Investors Clamor
To Expand in China

Foreign real-estate investors are ramping up their activities in China's biggest cities, even though prices have risen and there are signs of a coming downturn.

The thinking is that Shanghai will beat out Hong Kong to become China's financial and commercial center and emerge as one of the world's great cities, on a par with New York and London. Investors in Beijing's hot market believe it will benefit from a pre-2008 Olympic boom.

And most recently, currency speculators have helped boost prices, snapping up real estate as they anticipate that China will ease its currency's peg to the dollar. That would drive the Chinese currency higher and raise the value of the investors' real-estate holdings.

It's a risky game. Skeptics argue that property values are rising too fast, outpacing personal-income growth among China's burgeoning middle class. Since 2000, residential prices in Shanghai are up an average of 85%. At the same time, rents have started to slide. Such an imbalance can't last, says Peter Churchouse, a Hong Kong-based hedge-fund manager specializing in real estate.

The upshot is that property developers accustomed to reaping 6% rental yields in Shanghai now are finding it difficult to eke out 3% to 4% gross, close to what real-estate investors expect in less risky markets, such as New York and London. Rents are unlikely to go up, Mr. Churchouse explains, as properties built to entice middle-class buyers increasingly become unaffordable.

Michael Hart, head of Shanghai research at Jones Lang LaSalle, says he has seen rents fall in apartments ranging between $1,500 and $5,000 per month. In one complex outside Shanghai, rents have dropped around 10% in three months, said David Zhang, an analyst at hedge fund Dynasty Asset Management.

Yet foreign investors are clamoring to expand in China. Although there is no exact calculation of foreign inflows into property, Mr. Hart says the available data indicate overseas investment is growing. In 1995, China real-estate investment totaled $38 billion, with a minuscule portion of that coming from foreigners, Mr. Hart says. By contrast, in 2003, $122 billion flowed into China's property sector, and a 2003 survey by the Shanghai government revealed that 5%, or about $6 billion, came from investors in Europe and the U.S., as well as in Hong Kong and Taiwan.

Shu Yin Lee, who manages a $25 million real-estate portfolio for Grand River Investments, says he isn't worried about having to pay two or three times what he paid in the past to acquire new properties in Shanghai. In his view, higher prices are justified because Shanghai's long-term prospects for becoming a world-class metropolis remain appealing. "In a way, we've taken the 'Real Estate for Dummies' approach," Mr. Lee says.

Many observers expect developers to manage risk by diversifying to other Chinese cities. "One of the reasons people are looking at other places is that the market in Shanghai is too crowded," says Mr. Hart. As for that city, he says, some developers who chose wisely will do well, while those who bought land and developed projects indiscriminately may struggle to see a profit.

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