China Real Estate: NOT a Good Time to Speculate

Stephen Chung

Managing Director

Zeppelin Real Estate Analysis Limited

November 2007

This is because the return to risk ratio has become less appealing for relatively short investment timeframes. For instance, if one invests $100 and gets to profit $50 or lose $50 say in equal probabilities, then the return to risk ratio would only be 1. Naturally ratios less than 1 are worse. Then what is a good ratio? There is no fixed answer yet subjectively perhaps something like a 2 would be better i.e. winning > losing.   

For clarity, first your humble author is only saying NOW is not a good time to be speculative, not all the time. Second, he is not against speculation provided it is done say professionally in the broadest sense of the word. Also, speculation confers a sense of short investment timeframe yet adjectives such as short, medium, or long term could mean different things to different people. To avoid confusion, here we define it as a timeframe less than 3 years.  

Then what is a better or more appropriate investment timeframe for now? Say 5 to 6 years or better still, in an idea sort of way, 10 years. TEN YEARS?! Some of you would probably be screaming by now, who have such patience? Nonetheless, real estate development and investment to some extent are usually long term endeavors and do not speed up just because we do not have the patience. If one wishes to speculate on China real estate in this ¡§round¡¨, they should have started earlier say in 2004 or even 2001 (read our past article = Double your Money by Investing in Beijing and Shanghai Real Estate written in August 2001 10 years is also necessary to capture the ¡¥golden years¡¦ which are subjectively expected of and offered by a few markets in years to come; the impatience will not be able to benefit from these, nor will be the easily scared.  

Still why a timeframe less than 3 years is not desirable? This is because the risk has overall increased for the less patient investors. Do note this is NOT the same as saying that real estate prices will not go up (they will likely continue to go up at the time of writing this article), it is just that the return will be matched by a proportionately increased risk. And why do we think in this way? Here are the angles: 

A)    Relative Pricing Angle = while China real estate markets are not the priciest in nominal terms compared to other markets in the world nor are they the most bubbly, they do nonetheless belong to the proportionately pricey category when compared with other markets in the world. How much proportionately pricier? Say by 30% to 50%. Some may argue that e.g. Shanghai real estate prices are still only a fraction of London but this misses the point that when adjustments come to London, Shanghai would be affected too keeping the differential between them more or less stable within a certain period.  

B)    Good Fundamentals Angle = some investors think that the strong China reserves, the high saving rates, the reasonable employment rate, the increasing income, and / or the 2008 Olympics would prevent any significant price adjustments from occurring. This always appears sound reasoning BUT similar descriptions could have been used to argue way back in 1997 that Hong Kong asset prices, despite being then sky high, would not suffer much from any financial adjustment or crisis. Naturally we know the answer now = having a lot of money in the system with lots of wealthy folks will NOT help avoid financial crises. One reason is because investors do not enter the market to save it from falling but to profit from it. As long as a profiting expectation remains absent, not even the billionaires would invest let alone the common folks. In any event, much of the current good fundamentals are brought by the US$ printing press leading to an oversupply of cash (against assets). 

C)    Technical / Trend Angle = especially with residential real estate, there does not appear to be a worrisome oversupply situation based on a number of new units to number of households measurement. However, there could be product mismatches and non-equilibriums in some markets. On a price to income basis, the price incremental rate is more or less matched by a comparable income incremental rate although one may always suspect the price to be out of the income range to begin with. However, some markets appear to have faster increments in recent years which mean the volatilities have become bigger which in turn implies higher risks.   

D)    Market Sentiment Angle = whether via published information or via business encounters with some Mainland businesses, it appears that many, if not the majority, in China are not only very optimistic of China economic prospects (count your humble author as one too), they are also thinking in a straight-line up fashion (count your humble author out), yet markets seldom behave linearly up or down.  

Summing up, notwithstanding upward price trends, the time has come for considering the issue of [profit x frequency x probability] versus [loss x frequency x probability], i.e. their respective total impacts.


Notes: The article and/or content contained herein are for general reference only and are not meant to substitute for proper professional advice and/or due diligence. The author(s) and Zeppelin, including its staff, associates, consultants, executives and the like do not accept any responsibility or liability for losses, damages, claims and the like arising out of the use or reference to the content contained herein.                                

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