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China: China

Guide to the Risk and Opportunity Ratings

At the end of each country profile, we have given a risk rating and an opportunity rating. These ratings are a summary of our analysis indicating the levels of risk when investing in a market and the level of opportunity to profit from it.

The ratings themselves are simple. Both work on a scale of one to five. The opportunity rating is indicated by the $ symbol. A single $ equals a low opportunity whilst 5 of them ($ $ $ $ $) equals the highest opportunity ranking.

For risk we have used the * symbol. A ranking of * equals a low risk rating whilst * * * * * equals a high risk rating.

Introduction and why this is a good place to buy

To many, investment in China may seem like a difficult prospect. Apart from language and cultural differences, concerns may range from laws and regulations which may not be transparent, to complicated bureaucracy. However, China has made huge progress since it joined the UN and embraced a market-oriented economy in the late 1970s. The country is opening up to trade, has an increasingly liberal global trade regime, and labour costs are a fraction of what they are in the West. China also showed its openness to progress and development by joining the World Trade Organisation (WTO) in 2001.

A key element of China’s new-found economic freedom has been the introduction of property rights. These property rights include laws which state that the government may not confiscate property without payment of compensation, and allow for claims to be made against the Chinese government (although this is on a reciprocal basis – if the home State of the claimant allows Chinese citizens to make claims this will be allowed, if not it won’t). China also has dual taxation agreements with 78 countries, including the UK (further details of these agreements can be found at www.chinatax.gov.cn/ssxd.jsp).

Due to these developments, China is seeing extraordinary economic growth (averaging approx 9.4% per year between 1978 and 2001). In 2004, the Organisation for Economic Cooperation and Development (OECD) predicted that the Chinese economy would grow by 9.3% in 2005, rising to 9.4% in 2006 and 9.5% in 2007. The total GDP between January and June 2005 reached 6.7 trillion Yuan Renminbi (RMB) (£466bn), a growth driven by exports and largely private sector investment. This is one of the largest growth rates in the World. To complement this, the Chinese currency is undervalued – the World Bank estimated the currency to be 75% undervalued in 2000. Until July 2005 the Yuan was pegged at 8.28 RMB to the US dollar, a fact which enabled China to build up a huge trade surplus. On July 21 the People’s Bank of China announced the adoption of a more flexible exchange rate system and a 2.2% appreciation of the RMB against the dollar. The likelihood of further appreciation, along with the aforementioned economic growth, has helped to drive investment interest in recent years. Straightforward currency purchase would appear to be the best tactic to take advantage of these factors, but the Central Bank of China maintains strict controls over the RMB, an untradable currency. The Bank has imposed a limit of $50,000 a month on the buying of the RMB, and once bought, it is extremely difficult to repatriate funds or to convert the currency back into foreign denominations. Funds can, however, be taken out of China through investment in a business or in property, and the commitment required to run a business in a foreign country means that property investment is the simplest and most advantageous way to benefit from the opportunity that China offers.

Price history

China’s property sector began to take off in 1998 (when the Chinese began to be allowed to buy their own homes), and has been growing at an average rate of 22% a year ever since. The investment boom in 2003 raised growth to 32.5%, an unprecedented level. In Beijing, statistics from the Beijing Land Bureau show that the revenue to investment ratio of high and medium-grade housing has reached as high as 30% to 40%, compared with around 5% in Europe and the USA. The consistently high returns on property investment have meant that money is pouring into the property market, and according to research by Morgan Stanley, up to $2 billion in foreign capital will flow into Shanghai’s property market in the next few years.

The massive appreciation has caused fears that this amount of investment is unsustainable, and that a property bubble is being created in China. In response to this the Chinese government took action in 2005 to raise taxes, interest rates and deposit requirements, also imposing restrictions on certain types of sales. The residential property market has slowed as a result, whilst the commercial sector has gained ground, continuing to return impressive rental yields and capital appreciation figures. The government is continuing to keep an eye on the situation, and is ready to provide stricter controls if necessary, a fact which means that a bubble is unlikely. Over the longer term the government’s action should inspire careful and sustainable investment, rather than short term speculative investing by investors looking to make a quick profit. The real estate market therefore looks set to remain in a sustainable price increase curve for a number of years to come.

Where taxation is concerned, this is currently under the control of the regional governments and is periodically adjusted in moves designed to stabilise the economy. Capital gains tax is floating and varies between 0% and 30%, although as the government is currently looking at stabilising their taxation systems, this should only be of concern to short-term investors.

Which type of property should you go for?

All property in China is under a ‘land use right’ system, similar to the western leasehold concept. There are three types of lease on land: residential, which is run on a 70-year lease; commercial, which is on a 50-year lease; and industrial, on a 40-year lease. At present, due to the relatively recent nature of this system’s creation, what happens at the end of this period is uncertain, although the government is likely to create possibilities for renewals of leases similar to European models.

The recent drop in prices in the residential sector, combined with the sustained strength of returns in commercial properties, means that institutional investors are now more certain than ever that the Chinese commercial property sector is the one to become involved in. Investors are aware that prime office space in China’s main cities is in relatively short supply, allowing owners of such properties to charge ever increasing rents as demand increases, and domestic purchasing power in many Chinese cities is also increasing, meaning that businesses are able to pay higher rates for retail space. The residential market is also by no means finished; in fact Chinese residential property probably offers one of the best long term investment opportunities around.

The securest investments currently on offer, however, are most likely those available in the serviced apartment sector. The demand for apartments and hotel accommodation is rising rapidly in major cities such as Shanghai, Beijing and Guangzhou, especially in areas close to the financial and business centres of these cities. The great advantage of these properties lies in both guaranteed rental schemes (an example of a property currently available has a guaranteed rental averaging 8.9% of the purchase price over an 18-year agreement) and in a capital appreciation rate of, in many cases, around 10% per year. A number of new developments are also available with their full lease period intact.

More pages

Page 1: Guide to the Risk and Opportunity Ratings
Page 2: Buyers this market will appeal to
Page 3: Future opportunities
Page 4: Risk rating

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