Voluntary Report - public distribution

**Date:** 10/14/2004

**GAIN Report Number:** CH4826

CH4826

**China, Peoples Republic of**

**Solid Wood Products**

**Shanghai Housing Update**

**2004**

**Approved by:**

![](media/image1.wmf)Ross Kreamer

U.S. Consulate

**Prepared by:**

Ralph Bean

**Report Highlights:**

Shanghai\'s housing prices increased by up to 30% in 2003, leading to
widespread concern over a real-estate price bubble, but estimates for
2004 to date indicate that price increases are slowing. The dynamics of
the housing markets are changing, with young professionals becoming an
important factor. The Chinese government and the government of Shanghai
are both implementing a number of regulations and policies that are
likely to affect housing markets in the future, which will in turn have
a profound impact on demand for imported wood products both for interior
and exterior use.

Includes PSD Changes: No

Includes Trade Matrix: No

Unscheduled Report

Shanghai ATO \[CH2\]

\[CH\]

Table of Contents

[Summary Page 3](#summary-1)

[Toil and Trouble (the real estate bubble) Page
3](#toil-and-trouble-but-is-there-a-bubble)

[Young and Restless (new home buyers) Page
3](#young-and-restless-shanghais-new-generation-of-home-buyers)

[Turning the Key (turnkey housing) Page
4](#turning-the-key-the-growing-market-for-finished-housing)

[Regulating Chaos (new policies and regulations on real estate) Page
5](#regulating-chaos)

[Cleaning Up (rules to improve opacity and reduce speculation) Page
5](#cleaning-up-market-reforms)

[Cooling Off (policies to slow economic growth) Page
6](#cooling-off-slowing-growth)

[Get Out of Dodge. Please. (suburbs and satellite cities) Page
7](#__RefHeading___Toc85536563)

[The Villa Blues (cooling down the market for high-end villas) Page
8](#the-villa-blues-high-end-housing)

[Serve the People (policies to support affordable housing) Page
9](#serve-the-people-affordable-housing)

# Summary {#summary-1}

Shanghai property prices rose at breakneck speed during 2003, leading
many to conclude that a real estate bubble exists. This has spurred a
rash of policies and regulations designed to limit speculation,
stimulate production of medium and low-end housing, and channel more
development to suburban districts. These policies are likely to have a
substantial influence on the city's long-term development and demand for
housing and decorating materials. There are a number of emerging trends
that are also changing Shanghai's housing markets, and will influence
the markets for both structural wood and interior wood products in areas
well beyond Shanghai.

# Toil and Trouble -- But is there a bubble?

![](media/image2.wmf){width="4.571653543307087in"
height="3.0484251968503937in"}The immediate source of concern is
property prices. Most sources agree that prices have increased far too
quickly over the past two years, but opinions differ as to whether a
bubble exists. Price increases for 2003 are estimated at between 23% and
30%. Raw materials prices were undoubtedly a factor, as the price of
cement, for example, rose some 20%, adding fuel to the notion that
China's rapid economic growth was creating inflation. Some sources argue
that, while perhaps rising too fast, the jump in prices was a necessary
rebound from weak markets that developed during the Asian Financial
Crisis of 1997/98. During that time, a large number of high profile
building projects went bankrupt, and construction ceased. The unfinished
hulks have dotted some of Shanghai's priciest downtown districts ever
since. Only recently have markets recovered to the extent that many of
these unfinished projects have been refinanced and are now underway
again. Most will reach completion within the next year or two.
Supporting the notion of a bubble is the large amount of unfinished
housing being purchased and re-sold by speculators, as well as the
high-profile presence of out-of-town buyers in Shanghai's real estate
markets. Recent developments have many experts backing away from the
notion of a real-estate bubble. Most now expect prices for office space
to remain stable for some time, before they start rising again, although
home prices are expected to remain strong.

# Young and Restless -- Shanghai's new generation of home buyers

Anecdotal evidence indicates that many speculators have cashed in during
recent months, and moved on to greener pastures (Chongqing is now
rumored to be the hot market for real estate speculators) without
causing prices to drop. Statistics for the first five months of 2003
indicate a slowdown in real estate prices but not a collapse, as prices
for office space appreciated by less than five percent. Residential
property prices are expected to continue rising for the near term. The
municipal government has also stepped in with various measures designed
to limit real estate speculation. More importantly, many sources
indicate that the buyer profile for residential property is changing, as
young professionals have replaced wealthy speculators as a market
driver.

![](media/image3.jpeg){width="3.0131944444444443in"
height="2.140277777777778in"}

## 

# Turning the Key -- The growing market for finished housing

Young buyers are also helping to fuel markets both for turnkey housing
and interior decoration materials. Chinese housing is traditionally sold
on an unfinished basis, as a concrete shell. Buyers are responsible for
installing internal plumbing, doors, flooring, etc. This is commonly
referred to as 'decoration' (not to be confused with 'interior
decoration' as used in the West). Although this gives buyers
considerable say in how their apartment looks, the home-finishing
industry is a small-scale, makeshift affair, plagued by fly-by-night
operators. Homeowners must often hire different contractors for
different parts of the job, and watch carefully to make sure that the
materials specified (and paid for) are the materials that actually get
used. Unscrupulous decorating companies can avoid the consequences by
shutting down and re-opening under another name. In an attempt to
address these problems, the Chinese government several years ago
launched a turnkey housing initiative, that would gradually shift home
sales to a finished basis. The assumption was that builders, being
large, well-established companies, would be more accountable for
quality, and that economies of scale would reduce the costs of
decoration. Buyers seem to regard turnkey housing as a good idea, with
over 43% favoring it, and 35% of Shanghainese planning on buying a
finished home. Shanghai has served as the test case for this project,
launching its turnkey housing initiative some two years ago.

Two years down the road, the initiative continues, although it has hit a
few snags. By 2010, the government expects some 80% of housing to be
sold on a finished basis---later than original target of 2007, but
impressive for such a large-scale change. The key problem appears to be
the market structure of the decorating industry. It was initially
expected that large-scale demand from developers would force
consolidation of the decorating industry, with a small number of large
decorating firms coming to dominate the market fairly quickly. In
reality, developers have awarded decorating contracts on a lowest-cost
basis to large numbers of small decorators, and the results have been
poor. Lowest-cost contracting has created savage competition in a race
to the bottom, with little incentive to ensure quality. Even large
developers have a hard time guaranteeing the quality of decorators'
work. It appears that this is beginning to change however. One of
China's largest builders, Vanke, has announced a deal to source building
supplies exclusively from a foreign joint venture materials supplier,
B&Q. This, at least should help to ensure the quality of the materials,
and the presence of a single large supplier on one end and a large
developer on the other should help to spur further consolidation among
the decorators.

Interior decoration constitutes a massive market in itself. According to
housing officials quoted in Shanghai Daily, the average cost for
decoration of new or refurbished homes in China is RMB 800/square meter.
(New home sales in Shanghai for the first 6 months of 2004 amounted to
14.7 million square meters). Shanghai is a particularly good market for
interior decoration, owing in part to the growing number of young
homeowners who are more willing to spend their money. In the first six
months of 2004, homeowners in Shanghai spent an average of RMB 669 on
interior decoration for existing or new homes: 36.5% more than Beijing
and 18.2% more than Guangzhou. Foreign invested home-center stores have
capitalized on this trend, with the two strongest players being B&Q and
OBI. B&Q has stores in Shanghai, Suzhou, Kunming, Shenzhen, Kangzhou and
Beijing, with plans to open 10-15 new stores per year, to reach a total
of 80 stores by 2008. OBI has stores in Shanghai, Suzhou and Wuxi, with
plans for a total of 100 stores. Since most homes in urban China are
apartments, these stores act less as do-it-yourself outlets than as
wholesalers to China's myriad small decorating companies. The potential
of this market has not been lost on ATO, which is planning a promotion
for U.S. interior wood products with the American Hardwood Export
Council and the American Forest and Paper Association at one of the
major home center chains.

# Regulating Chaos

China's government has taken fears of a price bubble seriously as part
and parcel of its broader concerns about an overheated economy. While
Shanghai real estate may have slowed down somewhat, the city's overall
economic growth hit a blistering 14.8% during the first half of 2004,
far above targets in the range of 7%. Both the national and local
governments are pursuing policies that will have a major impact on
housing and decoration markets. At the same time, the city of Shanghai
is pursing a number of regulatory reforms that are designed to address
deficiencies in the market mechanism, including opacity in pricing and
the lack of low-income housing. Following is a general roundup of recent
policies and regulations on housing and land use that may have a
significant impact on wood products markets.

## 

## Cleaning Up -- Market reforms

![](media/image4.jpeg){width="3.0208333333333335in"
height="2.4208333333333334in"}

Some of the most effective reforms are being pursued by the Shanghai
municipal government in an effort to clean up the notoriously opaque
real estate market. For land sales, the first step in the reform effort
was the move to open bidding. This was done to address abuses wherein
developers offered favors to local officials in exchange for sweetheart
deals. Since most deals were concluded off the books, no effective
market for land existed. Following a series of controversies, Shanghai
switched to open bidding in July 2001, well ahead of the rest of the
country. Putting developers into direct competition, often for the first
time, open bidding led to an immediate rise of as much as 30% in land
prices in some districts.

For housing, most of these reforms are aimed specifically at
speculators. Shanghai officials blame speculators for a significant
portion of the inflation in home prices, stating that 16.6% of new
housing sales are speculative deals. For new home sales, developers are
now required to post all relevant information on the sale on the
internet, including the price. Trading is limited to the hours of 8 AM
to 10 PM, and a further project is underway to create a standardized
contract for home sales, which can be downloaded from the internet for
free. These measures are all designed to eliminate dodgy practices in
which entire blocks of housing are sold overnight before regular bidders
have an opportunity, with the homes re-sold days later at a substantial
markup. The same regulations now restrict the re-sale of unfinished
apartments, and restrict buyers from taking out more than one mortgage
at a time. The city is also hoping to eliminate the practice of
'overbooking' in which home buyers provide a down payment, but are later
informed that the house they were promised has already been sold.
Ultimately, Shanghai is pressing for aggressive consolidation of the
real estate industry, with the current 4,000 real estate firms declining
to some 200, which would provide both a more coherent market, and
simplify the task for regulators.

Another set of regulations is designed to improve the living environment
within the city, but could also have a significant impact on future
development. The most important of these are the building height
restrictions, first announced in September, 2002. Building height has
become a concern, not just for reasons of quality of life, but also
because they are blamed for the subsidence that has become a significant
problem in Shanghai. At the start of 2003, Shanghai had 4,916 buildings
over 18 floors, with over 2,000 more under construction. The new
regulations will limit the net plot ratio of buildings within a single
property to 2.5 for residential areas and 4 for business districts. They
also include requirements for green space and adequate parking. The
short-term impact is not likely to be significant. Property leased
before the regulations were adopted has been grandfathered in---an
enormous exception, given the number of leases for future construction
that have already been signed. To get an idea of how large this
exception is, it is useful to note that leasing for buildings over 30
floors ceased in 1999, yet as of June 2003 587 plots were still slated
for construction of buildings more than 30 floors tall, based mainly on
prior leases.

## Cooling Off -- Slowing growth

![](media/image5.jpeg){width="2.9118055555555555in"
height="2.18125in"}[]{#__RefHeading___Toc85536563 .anchor}

Get Out of Dodge. Please.

## In fact, relocation and development of satellite cities and suburbs are another part of the government's policy. There can be no doubt that, at 20 million people, Shanghai is overcrowded. According to the Shanghai city government, downtown Shanghai now has a population density three times that of Tokyo. The government's objective is to increase per capita living space from the current 17 square meters per capita to 25 square meters by 2020. One of the methods proposed for doing so is quite simply to move some of the people out. The city government has announced plans to reduce the city's overall population by over 1 million, and the downtown area by 500,000. This population is to be absorbed into suburban areas.

In reality, the market is already doing much of the work for them. Even
within the city of Shanghai, real estate prices vary considerably
depending on the district. During the first five months of 2004, prices
in the downtown Puxi district climbed by 5%, compared to 1% for the
Pudong district across the river. During that time, construction of
additional bridges and tunnels has made locating in Pudong more
convenient than ever. This advantage is further cemented by the fact
that most of the space available in the suburban districts is new
relative to that in downtown areas. The most recent, and favorable,
trend in these suburban districts is custom-constructed office space in
office parks, built to the needs of the customer. For residential
construction, major developers have already moved to the suburbs, where
more land is available. These developers are, under some pressure from
the government, building entire communities including schools and other
public facilities. China's largest home builder, Vanke, builds almost
exclusively in suburban areas due to insufficient land for the
integrated communities it specializes in building.

![](media/image6.jpeg){width="2.4451388888888888in"
height="3.2597222222222224in"}Suburbanization is actually just the tip
of the iceberg. Although cheaper than downtown, even the suburban
districts of Shanghai are expensive by Chinese standards, and there are
limits to how much additional population they can absorb. Many
businesses are now opting to move further out to neighboring cities: the
Yangtze Delta is home to numerous large and prosperous cities, many of
them within one or two hours' drive of Shanghai. Infrastructure
throughout the Yangtze Delta region has improved to the point that there
is little wanting in any of these cities. Transportation is also good
enough that it can actually take less time to travel from one of these
cities to Shanghai than it does to drive from one part of Shanghai to
another. The process of out-migration has actually been underway for
quite some time: costs in the city of Suzhou, a short 1-hour train ride
from Shanghai, have already risen to the point that some businesses have
moved less than an hour down the train tracks to Wuxi.

Though not new, this migration is now getting a boost from the national
government. China has launched an initiative to draw labor out of the
countryside without overburdening the major cities, by establishing new
cities. This policy has been on the drawing boards for a long time, but
the government now appears to be prepared to put its money where its
mouth is. A planned community is under construction near Suzhou, and
will be the flagship and model for this policy. When completed, it is
designed to house 700,000 residents and accompanying businesses. The
Chinese government is going to great pains to ensure that this flagship
community is a state of the art development. It also appears to be
committed to use this as a model for environmentally-friendly
development, and is including substantial green space and public
facilities in the design. ATO has already identified this project as one
with great potential for U.S. exterior wood products, and a U.S. company
has won contracts for wooden footbridges and other outdoor wood
products.

## The Villa Blues -- High-end housing

![](media/image7.jpeg){width="2.9in" height="2.165277777777778in"}

With such strong incentives to build villas, the city government has
found it difficult to get developers to back off, and villas have
continued to sprout up throughout the Shanghai area. Faced with such
resistance, the government finally, in 2003, declared a ban on approvals
for villa developments, making it clear that no additional land would be
made available for villas in the Shanghai area. This is not as drastic
as it sounds, since existing approvals were grandfathered in, and
include enough land to allow a number of developments to be built before
land runs out. In addition, the ban does not include nearby parts of
neighboring provinces. These areas have also passed land use
restrictions, however, which have dented villa development, particularly
for vacation homes. The restrictions are designed both to restrict
overdevelopment and to protect the environment. The Suzhou district
government, for example, declared all islands in Lake Taihu (a famous
scenic lake near Shanghai), to be natural resources, off limits to
developers. This restriction caused prices for existing villas in the
area to double in less than one year.

Villas are not the only housing projects being affected by land use
restrictions. The government in general is taking a much more aggressive
stance on the loss of agricultural and natural land to developers.
Increasing restrictions on land use also mean that less land is becoming
available, and land purchases fell by 19.5% in 2003. Much of the land
that is likely to become available within the city in the future will be
freed up through the demolition of older neighborhoods. This land, too,
comes with limits, as the city is becoming more aggressive in seeking
compensation from the developers on behalf of the former inhabitants of
these neighborhoods. Reforms to land sales practices are also likely to
hit land-intensive villa development harder than higher-density types of
housing.

## Serve the People -- Affordable housing

![](media/image8.jpeg){width="3.261111111111111in"
height="2.451388888888889in"}