Property services in an era of rapid development
Never has a city materialized at the speed and scale of modern Shanghai. From the dilapidated tenements, ancient warehouses and empty plots of Lujiazui district of 1994 to today’s mega skyscrapers that have become China’s financial center, the past 20 years have seen Shanghai transform into a world-class metropolis.
The sheer number of buildings constructed over this period has brought a wealth of opportunities to Western property services companies. Today, these firms are still growing, but a number of factors are reshaping how they operate. Slowing economic growth and the shifting structure of China’s economy are changing what types of buildings get built and new government policies are changing what is allowed, and where. In Shanghai, the more than 130 skyscrapers (buildings at least 150 meters in height) are pushing the limits of how much can be constructed on a finite amount of land; and the rise of local competitors in the property services field is bringing new challenges to Western firms in this once foreign-dominated field. On the other hand, a growing number of local clients seeking such services is providing a welcome source of balance. There are those who say the 20-year boom is coming to an end, but while many of these changes bring difficulties, they come with many opportunities as well.
Laying the foundation
Western construction and project management firms have been in China since the 1990s, and have significantly influenced the development of the sector. These companies typically oversee the entire process of a new structure’s realization, including design, permissions, the identification of appropriate contractors, finalization of specifications, monitoring of the construction process for quality and safety, and managing costs and schedules. In the early days of rapid construction, these services were not commonly used by Chinese developers and the clients of Western firms were almost entirely foreign companies expanding into China.
“The project management discipline didn’t exist here until just a few years ago,” says Phil Branham, president of B&L Group, a Shanghai-based, American-owned project management and consulting company.
Previously, the top priority for local developers was to keep costs low, build quickly and sell quickly. Important decisions were typically left to the contractors or not made at all.
“‘I want a compressor’ [an investor would say], and they would give a rating for the compressor, and then the contractor would supply it,” Branham says. “And then they would say ‘ok, we want a white paint,’ or whatever it is, and the contractor would supply it.” Contractors would then quote a price for paint and seek out a cheaper, inferior paint to boost their profit.
This created an environment where quality was far less of a concern than cost, and also left plenty of room for corruption and other problems along the way. With no one focused on optimizing the process of project completion, things like obtaining the required permits and overseeing specifications were often not handled in a structured way, leading to delays and inefficiencies. “The procedures you go through on a project with costs and schedule and quality and deliveries, those procedures did not exist here,” Branham says. “The investor was never sure of what stage they were in or if they were proceeding according to law.”
Today, property development in China is maturing and such services are in much greater demand. The market is shifting to a more long-term view based on asset quality. But it is a slow transition that has a long way to go.
“Historically it’s very much been a cost-driven market. It’s about build things quickly, and generally sell things quickly, because that’s how you make your money,” says Ray Chisnall, Asia Pacific regional director and China country manager at Gleeds, a leading global property and construction consultancy. “With property values doubling so quickly here, people make a lot of money by buying and selling. There hasn’t been the same tradition [as in the West] of seeing an asset that you are building for a 20-30 year life – and investing in it on that basis and maintaining it in that way.”
Gleeds established its first China office in 1994 and, Chisnall says, “for the first 10-15 years, all of our clients would’ve been foreign, because they understood the difference between cost and value.” But in recent years this has changed, and today Chisnall estimates that about a third of Gleeds’ Shanghai business comes from local clients.
Meanwhile, the “new normal” of slowing economic growth and China’s efforts to transition from reliance on manufacturing to an economy where domestic consumption plays a leading role has also had an impact. The shift away from manufacturing has been accelerated in Shanghai by government policies pushing such industries to the outskirts of the city to reinforce its role as China’s financial center. “There’s definitely been a reduction in the number of projects people have been doing,” Chisnall says.
One trend significantly impacting the property services business is online shopping. Chisnall refers to this as the dilemma of “bricks versus clicks,” where some retailers are choosing a smaller physical presence accompanied by a stronger online focus. This in turn has had significant repercussions for shopping malls, which in Shanghai were already suffering from high land prices and rental rates as well as oversupply.
B&L Group’s Branham adds that another significant challenge arises from the lack of reciprocity regarding investment flows between the United States and China, and hopes to see the proposed Bilateral Investment Treaty (BIT) and Trans-Pacific Partnership (TPP) agreement passed.
“Lack of reciprocity really hurts. It hurts our clients, which in turn then hurts us,” he says. “If we could get a reciprocity agreement, things would get better. It would allow Americans into more industries in China.” Nonetheless, Branham remains optimistic about growth in China, albeit coming from new directions. “Industrial obviously is down, so we’re going to have to shift a lot more resources into the high-end commercial area,” Branham says. “High-end commercial is going to become big for us, at around 50% of our business model.”
Office space on the rise
Growth of high-end commercial property has indeed been strong. Four new projects hit the market in central Shanghai locations in Q3 of 2016, with the corresponding 206,000 square meters of office space representing the largest quarterly increase since 2013. Although the new supply has temporarily caused the vacancy rate of Grade A office space to reach its highest level in several years, occupancy still remains above 90%. “On the commercial real estate side, if we look at the office standpoint, the occupancy rate in tier-1 cities in China has grown to a very healthy rate,” says Mario Qian, director of Occupier Services, China, for DTZ/Cushman & Wakefield.
While vacancy rates in lower-tier cities are much higher, DTZ/Cushman & Wakefield is continuing to expand its already large presence throughout China. “We have around 20 different branch offices,” Qian says. “We have covered almost 80% of tier-2 cities, and we would like to open another few offices this year.” While DTZ/Cushman & Wakefield’s expansion demonstrates their optimism, competition in the office services sector is intensifying, both from international firms and emerging local competition. “Recently we see some local Chinese real estate service companies,” Qian says. “They’re either coming from residential or they come from our competitors such as CBRE, JLL, etc.”
Despite the economic slowdown, the occupier services sector has also seen a rapid expansion of local clients. “Four or five years ago, 90% of the business came from servicing international clients,” says Michael Wu, director of Tenant Representation and Office Services for Colliers International. “But this year will be 50/50, and toward the end of the year I believe domestic companies may even exceed the business opportunity from international clients. It’s quite a shift.”
The shifting nature of work in many sectors and professions is also creating change. In many cities around the world, growth in the tech sector has increased demand for office space in trendier locations. In China, it is also common for growth to be focused into clusters of government-designated high-tech zones, although this has had less impact in Shanghai due to its role as China’s financial center, Wu says. Rather than tech sector growth, a recent trend impacting office space in Shanghai has been the rise of co-working spaces, with several of significance emerging in recent years.
Building the future
While the changes taking place in the property services sector are in large part the product of broader economic changes occurring in China, they are also the result of increasing maturity in these industries. On the construction and project management side, more local clients are seeking established professional services companies to oversee their projects as they transition from the old ways of quick-and-cheap construction to a more sophisticated approach of focusing on building value into the assets they create. On the occupier services side, at least in Shanghai and some other tier-1 cities, the increase in local clients is even more impactful as these cities shift toward more service-oriented economies.
Most of the challenges facing the property services industry are more about navigating change in a rapidly-evolving environment rather than the emergence of any sustained barriers to growth.
“Opportunity happens every day and everywhere,” Wu says optimistically. “It’s a very trendy thing. It goes along with the economy, it goes along with the marketplace, it goes along with government policy. No specific industry, we have different waves of market opportunity coming in. So we just have to be very adaptable.”