Savills World Research Shanghai

Briefing Investment March 2015

Image: Shanghai International Shipping Centre, Hongkou SUMMARY The divergence in yields between domestic end users and institutional investors will persist as investors remain conservative while domestic end users buy properties for long- term hold and self use.  RMB56 billion of investment deals  Gross yields for Grade A offices were concluded in 2014, down 29% transacted by international funds year-on-year (YoY). Six key deals were increased to 6.0% on a gross concluded in Q4/2014, for a total reversionary basis, up 0.8 of a consideration of RMB8.1 billion. percentage point (ppt), while capital “Softening market fundamentals values decreased. are competing with the appetite  International institutions remained conservative, given the sluggish  Gross retail yields remained for exposure to China, plentiful economy and continuous negative unchanged at 6.5%, due to subdued yield spread. The only downtown asset rental growth. capital and falling borrowing sold to an international institution was Shanghai International Capital Plaza,  The Dongjiadu plot blocks 13 & costs to determine where sold to Alpha Investment Partners for 15 were sold in November 2014 to the RMB1.55 billion. newly established China Minsheng property yields should rest.” Investment Corporation, for a record James Macdonald, Savills Research high total consideration of RMB24.85 billion.

savills.com.cn/research 01 Briefing |Shanghai investment March 2015

Market commentary GRAPH 1 Despite a slowing economy, the Shanghai large scale real estate acquisitions, 2004– Shanghai investment market remained active in 2014, in large part due 2014 Office Development site Retail to strong demand from domestic SA Residential Hotel purchasers. Total transaction Office park Mixed-use Industrial consideration of RMB56 billion was 90 concluded in 2014. Transaction volume fell by 29% YoY, as international 80 institutions turned cautious on 70 the market given the weakening

fundamentals and persistent negative 60 yield spread. Six sizeable deals were 50 concluded in Q4/2014, for a total RMB billion 40 consideration of RMB8.1 billion. 30 Office properties continued to 20 dominate activity, accounting for nearly 60-70% of Shanghai’s investment 10 market in terms of total consideration 0 in 2014. The office market offers 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 greater transparency, stable demand, Source: RCA, Savills Research less management resources and strong liquidity. Retail projects remain highly sought after, but with limited fewer exit options, and limited retail manner. As a result, yields, based on tradable investment-grade stock, management expertise, this sector recently transacted deals and ongoing tends to produce fewer transfers. negotiations by international funds, have started to rise reaching a gross GRAPH 2 In the past year we have seen a pickup reversionary level of approximately Office gross yields, Q1/2000–Q4/2014 in activity in more decentralised areas, 6.0%, representing a net operating both in the logistics, business parks income (NOI) yield of approximately Grade A office gross yields 10% and R&D facilities. The main driver 4.5% -5.0%.

9% behind this trend is the continuing rapid development of the ecommerce Fewer retail assets are held by funds, 8% market, improved infrastructure, with the majority held by developers 7% maturing business environment for the long term, and no stabilised 6% in these areas and relocation or retail assets have recently come to the 5% bifurcation by companies looking to market, resulting in relatively sticky 4% lower overheads. yields, ending the year on a gross

3% reversionary yield of approximately

2% The luxury hotel market, while seeing 6.5%. a pickup in activity of late, still remains 1% one of the smallest markets, beset by Office Sector 0% Q1 Q1 Q1 Q1 Q1 Q1 Q1 Q1 Q1 Q1 Q1 Q1 Q1 Q1 Q1 strong competition, low yields (due Shanghai’s Grade A office stock stood 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 to high running costs) and softening at 5.7 million sq m by the end of 2014. Source: RCA, Savills Research demand from corporate clients who ‘Little’ Lujiazui, the largest submarket are tightening belts. Much of the in Shanghai, accounts for 1.9 million sq GRAPH 3 activity that has been witnessed has m of Grade A office space and has the Retail yields, Q1/2000–Q4/2014 been between related parties or for lowest vacancy rate of any business conversion for other use. district at just 1.6%, though the Retail gross yields situation may change with the launch 12% While most investors remain optimistic of the 200,000-sq m Shanghai Tower on the mid- to long-term potential expected this year. Puxi’s vacancy rate 10% of the Shanghai market, many also fell 4.7 ppts YoY to 7.3% by the end of 2014. 8% have fixed term investment periods which mean that they will have to exit existing investments irrespective Grade A office rents increased by 6% 1.8% in 2014, ending the year at an of market conditions within the next average of RMB8.6 per sq m per day, 4% year or two, unless they can obtain largely driven by strong demand in an extension. Given the softening Pudong. Pudong recorded the highest 2% fundamentals and the fact that it rental growth of 6.5% YoY, to an is now taking longer to dispose average of RMB9.2 per sq m per day. 0% of assets, some funds are taking Q1 Q1 Q1 Q1 Q1 Q1 Q1 Q1 Q1 Q1 Q1 Q1 Q1 Q1 Q1 The Puxi market witnessed a reduction 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 steps to lower pricing in order to be in rents during 1H/2014 but saw them Source: RCA, Savills Research able to exit investments in a timely

02 Briefing |Shanghai investment March 2015

stabilise in 2H/2014, ending the year 2014, down 29% compared with the purchasers continued to place a at an average of RMB8.3 per sq m per previous year. premium on these assets, buying day. above market to secure preferred Core assets in prime locations remain premises and placing significant Gross reversionary yields on office popular among investors as they downward pressure on yields, assets traded by international funds seek more defensive investment especially in the office sector. are believed to have edged up, opportunities. Nevertheless, other While gross reversionary yields for given recent transactions and deal more opportunistic investors are international institutions ranged from negotiations ending the year at exploring opportunities in more 5.0% to 6.5%, end users were willing approximately 6.0%. Nevertheless, decentralised locations that are to pay the equivalent of 3.0-4.5%. at the same time there are a number beginning to see the benefits from of assets that have been acquired improved accessibility and business Q4/2014 overview by domestic funds and domestic environment and lower costs while Six key deals were concluded in end users at significantly lower yield still representing higher yields and Q4/2014, for a total consideration valuations. greater scope for value appreciation of RMB8.1 billion. Assets along the in the midterm. The contribution of Huangpu riverside remained highly Retail sector assets in core locations to the total sought after by both end users and The city-wide shopping mall stock consideration in 2014 fell to 48.4% investors. climbed to 7.0 million sq m by the end from 65.8% in 2013. of the year, an increase of 12.5% YoY. Shanghai ICP was acquired by Alpha Prime areas account for only 21.2% Shanghai International Capital Plaza Investment for RMB1.55 billion. of total stock, though this figure is (ICP) was the only downtown asset Located in Hongkou district, the expected to fall to 16.5% by 2017, as sold to an international institutional project comprises both office and new supply focuses on large-scale investor in 2014, with others focusing retail components, with a total GFA shopping malls in decentralised areas. on business parks for add-value of 57,000 sq m. opportunities and higher yields. Retail rental growth has been very Among the established business Gopher Real Estate Fund, a modest in 2014, with the market parks, Zhangjiang Hi-tech Park saw subsidiary of Noah Holdings, believed to be at an inflexion point. the most activity in 2014, benefiting acquired Suntown Plaza in Huangpu In the fourth quarter, prime retail area from the prosperous IT industry and District for RMB3.126 billion. This rents remained unchanged, while the expansion of Shanghai Free is the largest deal in terms of non-prime areas fell 0.2%. For the full Trade Zone. Ascendas, Kailong total consideration in Q4/2014. year, this represents a 0.1% and -0.7% REI, Starcrest Capital Partners and Comprising office and retail podium change respectively. Morgan Stanley all purchased or space, this building is expected to be established partnerships to develop completed in 2016. Gross yields for retail projects remain commercial-use projects in this park. unchanged at 6.5%, due to subdued #18-1, Shanghai International rental growth and a lack of traded Divergence between institutional Shipping Service Centre (SISSC) was assets. investor and end-user yield bought for RMB1.3 billion by Suzhou valuations persisted in Q4/2014. Bank, representing a new record high En-bloc investment While funds stood on the sidelines unit price at roughly RMB100,000 per market looking to pick up distressed or sq m. 2014 overview underperforming assets at higher Total transaction consideration of entry yields, the end-user market Media Tek purchased 12,500 sq m of RMB56 billion was concluded in remained very active. End-use Poly West Bund Centre (13/F to 19/F)

TABLE 1 Yields and capital values by sector1 , Q4/2014

Prime shopping Prime retail street High-end serviced High-end strata Grade A Office 5 star hotel mall store apartments apartments

Gross reversionary 4.5-6.5% 6.0-7.0% 4.0-5.0% 4.0-5.0% 2.5-3.0% 6.5-8.0%

NOI 3.5-5.0% 4.0-4.5% 3.0-3.5% 2.2-2.8% 2.0-2.5% 1.5-2.0%

Approx. values 50-90,000 60-100,000 150–250,000 55-70,000 100-200,000 40-50,000 (RMB per sq m)

Source: Savills Research 1Yields refer to stabilised assets in downtown locations free of any impediments and with a clean holding structure owning 100% of the building, assuming 100% occupancy. Capital values refer to the average for the building on a GFA basis – retail assets will have higher CV for lower floors.

savills.com.cn/research 03 Briefing |Shanghai investment March 2015

in Xuhui district for RMB693 million. with land plots sold for new highs GRAPH 4 This project is located in Xuhui in terms of both accommodation Land transaction spaces and AVs, riverside area and was still under values and total sales consideration construction at the end of 2014. in Q4/2014. 2008–2014 Commercial GFA (LHS) Residential GFA (LHS) Industrial GFA (LHS) City Development Limited, a The land market in 2014 saw total Commercial AV (RHS) Residential AV (RHS) Industrial AV (RHS) 40 16,000 Singapore-based developer, bought sales fall by 22.9% to RMB171 Xiang Shui Wan Villa in Qingpu billion, with commodity residential 35 14,000 district for RMB799 million. This and commercial sectors accounting for 63.8% and 25.1%, respectively. 30 12,000

high-end villa project was completed in 2013, with total GFA of nearly Echoing a rebound in the residential 25 10,000 m sq per RMB 48,456 sq m, of which 35,732 sq m market in the last quarter, commodity residential land sales recorded an 20 8,000 comprising 85 units remains unsold. million sq m average accommodation value (AV) 15 6,000 of RMB15,786 per sq m in Q4/14, Future Holdings acquired Block 6 pushing up the annual average to 10 4,000 in Guoson Centre in Putuo district RMB14,619 per sq m. from Guoco Land China for RMB623 5 2,000 million. The Dongjiadu plot (blocks 13 & 15) 0 0 was sold in November 2014 to the 2008 2009 2010 2011 2012 2013 2014 In January 2015, it was reported newly established China Minsheng Source: Savills Research that AVIC Joy Holding had acquired Investment Corporation (中民投). #18-2 in SISSC, just next to the The acquisition represents the most ground: 701,900sq m; below ground: tower acquired by the local bank in expensive plot sold to date in terms 437,500sq m), comprising retail (not December 2014. The valuation for of total consideration at RMB24.85 greater than 17%), office (not less this transaction was slightly lower, billion, beating the previous record than 65%) and residential (not greater at RMB96,000 per sq m and a total set by Sun Hung Kai Properties in than 18%) components. lump sum of RMB1.6 billion. September 2013 when it acquired the Xujiahui plot for RMB21.77 billion. The Jing’an land plot (南西社区111- Land market This mixed-use development has a 09) was sold to Jing’an Real Estate SShanghai’s land market has total GFA of 1.14 million sq m (above (静安置业), a state-owned developer, witnessed an active end to the year,

TABLE 2 Key investment deals, Q4/2014

Shanghai Poly West Project #6, Guoson Centre 18-1, SISSC Suntown Plaza Xiang Shui Wan Villa International Bund Centre Capital Plaza

Location Xuhui Putuo Hongkou Huangpu Qingpu Hongkou

Date Dec, 2014 Dec, 2014 Dec, 2014 Dec, 2014 Dec, 2014 Oct, 2014 Office and retail Property Office Office Office and retail Office podium Villa type (under construction) (under construction) podium (under construction) Transacted price 693 623 1,309 3,126 799 1,550 (RMB mil) Above- ground GFA 12,490 24,928 13,012 73,300 35,732 56,859 (sq m) Franshion Group JV Shanghai Sunac ARA Asset Vendor Poly Group Guoco Land China Shanghai Intl Port TBC Greentown Management Group Gopher Real Estate City Development Alpha Investment Purchaser Media Tek Future Holdings Suzhou Bank Fund Limited Partners Source: Savills Research

04 Briefing |Shanghai investment March 2015

for a total consideration of RMB1 Qianhai and Zhuhai Hengqin New expanded to cover other services billion, giving an AV of RMB53,575 Area) and Fujian (industrial areas in sectors such as telecoms in 2014 per sq m. With a total buildable GFA the provincial capital of Fuzhou, the and now the real estate sector in of 18,665 sq m, this commercial site whole of Xiamen, and Pingtan). 2015. The transition is expected to is directly connected to the future reduce the tax burden on developers Nanjing West Road station, Metro The SFTZ will also expand its as it allows them to claim tax credits Line 12 and is designated as an geographical coverage to include for much of the input costs that were open-plan retail space. Lujiazui Finance and Trade Zone, previously double-taxed, therefore Zhangjiang Hi-tech Park and Jinqiao while business tax on sales was Three commodity residential land Export Processing Zone. This originally 5.5% and the new VAT is plots in Qiantan were sold to two expansion will increase the area to expected to be closer to 11%, as the domestic developers, Gree (格利) 120 sq km from the current 29 sq km. tax base will be markedly different and Sanxiang (三湘) for RMB4.9 given the application of tax credits, billion, representing the highest Tax reforms the effective tax rate is expected to AV of residential plots on record VAT reforms for the construction and be lower than it was previously. for Pudong. The “land king” was real estate sectors will be accelerated Sanxiang, which acquired one of in 2015. The transition from business Retail Estate Investment Trusts the plots for RMB1.86 billion, with taxes to VAT was first announced (REITs) an AV of RMB66,629 sq m. Located in late 2011, with a trial started in China REITs were once again along the Huangpu river and planned Shanghai in January 2012, and then in the spotlight as China’s as a new high-end international later in the year expanded to Beijing, Ministry of Housing and Urban- commercial and residential Tianjin, Jiangsu, Zhejiang, Anhui, Rural Development (MOHURD) compound, Qiantan is highly valued announced plans to speed up the among international and domestic Fujian, Hubei and Guangdong, and developers. the cities of Xiamen and Shenzhen. implementation of REITs in China. This was later extended to the whole The pilot plan, announced in January, Market news country in August 2013. is expected to begin with four tier-1 Free Trade Zones cities and focus on financing state- China’s free trade zone scheme has The tax reforms hope to boost the subsidised affordable homes for rent dramatically expanded in recent services sector, planned as one of to low-income families.  months. the key drivers of future economic growth. China has long imposed VAT In late December it was announced on tangible goods but services are that China would replicate some instead subject to a business tax, practices from China (Shanghai) often resulting in double taxation. Pilot Free Trade Zone (SFTZ) in The transition allows companies to other parts of the country including claim an “input credit”, deducting the Tianjin (Tianjin Port, Tianjin Airport VAT they have paid on their supplies and the Binhai New Area industrial and therefore eliminating the double park), Guangzhou (Nansha New taxation. The pilot programme first Area in Guangzhou, Shenzhen focused on transportation but has

TABLE 3 Key land deals, Q4/2014

GFA Consideration AV Plot District Use Buyer (sq m) (RMB million) (RMB per sq m)

#36-01, Qiantan Pudong Residential 27,931 1,861 66,629 Sanxiang

#32-01, Qiantan Pudong Residential 24,517 1,614 65,832 Gree

#38-01, Qiantan Pudong Residential 26,899 1,450 53,905 Gree

#111-09, Jing’an Jing’an Commercial 18,665 1,000 53,757 Jing’an Real Estate

Pingliang Yangpu Residential 51,318 2,108 41,078 Yango

Dongjiadu Huangpu Mixed-use 702,140 2,485 35,392 China Minsheng

Source: Savills Research

savills.com.cn/research 05 Briefing |Shanghai investment March 2015

OUTLOOK

 The office sector will platform deals are expected to be  The divergence in yields still continue to account more common, particularly in the between domestic end users for the majority of deals in retail sector as well as in finance. and institutional investors is Shanghai, despite weakening expected to remain significant fundamentals and concerns  Some developers and owners in 2015 as institutional investors, about substantial supply in may be faced with increasing particularly international ones, most areas. Given the low financing difficulties over the next remain conservative and seek yields, institutional investors are twelve months, and we may see out distressed asset opportunities, expected to focus on add- the disposal of previously acquired while domestic end users buy core value opportunities in core land plots to better capitalised new build properties for long-term locations and business parks, developers and rising yields. hold and self use. over stabilised assets, unless Muddled market conditions open they have long-term core up new investment opportunities money mandates. Portfolio and for brave investors.

Please contact us for further information Savills Research Savills Agency

James Macdonald Albert Lau Simon Ha Director, China Head & Managing Director Head of Shanghai Investment +8621 6391 6688 +8621 6391 6688 +8621 6391 6688 [email protected] [email protected] [email protected]

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