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Significant returns still available in China
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TRADITIONAL real estate sectors in China — such as retail, office and residential — continue to find liquidity and appeal among investors.
This presumes that access and exit are clear and the institutional framework is better developed.
It is still possible to extract significant returns. However, there are niche areas that we believe enjoy the best top-down and bottom-up narratives, and in this section, we focus on several of these.
The transition toward a consumption-based economy has driven exponential growth in some real estate segments, such as retail, as the rise of the Chinese consumers creates demand for physical retail spaces.
Starting with the first iteration of roadside retail shops, progressing to humble department stores and finally moving into the era of sophisticated shopping malls with an ever-growing plethora of international brands, China’s retail sector has seen considerable progress in the past two decades.
On the retail front, a mass of decentralized retail space is expected to be completed across major cities in China.
We believe robust income growth and high propensity to consume (a rising middle class and material aspirations) will cushion the resilient leasing demand for retail space despite the surge in decentralized retail space and the recent austerity drive by the government.
The near-term fundamentals of the retail sector point to an interim period of adjustment as the outlook for rents and performance remains uncertain. While consumption growth has been resilient, there have been very obvious leakages in retail spending via e-commerce that have bypassed traditional physical retail channels.
The growth of online retailing is currently the biggest threat to the existence and survival of retailers in China, with major international retailers increasingly looking to Beijing and Shanghai, among others, as gateways for expansion.
We still believe in the long-term appeal of the retail story for China real estate, as the upgrading of consumer markets is almost a certainty, while middle class aspirations and higher wages provide a long-term impetus for spending growth.
However, this also means the operational ability of retail landlords to transit smoothly into omni-channel modes of retailing and a greater focus on experiential shopping will define the winners and losers.
It is clear that there will be more losers than winners, and the winners will no longer be taking home a bigger pot of gold.
In advanced cities such as Beijing and Shanghai, there continues to be a dearth of retail space in prime and well-established locations as reflected in the strong showing in prime rental growth.
We estimate that in China, there are currently less than 20 developer-operators with a lifetime track record of building and managing more than 10 malls. Especially in lower-tier cities, a significant proportion of retail malls are poorly designed; for example, gross floor areas in excess of 100,000 square meters, with lackluster management.
At the right entry price point, the repositioning of aging but well-located retail assets in Shanghai and Beijing is looking to be a reasonable strategy for investors with retail know-how to gain access to the retail sector in the near term.
In addition, there has been strong interest by capital seeking exposure to the niche retail sector of outlet malls.
This applies in particular to the international designer brand segment, where the structural themes of rising middle class aspirations and brand consciousness continue to drive the pent-up demand for such real estate.
The current offerings scattered across China are often sub-par and that creates a gap where landlords or investors with strong retail tenant networks will be able to benefit from these structural trends.
(This is part of a real estate research paper by UBS Asset Management.)
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