The Leader - March/April 2009 - (Page 86) CAPI TAL CORNER By David Jacobstein, Senior Adviser to Deloitte Real Estate Real Estate in China: GREAT OPPORTUNITIES, GREAT RISK For the foreign investor, Chinese real estate offers great opportunities but not without risk. As with any investment, prudent risk mitigation can be the difference between success and failure. Opportunities created by rapid urbanization, an expanding middle class, and exploding housing and infrastructure demands can be executed upon if foreign investors take the initiative to understand China’s business culture and customs and perform thorough due diligence. The Chinese government has been pursuing a policy of urbanization for some time through relocation of citizens from the countryside to established and nascent cities. For the Chinese people, this trend means a new, more modern way of life; for the real estate investor it means a need for capital and expertise to build homes, offices, retail centers and infrastructure. In China, like other emerging and developed markets, real estate demands follow economic and cultural trends, which investors can track and target. For example, the Chinese government has strongly encouraged growth in the biotech field. As a result, one key area for real estate growth is in R&D facilities and other high-tech business parks, which require capital and design and construction expertise, including sustainable design and construction. Green construction is of unique interest in China given the country’s mixed environmental profile. For older buildings, retrofitting will become a priority, though at a slower pace than in Western markets. However, new development will give China the greatest opportunity for energy efficient buildings with carbon neutral footprints. Strategic investors in Chinese real estate are best suited to take advantage of relatively high risk adjusted returns and the potential for future cap rate compression. Like the rest of the global economy, China is not immune to the current economic downturn. Declining exports resulting from decreased Western, particularly U.S., consumption has reduced manufacturing resulting in plant closings, layoffs and decreased short term housing demand. To counter decreased exports and still meet the Chinese government’s targeted GDP growth, the government is encouraging increased domestic consumption. This has been difficult to achieve, however, because of China’s savings oriented culture. Continued economic hardship could burst the bubble of rising expectations and disrupt the country’s growth profile and relative domestic tranquility. Other issues foreign investors face in China include a lack of transparency and available market data, a disconnect between central government policy and local government implementation, competition to private industry from state-owned enterprises, and gaps in certain types of talent needed by multi-national companies. But the most challenging risks are related to the business culture in China and the government’s role in real estate transactions.Relationships are critically important in China, and the foreign investor stands little chance of success without selecting the right business partner. Additionally, the Chinese government owns all land in China so it is leased on a longterm basis to real estate investors. However, because this land auction and leasing process is relatively new, no leases have yet to be renewed. Given the ever-changing regulatory environment in China, there is some cause for concern surrounding the renewal process. When it comes to risk mitigation, the single most important step an investor can take is to select the right local partner. While due diligence is difficult in an opaque environment, it is the single strongest indicator of future success. The right local partner will bridge the gap between the foreign investor on the one hand, and the government and local power brokers on the other. This bridge will create the all important relationship framework that supports business transactions in China. That, coupled with more traditional risk mitigation techniques of thorough due diligence, use of knowledgeable in-country professional advisors and sophisticated tax planning, can appropriately hedge real estate investments over the longer term. Real estate investing in China is still in its early days, but with the right mix of risk taking and risk mitigation, the savvy real estate investor can take advantage of the immense opportunities created by China’s urbanization and modernization. The result could be the creation of diverse, new real estate markets with strong returns on invested capital. 2 0 0 9 THE LE ADE R 86 MARCH / APRIL
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