Shanghai Promise

It’s difficult enough to invest successfully in domestic residential real estate when you think you understand the local market, so common sense would suggest it’s a great deal more difficult again speculating in Chinese housing.

That’s not deterring a new entrant in the crowded investment marketplace from trying to convince Australians that buying one-bedroom serviced apartments in Shanghai is worth the risk.

We don’t present the accompanying interview with David Cunningham, managing director of Shanghai Vision as a recommendation, but as an example of the increasingly exotic range of investments on offer in a world flush with cash and always searching for something different.

The core of the Shanghai Vision pitch is that Shanghai will continue to boom and therefore so will the better end of its housing market. With the “China story” a constant in our economy, punters might see real estate as a means of gaining direct exposure to China’s economic growth.

However, as many of the world’s major corporations have found to their cost, investment in China is not a simple business. At the real estate level, some astute and well-informed investors have done very nicely during the global housing boom, but there are also horror stories of projects going wrong in a country whose legal and banking systems lag a long way behind ours.

The interview

Michael Pascoe: Shanghai Vision is obviously cashing in on the investment interest in China in general but why residential real estate in Shanghai?

David Cunningham: Residential real estate has higher yields than commercial. Commercial yields are at 4.5% where residential is at 7%, and because it’s 7% it’s a cash flow positive investment.

Those yields in Shanghai can be a lot lower than that in over-supplied areas.

Yes. On Zone 1 you’re correct and Zone 1 is very high demand with expatriates as well as the white-collar worker, whereas in the other zones it’s lower demand. That’s why we only deal in Zone 1. Shanghai being a population of 19 million people, there’s huge, huge demand.

The 7% yield is positive as long as you can borrow for less than that.

That is correct. The mortgage rates in Shanghai and China are 6.1% so money is cheaper than here in Australia at 7.3% on average.

But there’s a danger of interest rates rising in China.

Absolutely. Like other economies in the world, interest rates are variable and there’s no fixed mortgage rate so that is a risk.

There’s also a risk in an individual buying real estate in a market that they may not understand, that they’d probably have trouble doing due diligence on.

Correct. And, like if you were buying interstate in Brisbane or in Western Australia, you have to conduct some due diligence and even more so if you’re going abroad. That’s where experienced real estate people are critical '” not only to use them to buy the property but also to investigate via them on the value of the property, on the realistic nature of getting your tenants and also on any currency fluctuations that you might be exposed to.

Your website doesn’t really spell out Shanghai Vision’s position. You’re marketing a development for a developer in Shanghai?

No actually we’re buyer’s agents. We’ve worked with 10 different developers on 10 different projects. We never work with the same developer. The reason is because of integrity. If we work with one developer, for example Capital Land or somebody, we’ll sell whatever product they put in the markets. We don’t think that’s very good because if the market is outside of Zone 1, in Zone 3 or 5, we don’t believe that that product is strong and so we are independent from the developers.

So you get no commission, no nothing '¦

That is correct.

'¦ property development '¦

Yeah. So like a tax accountant or solicitor, any of those three and they charge a professional fee so do we in Shanghai Vision but we work on behalf of the buyer.

Well what fee do you charge buyers?

It’s 11,000 Aussie dollars. A flat fee, yeah.

One of the things missing on the website is an indication of how much the properties are.

Each project is different depending on the area and the size. On average between $190,000 and $230,000 for a one to two-bedroom apartment in Zone 1 Shanghai, near a metro station.

That’s in Padong, the new financial district in Shanghai. The ones you’re selling on the website at the moment look like they’re going to be one-bedroom managed apartments.

It is indeed, yep. It’s one of the serviced apartments. Because of all of these expats in the city and working for JP Morgan, Morgan Stanley, Goldman Sachs '¦ whomever '¦ they would like a 12, 18 or 24-month lease so serviced apartments are in high demand.

This deal involves signing over to an apartment manager rental returns, guaranteed rental returns, of only as good as sometimes a $2 company backing them up. It’s a lot of faith to put in what someone on the other side of the earth that you may not have much legal recourse to.

Yeah. We don’t put [fees] on them. We conduct a due diligence. My background is risk management in J P Morgan, the investment bank, so I know that if the background of the company that is guaranteeing is weak then the guarantee is weak so we asset-back our guarantees so if they default on the rent we sell carpark spaces or we sell the commercial property that this developer has.

So you’re saying you have a mortgage over the developer?

Yeah, absolutely correct. Now we believe in the strengths of the developers we work with and their ability to rent in these areas because they’re prime central areas, but just for a bit of extra security we asset-back them.

That would be a difficult thing to do in Australia let alone in China.

Absolutely. We work with the number-one law firm in China. They won the award again this year for real estate, the Zhong Lun law firm, and their expertise is in that, so yeah we rely on them.

There’s a big leap of faith to buy off the plan in China. Some buildings there don’t get finished and people are left in limbo for years.

The Government were aware of that and they’ve addressed it. It’s now illegal to sell off the plan in China. Before you get a sales licence the development has to be 70% complete. The health and safety and quality authorities come in, conduct a review. If there is a lack of quality they don’t issue the sales licence. If it’s coming up to the standard they issue a sales licence and then you can sell. So off the plan is illegal; pre-completion is OK. It will be 30% left to complete.

That 30% is still a risk though, isn’t it?

Yes it is. But we mitigated 70% of the risk.

As part of this deal is it compulsory to retain Shanghai Vision as an agent after the purchase?

Optional. We do have three companies. We have the buyers’ agents to allow you to purchase property; we have a mortgage broking company to facilitate a mortgage in China; and then finally the asset management company, which allows you to get rental and to manage the property. If anything happens you don’t have to fly to Shanghai. We act as your power of attorney for you. We pay your taxes. A 5% tax on rental income. We guarantee or ensure that it’s insured via Royal & Sun Alliance or one of these companies annually because you can’t insure for longer periods. So it’s these type of services that we provide, yeah.

Five percent rental tax, a 10% of rent management fee, is this still cash flow positive?

Yes it is. Absolutely. Because the 6.1% '¦ you’re paying that mortgage on 70% of the price whereas the 7% yield is on all of your money, is 100% of the price.

That’s a gross yield, that’s not a net yield?

That’s correct. Yeah. So it’s still cash flow positive.

As long as you don’t count the opportunity cost of that 30% deposit?

Correct yeah.

So who are you renting them to?

It’s 95% local wealthy Chinese. It’s not the expat population driving it all. It’s people coming in from the west and the south going to Shanghai because that’s the new financial capital.