Anecdotes from a Recent Trip to China

Andrew Clifford shares his observations from a recent field trip to China where construction activity seems to have reached a medium-term peak in both the property sector and public infrastructure. He also reports on a detour the team took to Burma.

In early March we went on one of our regular trips to China making stops in five provincial cities; Hefei, Zhengzhou, Chengdu, Chongqing, and Kunming. 

Meetings were held with a variety of local companies, entrepreneurs, various experts and the occasional government official. The picture that unfolded was a country which has reached a medium-term peak in construction activity with all segments of the property sector either overbuilt or on their way, and significant infrastructure construction having already taken place. If correct, this will have significant implications for construction related commodities such as steel and cement, and for the Australian dollar.

We have previously written about the take-off in residential apartment starts compared to sluggish sales. In China, the business model for developers is to use proceeds from pre-selling the apartments to fund construction, however, a pre-sale certificate is not issued until several floors of the superstructure (the rules vary by city) have been built. Surveying the cities as we travelled through them, there were an extraordinary number of building sites where little activity appeared to be occurring. Certainly crane movements were hard to spot, and trucks rolling into or out of the sites, the usual cloud of dust and the noise of construction work, often seemed to be absent! Of course, one should put a low value on this type of anecdotal observation, but through the course of our meetings over the week it was generally accepted that construction had slowed substantially. So it would appear that many developers, having rushed to build to the pre-certification level in the hope of selling down their land bank and improving their balance sheets, have not been able to make adequate pre-sales to keep the site moving along and for the moment are stuck with half built sites and plenty of debt.

However, this is not really news as markets have been concerned about a slowdown in construction activity since mid-2011. The general view has been that once the pain from the slowdown became great enough, that policymakers would unwind the restrictions on lending to property buyers, and soon enough it would be ‘back to the races’. This does not appear to be happening quite on cue. Indeed some people we talked to see the central government as having taken a philosophical view that residential property was an ‘end user’ asset and not for ‘hoarding’; terms that were mentioned a number of times in property related discussions. The expectation is that measures will continue to aim at restricting how much property individuals can accumulate and capping price appreciation. This points to a much slower recovery in activity in this important sector than might otherwise be expected.

Elsewhere, the retail and office property markets look well on their way to significant oversupply. In Chengdu, we heard from one of the major international property agents, that three million m² of A grade office space is expected to come on the market in the next three years. This compares with current annual take up of around 250,000 m² of office space. Of course, take up of new space might accelerate as rents fall, but still there will be significant vacancies for some time to come. In the retail property market, the pattern has become one of ‘winner takes all’, with the malls that attract the right tenants (Zara, H&M, Apple, Uniglo, and Muji at the top of the list) receiving significant foot traffic, while those next door, without the name tenants, receive a fraction of the traffic. In Chengdu, this hasn’t stopped developers starting work on up to 2.6 million m²of retail space which will be delivered over the next two years. This new supply alone would put Chengdu in line with typical European countries in terms of mall space per capita. Interestingly, construction continues on these office and retail projects, presumably because funding is in place, but ultimately at some point the looming oversupply will see a significant cutback in activity.

The other area of concern is infrastructure, where one can observe the number of airport terminals, rail lines, roads, bridges and tunnels, which were simply not there when visiting these cities several years ago. Getting a sense of how much is enough is difficult, but one Yunnan government official responsible for infrastructure development remarked that the major road and rail links in his province were either complete or on the way to completion. In the short-term, funding has become an issue because infrastructure projects have traditionally been funded via the sale of land to developers!

Construction activity is typically estimated to be around 10% of the Chinese economy, though some would argue it is potentially closer to 25% when one includes the industries that supply goods and services to this sector. Clearly a slowdown in construction will impact headline figures such as GDP growth, but for some fast growing industries we would expect any impact to be muted. For example, many consumer related goods are likely to continue to grow at good rates even in a downturn. The country is in the process of rolling out a nationwide health insurance system that should help underpin the growth of the healthcare industry. We would expect the growth of many internet related businesses in China would be barely, if at all, affected by a construction slowdown. If there is a simple message, it is to avoid investments that will be driven by Chinese construction and look elsewhere.

At the end of our trip we made a detour to Burma (Myanmar). The country sits in a strategic position, potentially connecting China and Indochina to the Indian Ocean by road and rail, cutting transport times significantly to markets in Europe, and for that matter, India. In particular this would be the case for Western China where goods are typically shipped to the coast before being exported. The country is well endowed with natural resources and pipelines will connect the region to Burma’s (Myanmar’s) oil and gas reserves. The country also has significant potential to develop as a tourist destination.

The political change that has taken place in many respects seems too good to be true. However, there does appear to be evidence of real change taking place with monopolies being broken-up and senior military officers being arrested for corruption. Ultimately though, the most important development has been Aung San Suu Kyi’s endorsement of the changes taking place through her participation in the recently held elections. The key to the country’s economic development will be the lifting of the US and EU sanctions that is expected post a fair and free election. This potentially opens the way for significant foreign direct investment. Though there are no significant ways of investing directly in the country, it is likely that many of our Thai companies, in particular the banks, will derive some benefit from the development of their Northern neighbour. 

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