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A Reality Check For Shanghai Real Estate


Six months ago, Shanghai's property market was the hottest on the planet. The story was compelling: the most dynamic city in the most dynamic economy, with affluent Chinese from both the mainland and abroad eager to pour their capital into the latest deal. Even foreigners were getting into the act: Morgan Stanley () was part of a $90 million real estate fund for Shanghai, and individual Americans were plunking down their bucks for Shanghai flats and houses.

The whole world, it seemed, wanted in on the game. Who cared if speculators were buying and selling apartments within days? Prices had been clocking 30% annual increases from 2002 on.

Today, says local real estate agent Anthony Ip, "the situation has reversed completely." Ip recalls how developers once would hang up on him if he dared to question the price of a new property. Now desperate developers are offering perks like free parking spots, country club memberships, and even free autos as incentives. Not only have prices of some luxury apartments dropped by as much as 30%, but sales volume is off by 70%, say Ip and other agents.

Shanghai is the latest victim of the government's effort to cool a rocketing economy. Last year, Beijing made it much harder for consumers to borrow to buy cars: The result was a sharp downturn in the auto market. Now it's real estate's turn. Ever since Shanghai's government slapped a series of taxes and other levies on real estate transactions in June in an effort to rein in speculation, prices have been sliding.

How serious could things get? Very serious, according to Credit Suisse First Boston's () Dong Tao, chief economist for Asia ex-Japan in Hong Kong. He reckons mortgages account for 40% to 50% of all bank lending in Shanghai and that Shanghai property lending accounts for a fifth of all mortgages countrywide. A Shanghai crash could slam China's already shaky banks. Property generated about one-quarter of Shanghai's 14.3% growth in gross domestic product last year. Moreover, while Shanghai accounts for just 5.4% of China's GDP, a crash could have a ripple effect. "It affects demand for materials and electronics, insurance and mortgages. It's the source of fiscal revenues and consumer confidence," Dong says. "If we see a major dip in Shanghai it will be a substantial risk to the national economy and the global commodity market."

Within the city itself, the drought of property sales has put a damper on what might be called the hustle economy. Some 4,000 small property agencies have closed their doors in the past three months. Speculators who bought flats by the half-dozen with the notion of flipping them have been left holding the keys -- stuck with empty properties and big debts to the banks.

FOREIGN PLAYERS

The optimists argue that in the long run, Shanghai property remains a good bet. The city of 20 million is a magnet for migrants from all over the country, and a favored destination for foreign companies establishing or expanding their China presence. Foreign institutions such as the Netherlands' ING Bank (), Macquarie Bank of Australia, and Morgan Stanley have all made multimillion dollar investments in residential property in Shanghai. "Sure the market is soft," says Tim Grady, managing director and head of Morgan Stanley Real Estate Fund for Asia Pacific, which is an investor in a high-end apartment complex called Jinlin Tiandi, in trendy Xintiandi. "But we believe the long term is still positive -- driven by continued urbanization."

Yet in the short term, property developers have had to pull out all stops to entice buyers. In the past the flats that developers sold were empty cement shells; the buyer was expected to install his own wall paneling, flooring, and appliances. Now developers are offering finished flats equipped with kitchen and bathroom appliances, air-conditioning, and even suites of furniture. "It's fiercely competitive," says Timothy Addison, managing director of corporate finance and development at Hong Kong developer Shui On Land Ltd. Addison will give you a deal on an apartment at his Rainbow City Apartment complex: $1,840 per square meter, down from $2,215 in March.

As in every real estate bust, buyers are waiting for prices to fall further, while sellers are unwilling to make additional cuts for fear of fueling the downward spiral. "There's a liquidity vacuum," says Alan Zhang, CEO of AnJia Group, a Shanghai mortgage services provider. He says his company's business has fallen off 80% in recent months.

So who's going to blink first? Most observers figure it'll be the developers, who will keep slashing prices until business picks up. Even before the downturn, margins had fallen sharply in the wake of a big runup in the cost of construction materials such as steel, cement, and aluminum. Land prices also shot up after the government in June, 2003 introduced a process under which government land is sold through public auction rather than in backroom deals.

Some contrarians are still out there. One U.S. lawyer, who asked that his name not be used, paid $896,000 for a 700-square-meter villa in late September. "It's a good buying opportunity," he says. Will others follow his lead? Traditionally, October is a busy month for buyers, who use the Golden Week holiday to house-hunt. But should Golden Week prove a bust, Beijing may start talking up the market to restore confidence. "If prices fall more than 30%, it will point to negative equity" for mortgage holders, says Kenneth Tse, property analyst for Morgan Stanley. "That's not something the government wants to see."

By Frederik Balfour in Shanghai


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