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147: China investment trends - socio-economic impacts

07-15-2007 team

This extensive special report covers how to use socio-economic trends to drive your investment decisions. The special report includes a survey of major current socio-economic trends including:

And finishes with:

Using Socio-Economic Trends to drive investment decisions

We are great believers in the value of monitoring and taking appropriate time to think about economic, social and marketing trends. They guide the way we should invest and help make for better investment decisions and improved investment performance for the longer term. Thorough analysis often leads to a more predictable, deterministic (or measurable) investment outcome.

Let’s take an example of trends in new transport/communication impacting property prices. As a rule, I only invest in property in areas that are “positively changing”. This normally means that a new train station/road is being built close by or regeneration is ongoing. It remarkable how little the average person considers when they buy their homes – they won't notice until they can actually see and use the newly built station – which is when the prices start moving up dramatically. Demand arrives when infra-structure opens – any demand before this is driven by investors speculating on what might happen.  

The trick is to get in well before the station opens, before it can physically be seen even being built. An example is investing in property in a Chinese city even before the Olympic bid was won - then continuing until the new infra-structure is build. It is remarkable that no-one seems to notice intul the infra-structure actually arrives. Most property purchasers do not give it much thought. Investors certainly do, as do companies and developers. Most the market is not ultra-intelligent. Its quite easy to beat the average market with some good analysis and thought. 

Baby-Boomer Power – Impact on Economies and Change

One outcome of the Chinese and Asian demographic shift to an aging population will be a concentration of power and wealth with the retiring population. The voter turn-out amongst the low numbers of younger people will be very low compared to elderly – hence the politicians are likely to pander to the baby boomer wishes to capture these votes.

One just needs to look at what happened in Japan since 1990 as an example of these dynamics – Japan’s baby boomers started retiring in the late 1980s – the Nikkei was at 38,000 and when the pensioners started pulling on their retirement funds, the Nikkei crashed to below 10,000, growth stopped, deflation set in and economic reform was very slow. Only now after 2003 did Japan come out of a recessionary phase that has lasted some 13 years – led by Chinese growth.

Europe (Germany, Italy and France) could be afflicted with similar sluggish growth or recession and deflation if an aging population and low fertility rates leads to lower population, lack of change / economic reform and higher taxes. This might happen around 2015 when a big wave of these people retire. The threat in such an environment is that innovation and flexible working practices are stifled and the power rests with aging politicians who pander to the baby boomers pressures on pensions, healthcare and not wanting change. This would definitely negatively affect property prices since demand would be reduced, investment conditions worsen and taxes would rise.

But China, with a population of 1.3 billion and rising, has a huge workforce of low cost labour that will become the world’s economic engine in the next 40 years, along with India and the rest of Asia. This should stifle inflationary pressures, give boom conditions and lead to property prices escalating to levels seen in Western Europe and the USA. The market is immature, but prices can quite easily triple in the next 10-20 years if GDP growth is maintained at levels in the range 7-10%.

Global Economy Helps Property Prices

Globalisation of industry has lead to more companies operating efficiently across countries and regions. Outsourcing of services and a shift of manufacturing to new low cost and wage centres is a trend set to continue. As under-developed countries are able to apply and manage new technology to produce goods and services cheaper, this should lead to lowering of prices over time and keep a lid on inflation.

The internet is an example of a medium that cuts across country boundaries to provide goods and services cheaper. Developed countries will have to shift towards knowledge based high-end services (bio-technology, financial management, services) and will be maximising profits and economic potential from low cost mass manufacturing centres such as India and China. This should all lead to lower prices, keep a healthy lid on inflation, drive down the cost of capital and keep interest rates low.  Any significant wage inflation in a country would have to be met with an increase in productivity, otherwise goods and services would be moved to other lower cost centres quickly.

Hence our prediction is for benign inflationary pressures, higher company profits, margins and productivity and low interest rates over the longer term – both fixed and variable. We see Chinese interest rates rising to say 5% then coming back down as the economy slows. This should all support house prices as the new order will be that households and individuals will be allowed to borrow higher and higher multiples as capital becomes more plentiful and cheap, particularly for the stronger currencies.

One could argue this same globalisation could suppress house prices since people can buy abroad cheaper, particularly holiday homes. However, this ignores the fact that most Chinese citizens either have to or want to live in China because of they want to be near their family, friends, work and schools. This is true for all nationals in respective countries around the world. This is not likely to change.

Will Globalisation and Retirement Lead to an Exodus from China / HK?

We do not believe there will be a mass exodus out of China. Our theory is that the average Chinese citizen will not move permanently from China after retirement. The more wealthy may have a second home in say Thailand, Malaysia, Macau or HK but will still spend the bulk of their time in a home in China because of their family, friends, links to their old job and network, continuing education, interests and culture. As long as people see the sun during the summer, supplemented by a few doses through the winter, this will probably be enough for the bulk of Chinese citizens – further supporting house prices.

A large proportion of the wealth created by low cost labour in countries like India and China could very well end up back in the main Chinese cities and in multi-national companies in the form of company profits, shareholder returns and capital market trading and services. The “offshoring” trend is a strong opportunity for value creation for all global firms, Chinese firms included, as well as a threat to certain lower-end jobs. Unemployment is running at low levels in China and this is likely to continue because of China’s cost advantage and oranisational skills over other low cost centres. A ready pool of 1.3 billion people and working population of some 900 million people provides the global skills pool for manufacturing expansion. Only the lack or oil/energy is likely to slow this rapid expansion now economic reforms have created a good environment for Chinese business.

Globalisation and Building

One could also argue that building could become cheaper in China as new technology and building practices helps and there is access to low cost indigenous labour. This is partly true, though advances in technology in building have been painfully slow in other countries, Chinese  labour cost are set to rise and  skills shortages from builders/tradesmen would hinder building growth. Furthermore, any advantage or value because of cheap labour in building is likely to be captured by the building company in higher profit margins – not with the end customer.

Hence we think the building companies operating on price/earnings ratios of about 6 look like good value.  Demand should stay strong with supply constrained because of the slow planning process. New building practices slowly feeding through will likely improve profitability further, though we cannot see any material impact from the recent Housing initiatives. Technology will not take the place of housing. Building innovation is slow and is likely to remain so because of a conservative approach to lending by banks and traditional housing views of the customers.

Impact of Asian Business Expansion

The expansion of the Asian trading block will attract hundreds of thousands of cross border workers  to Asian countries and generate massive new demand for accommodation. .

As country borders become more open for migrating workforces, the lower cost labour will gravidtate to where the work is. This might mean that China will see some immigration of skilled workers that the country may not be able to develop themselves. An example is – Vietnamese plumbers, Singapore Biotechnology Engineers and American M&A Investment Bankers.

These cross borders skills sharing will likely lead to improved rates of return for investments and

What Impact will Housing Initiatives have on property prices and investment?

Chinese Housing Initiatives which drive the large scale housing developments in Shanghai, Beijing and other large Chinese cities will struggle to keep pace with the rising urban population. Workers from agricultural areas will continue to stream into industrializing zones where employment can be found. These manufacturing dominated areas along the Chinese coast are centres where products are created and exported to USA, Europe, Japan, Middle East and other Asian countries. Because of a continuing shortage of housing and land, property prices are likely to keep rising. The Chinese government will control the pace of expansion and development to sustainable levels and we are not likely to see the boom and bust that occurred in the late 1990s in Malaysia and other Far East countries. Part of the reason is that the currency is controlled and currency speculation cannot so easily damage the economy in China like it did in other Far East countries the late 1990s. China is now the engine and growth and currency are controlled, so risks are therefore lower. 

However, because of the control of Chinese in the house building and permitting process, severe housing shortages are not likely to develop. The Government will want to keep the population at ease by providing access to housing and hence massive home building programmes will continue. Suburbs will spring up and a new middle class will develop – these successful business and public sector workers will want good quality family homes within commuting distance of central city locations. Workers living in apartments will aspire to own small houses. Small home owners will aspire to live in larger detached houses with gardens. The normal property dynamics that occur in other parts of the world will not be much different in China or other Asian countries. China will have a stronger feed of apartment from government lead housing initiatives, but demand will stay high for all types of property in the city and manufacturing areas.

A rise in protests from displaced people might slow home building process in future years, but for now, strong control by local and regional government supplemented by state level control should provide a platform for massive house building growth, rising supply to fuel the massive increase in demand.   

What Impact could Property Investment Funds (PIFs) have on property prices and investment?

If the Chinese government introduce tax efficient US style Real Estate Investment Trusts (REIT), this could help fuel the building boom. These have proved popular in other countries around the world – private companies turn themselves into tax efficient trusts – and dividends are distributed to investors with tax breaks. The important thing is how the REIT policy is described and enacted – to make sure the correct gearing, share ownership rules and dividend payment rules are attractive for private firms. These PIFs are often popular with retirement funds because their investment risk is rather lower than stock market investment. Also, many pension funds have a larger weighting of property in their portfolios now compared with 10 years ago. 

The Nimby Factor

So what about the much talked about “nimby” (“not in my back yard”) effect? This is a phrase coined in the UK and USA - listening to John Porritt, the CEO of Friends of the Earth based in the UK,  this factor only likely to increase. Mr Porritt said that the environment will always become more important to people over time. In a given period, it will either stay on a plateau or increase – it will never decrease.

This is what we see with nimbyism. People get genuinely angry with development in their community or immediate area or sphere of interest. Countries face massive housing shortages on the one hand with increasing populations and nimbyism on the other. Nimbyism leads to supply decrease – if demand stays the same, then prices will move up. These factors could of course make it increasingly difficult for first time buyers and key workers in China to get onto the housing market.

One unknown factor is how much “help” first time buyers get from their parents. Their parents are likely to have large amounts of equity tied up in property in future years – releasing some would be enough for a deposit for a first time buyer. If this equity release and gifts to offspring occurs systematically, it would support the lower end of the markets and improve ability for housing chains to occur. It may also decrease elderly people inheritance tax liabilities by helping their offspring buy property.

The Planning Factor

The planning process is current fast. But it could slow, become more bureaucratic and cumbersome as the Chinese economy matures. The reasons for difficulty getting plans through are numerous. Number one is probably Nimbyism of locals and communities. There may only be a small minority of the population, or even one or two very vocal opponents, but this can either stall or kill any developments, sometimes for very good reason.

Related to this, it is often not politically acceptable from a local stand-point to agree to new developments – planners and councilors do not wish to upset their stakeholders – the general public or the most vocal public in the local area. These public citizens after all vote in their councilors, so their power is not to be underestimated. These protests also constrain development and to a lesser extent probably reduce local economic growth.

However, if an area is particularly attractive, hideous developments can actually damage tourism and reduce the quality of life for residence living in the area. For areas that are less attractive and have higher unemployment, less reliance on tourism, and areas that have degenerated, barriers to development are far lower.

An example is what has been possible in the coastal area of Shanghai – massive new offices, housing, rail, roads, airport – all with little more than minor objection. Yet in the UK it took 10 years to get agreement to add one lane to the M25 motorway on the south-west fringe of London (a 6 metre strip of tarmac).

So if you want to build a new house, you’ll find it a whole lot easier where the “Local Plan” caters for new housing and sustainable development. You’ll probably be wasting your time in an established historic small villages or town with constraints on development, unless you find a good brownfield site.

More is being done to develop brownfield sites in existing cities and towns in China (rather than straying onto Greenfield sites). Development of such plots can be slow – probably because of the cost of preparing land (pollution and old works demolition) and improving the infra-structure, and constraints placed on developers by planners.

China is particularly good at providing affordable “houses” compared to most countries – this provides workers with an opportunity to live in a small apartment in most areas. As the economy grows and the private sectors gains more momentum, it could be that these levels of building of affordable housing reduce and this puts pressures on worker mobility and social aspects. 

Shanghai will likely double in population in the next 25 years – and central areas will become more popular as congestion increases and the super wealthy want to live close to the best amenities. This is similar to what has happened in New York (Central Park) and London (Mayfair/Kensington). The most select areas of Shanghai will see property prices rise dramatically because of slow new supply because of land shortages and massive new demand from the wealthy Chinese nationals. 

As land becomes scarcer, more properties will be demolished and re-built as bigger homes – particularly those on large plots with good views in private locations.

We also think the planning process will slow down and land will become more difficult to acquire for building purposes - so homebuilders will be able to keep prices high because of high demand and some degree of drip-feeding supply, or some would say “step-by-step supply”. Part of the reason why drip-feeding of supply takes place is related to financing. It seems the capital markets have not forgotten about the boom-bust cycles of Europe, Malaysia and USA caused by interest rate hikes, currency crashes and employment swings – the building companies also do not want to get into a precarious cash-flow squeeze, in part because this would lead to a takeover threat or worse bankruptcy.

Funding is not easy to come by for large capital-intensive developments that require much of the infra-structure costs committed up front and very expense planning processes. To be on the safe side financially, and also because of acute shortages of skilled building labour, developers have to build in a step-by-step fashion.

Shift from Agriculture to City Centre, Seaside and Suburban Living

There is likely to be a general trend away from agricultural village living in small houses to city centre flats and holiday homes in seaside areas. This will follow the trend of the baby boomers retiring. A massive increase will take place of demand for suburban houses and smart apartment for the new Middle Classes. The increase in the numbers of your “average” company suburban small working families will lead to increasing demand for suburban houses. Remote village property will be the losers – prices will rise, but not nearly as quickly as city property.

A trend over the last twenty years has been the increasing number of middle class families that aspire to live in a trendy city houses and apartments. These new wealthy city dwellers will want luxury, spacious property in central locations, in the best areas for schools, services and leisure activities.

As land becomes less economic to farm and the farms that remain become more mechanised and intensive, farms will be merging – some old farms will eventually be bought for purely residential purposes, particularly those close to cities. It is mainly the city dwellers who have made enough money that are buying these properties – this trend is likely to continue and the value of such farms, close to cities will rise. The land value will also rise with it.

One investment model is to buy a farmhouse only, then negotiate the purchase of some land around it thereby considerably increasing the overall value of the property. Before exchange of such property, an option can be bought from a farmer for such a purchase, thereby reducing the risk that the land cannot be acquired prior to the commitment to purchase the property.

We would envisage that farms with a reasonable amount of land (say 3-7 acres), particularly with countryside or sea views and close to cities, will be able to command an ever increasing premium, as retiring city dwellers chose to move to quiet locations, where they can enjoy recreation, walks etc.

Chinese Holiday Resorts Go Upmarket

Holiday resorts in the Chinese coast will gain in popularity over the next 20 years. This is similar to trends seen in the USA, France and the UK.  

Properties with sea-views should be targeted. The bottom line is, there are not many properties in the China with sea views – many of the 300 million or so baby boomers will want these views, so the prices are more likely than not to go up for such property, especially as it is so difficult to obtain planning permission for new properties with sea views – land is scarce, “nimbyism” is omnipresent and people don’t seem to like the coastal views or character altered.

Ex-Communal Seaside Resorts to Come Back into Fashion in China

Traditional Chinese seaside resorts have been generally on the decline since the mid 1990s when mass communal tourism ended. However, these same locations are likely to transform themselves as the 300 million Middle Class Chinese desire a holiday home in an area they used to visit in their childhood. Thee resorts will be re-developed into private resorts with some top class entertainments and leisure activities (e.g. golf, walking, sunbathing).

People have always desired to be at the sea for a mixture of fun, nostalgia and thrills. People have had good fun in their childhood at the seaside and it reminds people of their childhood and family. We predict the resurgence of interest in these resorts in the next 20 years as baby boomers retire, and wish to live at the sea-side in China.

In these resorts where improved communications to major employment centres and facilities occur, regeneration and improvements should drive up prices, particularly in property with sea/coastal views. We do not believe most Chinese citizens will want to move to Thailand and other Asian countries permanently – they may have a holiday home there, but their desire to be close to their families and friends will keep them in China – and the best place will be along the south coast of China, with good communications to Shanghai and the populated Guangdong Province (close to heir family, ex-business, airports, services).

Shanghai Property Investment

We are quite positive about all Shanghai locations for the following reasons:

The most significant risks is probably overheating of the economy or high energy prices and a subsequent bust environment, but we believe the government will control the financial services sectors risks are therefore relatively low.

Current Socio-Economic Trends

To further develop the argument for the importance of trends, the other reason why we believe in the longer-term investment potential of property in China is because of the following current trends:

The key risks that would work against property prices rising are higher unemployment, high oil/gas prices, higher interest rates, and poor affordability leading to the average person preferring to rent property instead. We believe in the medium term we still have a long way to go and that Shanghai and Beijing property prices will double in the next ten years. We might be wrong, it’s only our view – for your consideration, and as an example of how one can use trends for investment purposes.

We have found reading books there is very little concrete investment advice about where specifically to look for property opportunities – it seems people either want to charge for this type of service, are not willing to share it or it just does not exist. We have a different strategy – we like to share investment advice on property – we see nothing to lose from this.

Some of the Most Favourable Investment Areas

We will give you the areas we most favour at the moment for 5-10 year investment horizon – central Shanghai and central Beijing – any areas close to the centre that is close to new communications, developments and re-generation.

We also like in the medium to longer-term south coast resorts – particularly flats and houses with sea or harbour views – these are the future retirement homes of the baby-boomers.

We also like interior low cost cities like Xian – which will benefit from the internet and high-tech business development over the next 20 years.

All the above are micro-to-macro socio-economic trends, which can be used to justify (or not) investment in medium sized very central 1-2 double bedroom apartments in Shanghai.

Possible Future Socio-Economic Scenarios and Trends

We would advise it is good practice to take an active interest in trends - you may find these helpful to consider with regard to how your lifestyle could develop or be impacted in the future. We would like to flag these so you can consider them when planning your lifestyle, investments, and retirement.

Please consider them as “possibilities” rather than “most likely to occur” – they are both opportunities and/or threats (risks). The purpose of listing them is so you can at least consider them for planning purposes, so they don’t hit you in the face one day! The possible future trends below also contain more detail on the current trends outlined above. And no, we do not have a crystal ball – all the same, here goes:

The key question you should ask yourself in relation to these trends is - how can I maximise my value from these trends, both financially and lifestyle? The key way to gain financially from these trends is to invest money where you can see positive changes occurring.



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