China: Commercial Property

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China: The Commercial Property Market

In the early days of foreign investment into China, commercial property was tightly controlled by the government, with many investors being compelled to accept office space in designated and often unsuitable buildings. Factories and warehouses were simply unavailable, and incoming manufacturers had to build their own by agreement with local municipalities, often with involvement from Beijing as well.

The situation is very different today, with over-supply of offices, shops and industrial premises in a more or less free market where developers, both Chinese and foreign, have invested huge sums into purpose-built commercial real estate. Astonishingly, the building boom continued in China even during 2009, at a time when rents were falling quite dramatically and there was little take up of properties. Rents have since begun to recover, with significant net take-up in the first half of 2010. China is now said to have the largest commercial property market in the world. Commercial property investment in 2009, much of it through investment funds which were favoured by regulatory changes, is said to have been USD160bn.

Apart from office buildings and industrial parks, shopping malls have became a primary target for construction in the last few years, reflecting much greater freedoms for retail distribution by foreign-owned companies.

Despite improvements in the market in 2010, there is thought still to be substantial over-supply, with vacancy rates as high as 30% in the most important cities such as Beijing and Shanghai, handing a significant negotiating advantage to incoming tenants. In Beijing in particular the Olympics acted as a stimulus to development, particularly of shopping malls, and to some extent the same scenario is now being played out in Shanghai in anticipation of the World Expo.

The future for commercial property values in China is obscure. While economic growth is continuing at a fast clip (10% in 2010), nobody knows how large a pile of dud real estate loans is sitting unrecognized on the books of the Chinese banks, which are not known for transparency even now that some of largest have had external flotations.

Despite the apparent ready availability of commercial space, there are still traps for the unwary tenant. Much space, and especially the cheaper types, may not have correct government authorizations for use by foreign-owned companies, and in some sectors authorization may be required from Beijing even when a municipality seemingly offers a cast-iron permission of its own.

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China: Commercial Property Prices

It is impossible and unhelpful to generalize about property prices in China, since so much depends on location.

As a general trend, it can be said that this year has seen increases in rental levels in most cities, although these increases are from a low level. Rents fell in the previous two years by up to 40% in many cities. In Beijing, the increase so far this year has been at least 10%, and high-specification office space is currently on offer at RMB180 per square meter per month. Given the over-supply situation, it may well be possible to bargain for a 12-month rent-free initial period.

Retail rents dropped less, and are now showing greater resilience, as consumer spending continues to power ahead. To some extent, this reflects the unwillingness of banks to write down loans; they would prefer a property to stay on the market at a high price, in the hope of future improvement, rather than have to re-price a loan based on realistic lease rates. This is madness, of course, and does not bode well for the future. In retail, especially, an empty mall loses its attraction very quickly.

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China: Commercial Property Law

The current law governing property in China is the Property Law of 2007, although previous laws are still in force, including the Land Management Law of 1986, the Urban Real Estate Management Law of 1994 and the Rural Land Contract Law of 2002.

Under the Constitution, all land is owned by the State, so in China there is no consideration of freehold tenure, although in rural areas collectives have rights over the land they occupy. Until the new Property Law came into force, there was no clear separation of ownership rights between freehold and leasehold. Now, the State can (and does, in exchange for a fee) create time-limited rights for the use of land for commercial purposes. The 'owner' of such a land-use right can petition for an extension at the end of the permitted term; but since these terms are commonly 40, 50 or 70 years, that situation has yet to arise.

The law permits an ownership right over a building constructed on land which has a use permission, but it is quite unclear whether such a right could survive the expiry of the land-use permission, although it can be freely bought and sold during the land-use term.

(NB These remarks apply only to commercial property; residential use-rights benefit from an automatic extension when the use term expires.)

Chinese property law is very linked to the existence of a Land Registry, as is the case in many 'civil law' jurisdictions. It is important to remember that the existence of a contract, which is so crucial in 'common law' jurisdictions, is of comparatively little weight in China; instead, it is vital to make sure that the correct Land Registry entries are in existence. These are the best and probably the only defence against an attempt to expropriate or steal your property.

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China: Commercial Property Taxation

The basic property tax in China, under the Property Tax Temporary Regulation of the PRC 1986 is an annual charge of 1.2% of the price paid for the property; or in the case of a rental, 12% of the monthly rent.

There is also what amounts to a stamp duty on real estate transactions, currently at 1.5% of the consideration.

The government is considering imposing a further property tax at the rate of 0.8% of 'value', to apply mostly to commercial property; but there has been no clear announcement.

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