Sunday, March 1, 2009

A Property in Shanghai - Inspirations

On the Saturaday I went to an open-house in the Zhong-shan Park in Chang-ling area of Shanghai City. The developer is 麗新. Offical mortgage provider is Hang Seng Bank (China).

There is a big gardern at the middle of the complex with the full-facility club house. Underground parkade is located under the garden and each parking space is sold separately from the suite. Surroundings are a famous gigantic shopping mall with 3 subway lines intersected. Office towers (one of which locates Accenture's Shanghai office) are in walking distance. Yet by heritage this area was used to be a mid-low class residential area only.

6 Blocks were all sold and fully occupied on phase 1 around 2007-Oct. 3 blocks of Phase 2 has been on sale ever since 2008-April.
The units on sold are of the sizes 100sqm and 145sqm. By the drawings provided and actual inspection, the utilization rates (excluding even the balcony) are 78% and 84% respectively.

The indicative price are as follows:
1. Floor 1-5: RMB25,000/sqm
2. Floor 5-10: RMB25,000-27,000/sqm
3. Floor 10-25: RMB27,000-29,000/sqm
4. Floor 25 up: RMB29,000-32,000/sqm

I have checked the rental prices of similar suites in the surroundings. For apartment unit of an area around 140sqm at the middle high storey, the rental will be 12000RMB/month (tax included). It is about 86RMB/sqm/month. Therefore, rental return is about 86x12/28000 = 3.68% only.

While in recent time the Shanghai property in the same area should have decreased by 10-15% according to the statistics, there are new properties, like this one, have their price level stayed high and rigid. Is there any reason behind it?

Let me do a wild guess.

This apartment's phase 2 started selling on 2008-April, and phase 1 started half a year earlier which was on 2007-Nov. Usually it took 1.5-2 years to complete the construction of the complex. Therefore, construction should start around 2005 Nov to 2006-May. By practice it will take 1-1.5 year to complete the feasibility studies to land bidding and mobilization process. Hence, the land should be bought around the period of 2004 May - 2005 May. During that period, the land at that area should be priced around RMB6,000-8,000/sqm. Construction cost is RMB3,000/sqm, including interior decoration. Assume another RMB1,000/sqm for general administration and promotion, then the total cost, per land base, is RMB10,000 - 12,000/sqm.

Simply by the utilization rate of 78 - 83%, the actual selling price for the available-to-sell area can be around RMB14,400 - 15,400/sqm. Now, by the time they sold the units, the average price of such complex in such area has already escalated to RMB29,000-33,000/sqm. Thus, the units should have generated a profit margin of 88.3% - 129%.

With reference to the developer, the occupency rate is 100% of phase 1, 15% of phase 2. Thus the total occupency rate of the entire complex (as phase 1 is equal to phase 2), will be 50% + 7.5% = 57.5%. Assume the developer has exaggerated by 20%; an actual occupency rate of 46% is recorded. Therefore the actual profit margin is in the range of -13.3% - 5.4% based on the selling price for the available-to-sell area. If we calculate in the actual cost being distributed on every bit of the area, the profit margin is in the range of 11.1% - 51.8%.

On the other hand, recently the transaction volume is low, and the anchorage price has not dropped since 2008. The insufficient transaction will allow the developers which have sufficient cash in hand to continue a high-price policy without risking of losing market shares. Also, the low volume of selling, amidst a worsening environment, cannot be altered with a lower price (since the interest of purchase depends not on the price but on the willingness of the potential buyers).

From the little analysis shown above, the motivation for the developer to lower the price is not sufficient. The marginal profit gained by lowering price for larger volume is not sufficient to cover the marginal cost. Furthermore, the developer, just by the previous sales, has already earnt sufficient profit (to please the investors) and cash flow to sustain further operations. For developers with similar financial strength, most of which are from Hong Kong, may be able to hold off for a longer period and even make bigger profits during recovery.

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