first, this auction result says they are on course to do that. The other thing it has achieved is to put the ball firmly back in the regulators court.

As an isolated case none of this need matter, except for the fact that every other landlord in town has taken note and shifted their prices up citing this land sale as the new benchmark. Suddenly a building in Huangpu that was asking Rmb30,000 per sq. m. last week was no longer for sale this week. Some of the commentary has been interesting, in case you missed it: ‘flour more expensive than bread’ was one comment which sums it up rather nicely, while another was reported as saying ‘it gives the commercial market a shot in the arm.’ Commercial space is expensive enough in Shanghai already and that’s before it has gone through the roof, up into the sky and into the stratosphere. ‘Messes up everything for everyone else’ is what I say.