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The Bubble has a BIG Hole – and now?

The Bubble has a BIG Hole – and now?

Markus Appenzeller

Since more than twenty years, I am regularly coming to China. Ever since I went there for the first time, there have been talks that the real estate bubble will have to bust anytime soon. Partially this misjudgement of both, locals and foreign experts was rooted in the sheer scale of the economic development the country saw that time and time again seemed unforeseeable. But in recent years, and especially in the last half year, these warning voices saw their foresight materialize. Evergrande – (one of) the biggest real estate developer collapsed and kicked off a downward spiral of a loss of customer confidence, falling house prices, uncovered loans and unsellable real estate that affects the entire industry. This process is ongoing, and it remains to be seen where and when it stops, but it shows that something is not working any more in the way it apparently did for four decades. Speaking to a number of developers, it seems they all are in search for a new model that will allow them finishing running projects and starting new ones. Obviously, market saturation has reached a level that makes it harder and harder to keep, let alone expand, the current real estate production. In the first tier cities of Beijing, Shanghai, Shenzhen and Guangzhou, there seems to be sustained demand for property for the same reasons there is demand in Europe: changing demographics and increasing individual wealth create space demand in these young places. In other parts of the country, the picture is bleak. Already now, huge complexes stand empty and the rapidly ageing population and the flight to the economic powerhouses do not create any substantial demand in the foreseeable future. What is true for housing is also the case for other property like commercial office, retail and industrial premises.

So, what to do now? I believe China needs a new model of urban development that embraces different principles. Where until now, most of the building production came in the form of repetitive typologies rolled out over large areas at the same time, now an incremental model is needed. This reduces the upfront cash that has to be invested, and subsequent phases can be funded by the income from the sales of the previous ones. The problem is, Chinese developers always tended to sell entire living environments. Buying an apartment did not only come with a certain amount of personal floor space, but also with a whole host of amenities and shared outdoor spaces. This was possible because all development had the scale of an entire neighbourhood. But selling community is much harder if those buying on early stages cannot be sure the community will ever materialize, or fall victim to a change in the market that leads to a stop of the further delivery. An answer to this problem could be to deliver community on the scale of individual buildings. After all, the 150 or 200 meter high towers are no small structures and mixing open space, sport facilities and other community amenities could be integrated into them, delivering a more diverse and interesting typology. With this approach, chances are high, that buildings can adapt much more flexibly to changing market demand: Small flats are needed? The next phase has small flats. There is demand for elderly care homes? The third phase is an elderly care home. The result would be a more diverse urban fabric, where the individual buildings become distinctive again and break the uniformity currently present in many of the city extensions.

With this approach also comes another principle: slowness. It might sound counterintuitive to many Chinese ears, since speed has been the hallmark of the country’s unprecedented development. But this neck breaking velocity simply does not work well in an economy that has reached a scale and GDP per capita where saturation effects are omnipresent. Speed comes with high risk of producing too much of the wrong thing. It also comes with repetition and uniformity since that is what enables it, and it tends to  do all things at big scale. Slowness on the other hand does not bear the same risk: over production can be controlled much more carefully. There is a likelihood that it leads to more diversity since adjustments can be made in shorter intervals, and the operational scale can be smaller.

All of this could also better serve the desires of an increasingly wealthy and individualistic clientele. However, implementing an incremental and slow development model will be challenging. Developers will have to invent new business cases and models of operation and move away from essentially selling the same product with different extra’s towards more specific product offerings that also include services. And  the public sector will have to significantly increase its capacity to manage smaller scale urban development. Many developers are sceptical about this outlook since they fear their profits will shrink and public officials to date are also cautious embracing that model, knowing that their role will become a lot more complex and planning for the public sector will become much more expensive. But Europe shows, that both, incremental and smaller scale and a relative slowness can deliver exceptional urban landscapes and allow developers to be profitable. The profits might not be as high as they were in China in the last three decades, but most likely, they will come to the conclusion that less and lasting profit is better than no profit. For the public sector things are a lot more complex. The budgets of many cities are to a large extent dependent on income from real estate operations. If there are less or no transactions any more, then they simply cannot afford to offer the services they are obliged to or want to offer, let alone invest more into their urban planning departments. I believe there is no easy way out, but one way could be to start levying annual property taxes from property owners based on the value of their property. While a hefty bill to shoulder, this would at least charge those most that profited from the real estate boom and lead to public finances that are a lot less dependent on a single industry and a lot more planable than currently is the case. Since about 20 years this in discussion within the Chinese government and there have been numerous pilots to test different forms of property tax across the entire country. That experience should now be turned into a nation-wide tax system, eventually with a series of steering mechanisms to encourage types of development that are desired and needed, such as social housing or elderly care homes.

But – maybe I am completely wrong, and the legendary Chinese inventory spirit comes up with something completely different, as has been the case so often in recent decades. Time will tell, and I will keep an interested eye on it.

by Markus Appenzeller

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When leaving the house in Shenzhen, one thing keeps striking me: I seem to only see green number plates. That

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