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RTNominal down9.950 -0.090 (-0.896%)
Research Report

04/11/2020 17:21

China developers' foray into commercial property positive

[ET Net News Agency, 4 November 2020] Growth in China's US$2.3 trillion (2019 sales)
residential property sector is waning after years of stellar expansion. This is
encouraging some traditional developers and operators to invest further into commercial
property, according to a report published today by S&P Global Ratings titled, "China
Commercial Property: Incumbent Advantages Today Suggest Credit Strength Tomorrow.".
S&P believes China's established entities and higher-rated developers are best placed to
take advantage of this increasingly critical market, and that success in commercial
property will emerge as a key ratings enhancer.
While rental income comprised less than 2% of the total revenue of developers in 2019,
the commercial sector is growing in importance, particularly to S&P's rated portfolio.
Indicatively, commercial property accounted for 14% of all money invested in newly built
property in China in 2019.
"We see a growing relationship between rental income and credit quality," said S&P's
credit analyst Fan Gao. "Rental income is of a higher quality than development revenue,
which is lumpy, cyclical, and susceptible to policy shifts."
Companies with a large rental base and healthy pipeline are more likely to secure the
lowest funding costs. This feeds a virtuous cycle, as those firms go on to build more
rental properties, giving them a bigger base of high-quality recurring revenue to borrow
yet more, at ever cheaper costs.
Commercial property is a tough sector to crack. It requires substantial upfront
investments. Developers may not be able to flip the properties on completion. They may
instead sit on the assets for decades, slowly earning back their investments through
rental income, with the investment taking up precious space on their balance sheets. All
the while, players may need to fund residential land replenishment and further investment
in commercial properties to match investors' growth expectations.
"We believe the best capitalized, best managed, and highest-rated entities will thrive
in the commercial property market. We also see feedback mechanisms where the most able
players get stronger, while the weaker ones encounter an increasingly tougher path," said
Gao.
The COVID-19 lockdowns lasted just one to two months in China, even in the worst-hit
regions. Landlords offered rental concessions for only about as long. COVID hit retail
properties harder than offices, given social-distancing measures and lingering consumer
hesitation amid low wage gains and rising unemployment.
S&P expects retail rental reversions to be mildly positive in 2021. The year-on-year
growth of total retail sales started to turn positive in August. Consumption is slowly but
steadily climbing out from their pandemic troughs.
The country's recent retail history shows that good bricks-and-mortar players can
prosper even as the online sector booms. Online sales in China have climbed more than
fourfold in the past five years, hitting a penetration rate of 28% in 2019 from only 10%
in 2014. Rated companies' retail rental income also expanded threefold in the same period.
For many years now, developers have been busy with the lucrative job of turning over
residential sales. Many viewed with skepticism the more difficult and less immediately
remunerative task of assembling a commercial property portfolio. Most accumulated
commercial properties incidentally--they picked up commercial assets here and there from
the purchase of residential land that spilled into commercial zones. (KL)

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