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Shanghai’s residential market has proved very resilient to the cooling measures enacted by the Chinese government. While the rate of price growth has slowed from the dizzy heights of 2009, market indicators remain positive and capital values grew by 2.1% in H1 2013. This is despite an underlying slower economy, higher deposit requirements and restrictions on second home ownership.

By comparing rental value growth (an indicator of occupier demand) to capital value growth (signalling investor demand) we can evaluate the underlying occupier demand for housing. While capital values in Shanghai have risen by 148% since 2005, rental values have grown by just 15%. Yields stand at just 2.4%. This leaves a wide gap between rents and capital values, suggesting that rental growth has a long way to go before a more sustainable ratio is reached.

It is apparent that Shanghai’s future prosperity as a financial centre is already fully factored into real estate values, which have been driven by extraordinary domestic demand from a wealthy population with few other options for investment.

A growing tenant base and corporate occupier demand from the city’s burgeoning financial industry will underpin future rental value growth, but it will be some time before rents catch up with capital values. Any rebalancing will also be complicated by investors’ tendency to leave new property vacant to avoid the ‘new car effect’ – the sharp depreciation that follows the occupation of any new property in China.

While regulations have not had a meaningful impact on suppressing market demand, measures designed to increase land supply and limit price growth through increased housing delivery will probably be more successful over the longer term. This option is not available in many of the more land-constrained of our world cities but is expected to increase Shanghai’s supply.

China’s residential markets are too important to the economy for its government to allow any major price corrections. Real estate investment accounted for 11% of China’s gross domestic product in 2012 and affects over 40 other industries. Careful tinkering at the market’s edges is thus likely to continue.

Taken from
Insights: World Cities Review - H2 2013

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