October 8, 2013
Interviewed by: David Snow
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Housing Demand Drives Opportunity in China

The demand for middle-class housing in China is huge, but how can foreign capital take part in creating supply? Experts from Beijing and Dallas-based Century Bridge explain how the Chinese government actively encourages foreign capital in the housing sector, why second-tier cities are so different from Beijing and Shanghai, and why the scope of China’s housing opportunity is staggering.

The demand for middle-class housing in China is huge, but how can foreign capital take part in creating supply? Experts from Beijing and Dallas-based Century Bridge explain how the Chinese government actively encourages foreign capital in the housing sector, why second-tier cities are so different from Beijing and Shanghai, and why the scope of China’s housing opportunity is staggering.

Housing Demands Drives Opportunity in China

Residential Real Estate in China

David Snow, Privcap:

Today, we are joined by Tom Delatour, Deng Wei, and Jeff Tucker of Century Bridge Capital based in Beijing. Gentlemen, welcome to the program today. Thanks for being here.

All of you have spent a long time studying and investing in the Chinese residential real estate market. I’m fascinated to hear your overview of that opportunity, starting with Tom. Can we start out by painting a picture of the scope of the opportunity to invest in China’s demand for residential real estate?

Tom Delatour, 

Co-Founder, CEO, Century Bridge Capital:

The key in China, and this would be for any industry, is the growth of the middle class in China. That’s the real story. What interested us in the beginning and when we first came to China in 2006 is still consistent, and the fact that there’s a tremendous pent-up demand for housing that the middle class can afford. To give you an idea of the scope and size, 2010, 11, 12, and 2013 and even larger is you’re having over ten million units being sold every year.

Now that’s a staggering number. In the United States, a million and a half units a year would be a big number. When you look at research, depending on whose research you believe and there’s a lot out there, no matter who you look at, there’s tens of millions of Chinese households that can afford middle class housing that still live in government issued housing. You have tremendous pent-up demand. Of course, you still have the growth of the middle class that’s ongoing and the urbanization of China. So at 35,000 feet, that’s the scope of what’s going on in China today.

Snow: A follow-up question for Wei Deng, is there’s a difference in demand as you go to different parts of the country? For example, in a top-tier city like Shanghai, does the demand for housing look different than in a second-tier city?

Wei Deng, 

President, Century Bridge Capital:

Yes, if you talk about first-tier cities like Beijing, Shanghai, gradually, after ten years development, there is demand for luxury units. We call it authentic demand. But if you go to second-tier cities, the housing market is still in the early stage. More people demand for smaller units, so organic demand is in the dormitory sector.

Delatour: I could add onto another fact that might be helpful for the audience who are not as familiar with China. In the tier-two cities, basically we’re going to exclude Shanghai, Beijing, and Xinjiang. There is a group of approximately 40 cities that are approximately five to 12 million in size population. From 2006 to 2010, the housing prices in those markets grew an average of about 11.9% per year.

Household income grew at 13.1%. So during that time period, housing prices stayed the same affordability or slightly improved, where in Beijing, Shanghai, places like that, that was not the case. Housing prices were going up much faster. Since regulations have been put in place, the pricing has grown more in the single digits where household income has continued to grow in the double digits. There is tremendous demand in those cities. About 90% of the buyers in those cities are owner occupants, so they were never really heavily impacted by the investors like Shanghai and Beijing were.

Snow: One aspect of China that Western investors have the most difficulty getting their hands around is the role of the government. Can you talk a bit about what role the government is having in the ability to invest in residential assets or even the propping up of the demand for residential real estate in China?

Delatour: Let me jump in and adjust one question: The Chinese government does not need to prop up demand for residential. What they really need to do is encourage supply of residential. In that regard, they very much encourage developers to build housing that the middle class can afford. One example is a regulation that when you build a project, 70% of your units need to be 90 square meters or less so it can be affordable. There are many other regulations and Deng Wei, would you like to address some of those?

Deng: Prior to 2008, any foreign investment was welcome to the real estate business or real estate industry. But as Tom mentioned, if your money comes into the construction sector then it’s always welcome. After year 2008, 2009 in those times, the government realized that demand on the residential product or demand for office properties could raise the price higher and higher. The government started to discourage investment on the purchasing side. If you continue to invest in the construction partnered with local developers or put your money directly into the supplier side, then you’re always welcome.

Snow: All of you have been involved in vetting opportunities and also seeing firsthand the demand for housing in China. Do any anecdotes spring to mind of the sale of developments or just scenes that you’ve seen across China that would be illustrative of this demand?

Jeffrey Tucker, 

COO, Century Bridge Capital:

I think one thing that surprises people, particularly people who are making their first trip to China and if they venture outside of Shanghai and Beijing and go to one of the tier-two or tier-three cities, I think they’re amazed at the scale of these cities. I remember my first trip to Xi’an seven years ago and said how is it that there’s a city with eight and a half million people and I’ve never heard of it until now? It can be a bit daunting, but within those cities, the scale the developments, whether they be of any type, mixed use or in our case residential middle class projects, the scale is astounding

Snow: Let me ask another question about the government’s role. Are there different incentives or different, I guess friendly regulatory regimes in place at the national as well as at local levels that are supportive of the kinds of investing that you do?

Deng: You can tell central government manages the overall level of foreign capital that comes into the market. They always have certain controls. At the local level, or at the provincial government or city government, they always welcome foreign capital to come into their areas, regardless of which sector. That’s why you can tell that the second-tier cities, foreign capital comes into the city from an administrative standpoint. Local government always makes it easier, always have the green light for different sectors.

Delatour: Let me re-emphasize a point that Deng Wei had made earlier. It’s the type of investment that dictates whether you have government support or government disapproval, so to speak. One of the keys is if you’re doing a product type the government wants, as Deng Wei said, providing more supply of middle class housing, then the whole process of coming in, getting your approvals, going through the process, is just an administrative process and they encourage that type of investment.

Tucker: To make a third point. Talking about the regulatory environment, our experience over seven years has been that the government has been very consistent in the way they’ve implemented regulations. They tend to telegraph what they’re thinking about doing well in advance. You have time to plan. These are not arbitrarily enacted and enforced types of regulations. Our experience, particular operating in the middle class residential sector in the tier-two cities has been the government has been very consistent. The regulations that they’ve introduced, particularly since 2010, have all been good for the market.

Snow: What signs do you think you or regulators will be watching to see whether or not these secondary cities might reach a point of perhaps over-speculation or overheated demand? Are there certain signs that you’re following carefully to make sure you’re not bumping into that?

Tucker: We pay a lot of close attention to that relationship between price growth and disposable income growth. The other thing that Tom mentioned earlier that we pay a lot of attention to is the percentage of owner occupants in a market. When we’re going into a market, we look at what percentage are owner occupants based on organic demand versus speculative buyers? We look at it on city level and then down at the sub-market level as well. That’s an important metric.

Deng: There are some cultural things behind this demand for product in Beijing and Shanghai. The goals of Beijing and Shanghai are to be world-class cities. Over the long-term, a lot of rich people, rich Chinese people will want to own something in Beijing or Shanghai. They don’t necessarily use those products. They don’t necessarily live in Beijing and Shanghai but they can be very, very proud to tell other people that I own an apartment, a unit. That kind of speculative or investment demand that helps drive the market price higher and higher. That’s not necessarily healthy to us as a long-term investor.

Snow: There aren’t trophy apartment buyers in Xi’an?

Tucker: Very few.

Snow: Let me ask one final follow-up question that has to do with the foreign capital. Perhaps, some external observers of the Chinese market might think that there might be different rules for foreigners as there would be for local investors. Should anyone be concerned that the rule of law might not apply to any entanglements that foreign capital might get into versus local players?

Delatour: China definitely has laws in the real estate sector. They’re straightforward. Now that doesn’t mean that domestic equity and foreign equity don’t have some different laws because there are. You have to have approvals to bring your equity into the country and you have to have an approval process to take it out. Basically, the approval process to take it out is to show that you’ve paid your income taxes on those earnings, which is fair.

Deng: For us, we just need to learn the procedures, the rules, and then follow them. There are experiences, accumulated from practicing investment. So we learn that, we know ahead of time which step could be difficult when we deal with our partners. In general, there are differences in terms of the requirements of foreign capital and local equity money. We know our advantages and we understand how local developers play on their own equity shares in our deal structures. As long as we can deal with it, overall, we can play on the same level.

Delatour: I’ll add one thing. I don’t think most people realize that the Chinese government actually encourages foreign investment in China, in areas that they want. What we’ve experienced is, after we’ve invested in a project in a city in China, you’ll get a response back from government officials thanking you for the foreign equity because you are building middle class. We’ve actually seen land auctions where one of the requirements is that one of your investors needs to be foreign capital and needs to be a certain percentage. We’ve also seen situations in cities where the local government’s really encouraging foreign equity to come in because they actually have a quota of the amount of foreign equity they need to have invested in their city each year to build middle class housing.

Snow: Why would they want a quota of foreign capital in housing?

Delatour: I think what they want the supply for residential because for middle class housing there’s pent up demand. I’ll give you one statistic. Beginning in the first quarter of 2010, the supply of residential housing was about 16 months worth of sales. Today, it’s about eight months of sales. The supply is dropping and the volume, as we discussed, is very significant. Over ten million units sold a year. There’s still pent up demands of tens of millions. So they really need to encourage more capital to come into that market.

Snow: So they see by requiring foreign capital to be in there, that’s just diversifying the sources of capital that can flow into the city?

Delatour: Right, and understand, foreign capital is still just a single digit when it comes to the total percentage of equity in the real estate market in China. They’re trying to incrementally increase the supply.


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