China Property: Where's the Cash Flow?
Have property investors in Shanghai forgotten the fundamentals of Real Estate?
It's uncommon to run into someone in Shanghai or Beijing who hasn't made a "killing" in the property market over the past decade, or even the last year. One of the world's hottest property markets has everyone buying into the long term vision that property in China's major cities will continue to rise for years to come. And who can blame them? With limited investment options, and savings accounts rates near zero, investors have had little choice to turn anywhere else besides property. Expats and locals can't get enough of it. Try and convince someone that it's not a good time to buy, and you'll get the same response; "Yeah, but, property in China is different." Let's take a look at a typical Property Owner who's done well for himself in property here in Shanghai, and upgraded his lifestyle along the way. His investments would look like this:
Let's Zoom in on the Cash Flow.
For me, it comes down to one thing: Cash Flow. I want my money making me money. That way, if I get capital appreciation, great! If not, I have an income stream that still makes it a sound investment. Let's take a look at Property #2 in the example above and assume the Property Owner is going to sell this property and I'm looking to buy it as an investment. First step for me when I look at an investment, evaluate alternatives:
Cash Flow grade: D.
For those who don't use a letter grading system. "D" is bad. On the brink of failing. I'm not impressed. I'm also assuming that I have no repairs, no taxes, no insurance bills, I have wonderful tenants, and it's always rented out. You're probably thinking by now, "Who cares, it's about the capital gains!" I know, I know. Since no one in China is buying for cash flow, let's view it from a capital gains standpoint.
1. Capital Gains - "This market is different". There are not too many investments I can think of where it's a good idea to buy something after it's already risen 200%, 400%, 1,000% over the last two to four years. There is no exception to this rule in my book. I don't want to be chasing profits. The last one to the party, usually has to help clean up.
2. Rental yields will increase - If that's true, and rental prices in Shanghai increase, then the cost of running the apartment/house will too. If renting costs go up, then I doubt it will still cost less than 100 RMB to get a plumber to come over to fix a burst pipe, which by the way happened to my 1 year old apartment... twice, once flooding 3 rooms. Luckily I was home. Construction quality is another point altogether.
3. Construction Quality - Ask around and it won't take long to hear of full blown repairs on apartments just a few years old. Luckily, labor is cheap to facilitate all these repairs. But again, if the capital gains are going to be there in these cities, then inflation in the cost of these repairs is going to be too. This is a risk to future cash flow! I know investors who've been stuck with $100,000+ (USD) repairs on homes in Europe and the States. Since Shanghai is expecting to be priced like those cities, then I expect future repair costs to be priced like them too.
4. Compared to the other major cities, we're still cheap - Dubia was too. But, I like this argument. My counter argument would be that if Shanghai, Beijing, Xi'an, and the rest of China were still good value compared to other cities, and you're betting on the future global powerhouse of these cities and the country, then you're better off purchasing value growth stocks like China Mobile (CHL), CNOOC (CEO), and China Life Insurance (LFC) especially if you already have 3 properties. For clients looking to purchase property and live in it for twenty years, that's a different story. But as an investment, if the property markets go down, I want the cash flow to be there. Property opportunities will always arise, but with negative cash flow, these investments can quickly turn into a nightmare.
China Property: Where's the Cash Flow?
By: Kevin Monaghan