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BOOM, INTERRUPTED

CHINA’S GOVERNMENT SLOWS BUILDING PERMIT ISSUANCE IN AN ANTI-CORRUPTION DRIVE

By Curt Hazlett

Shanghai, which is sometimes described as the New York City of China, may be the only place on earth that makes Manhattan look under-retailed. In the heart of downtown, five shopping centers occupy a short stretch of Nanjing Road East; a few kilometers away, another five stand side by side on Nanjing Road West. In all, nearly 40 centers dot the city.

Development in Shanghai — and by no means just retail construction — has thrived to this degree in part because the population of 13 million is affluent and growing. Shanghai is China’s commercial center and its wealthiest city, a place where Western luxury goods like Louis Vuitton and Burberry are commonplace.

But Chinese officials allege that there have been more sinister reasons for the building boom as well. Local developers and city leaders long scratched each other’s backs with shady deals and kickbacks, they say — practices that came to light last September when Beijing launched a far-reaching crackdown on local corruption.

Among the allegations is that Shanghai’s powerful leader, Chen Liangyu, a member of the Politburo, allowed the widespread investment of public pension money in real estate development projects, which is forbidden in China. The national authorities have detained Liangyu and many other city leaders.

These actions, coupled with earlier state efforts to rein in lending for commercial construction, have already resulted in some large projects being put on hold, and it is likely that the chill will continue. “It will certainly slow down development of large retail facilities that consume large areas of land and large amounts of investment. There’s no question about that,” said Shuguang Wang, a professor at Toronto’s Ryerson University and chairman of its geography department. Wang is a specialist in retail geography and has done extensive research on Shanghai’s retail development.

But a slowdown should not discourage Western companies looking to enter Shanghai. On the contrary, Wang and others believe that the government crackdown could provide an opportunity for foreign REITs, which have yet to establish a significant foothold in Shanghai.

“Western REITs began to enter the market only recently, and they really have lost the first-mover advantage, because the price of land has gone up so much,” said Wang. The earlier developers of shopping centers, he says, were mostly from Hong Kong and Singapore. “The problem is that many of these centers are still not making a profit, and the developers who built with bank loans know they are in trouble. They have to find other sources of money to pay back their loans, and many of them are now looking at buyers. They cannot afford to hold the properties anymore.”

That may be music to the ears of Simon Property Group and the Taubman Asia unit of Taubman Centers, both of which have announced plans to enter the Chinese market. “I see all the ebbs and flows of regulatory changes, crackdowns or intervention as part of a much larger structural evolution that will ultimately yield a more sustainable and predictable retail real estate market in Shanghai,” said Morgan Parker, president of Taubman Asia. “Retail sales growth will almost certainly continue, driving demand for more retail stores and thus absorbing existing real estate space and driving additional supply.”

The government’s action came as no surprise to Shanghai watchers. “This did not just happen,” Wang said. “This was already happening three years ago when the state government began discovering irregularities and started a large nationwide audit of all large retail projects in the country, particularly shopping centers.”

What government officials say they found was large-scale corruption in Shanghai in which choice development parcels were sold at below-market rates and public pension money was invested in a wide range of commercial real estate projects. Liangyu was accused of directing $125 million in public pension funds toward his son, a sports executive with involvements in real estate development.

Shanghai’s boom has in recent years produced signs of irritation among Beijing officials, who took steps to curb what they saw as speculative development. “When local officials lent public pension funds to developers to sustain the commercial development, that really angered the state leaders,” said Wang. “I don’t think the recent crackdown is intended to correct past problems, because many of these land deals were made five or 10 years ago. It is intended to punish the local officials who ignored state directives.”

Even before the government took action, it had decreed that all large Chinese developments were to go through a public hearing before government officials, community representatives and other retailers. Projects are rejected if more than two-thirds of those present oppose them.

In the wake of Liangyu’s detention, Shanghai officials have grown cautious about approving new projects, including some proposed by Western companies. One such is Saks Inc.’s announcement last spring that it would team up with Roosevelt China Investments Corp. to open a franchised Saks store in Shanghai’s Bund district in 2008. Roosevelt China announced in March that it had ended its agreement with a local partner, I.T. Ltd., and now hopes instead to open a Shanghai store in 2009.

The meteoric rise in development raises the question of whether Shanghai retail has hit the saturation point. In a 2006 case study of shopping center development in Shanghai, Wang and two Shanghai-based academics note that 37 shopping centers had been built in the city as of the end of 2005 (the first of those, the 500,000-square-foot Shanghai Square, opened in 1993) and that 30 more were under construction.

The study says that the financing for some 65 percent of those centers came from overseas investors, almost all of them ethnic Chinese from Southeast Asia. The centers range from small, “flea-market style” centers to full-size regional malls, the most recent of which are similar to Western lifestyle centers, according to the report.

Wang says the fast development has left some areas of downtown Shanghai saturated with retail, Nanjing Road being but one example. “The developers all say they are making money, but the information I have is that they don’t,” he said.

The overbuilding is especially pronounced in the hypermarket sector, where France’s Carrefour, Germany’s Metro and Thailand’s Lotus are slugging it out for market share. “Shanghai has too many hypermarkets,” Wang said. The city’s 2000-2004 economic plan called for limiting the number of hypermarkets to 60, but there are now about twice that many in operation. “Obviously the planning is not working,” he said.

To Wang, it seems clear that Shanghai retail is headed for a shakeout — not unlike that of the city’s stock market, whose stumble in late February sent markets plunging around the world.

“The less-efficient will be eliminated, and we will see consolidation,” Wang said. “Weak ones will be acquired by stronger ones, and we will see a trend of mergers and acquisitions. Retail is always very competitive in Shanghai.”