China’s Shopping Mall Bubble: Free Rents to Attract Tenants

In China, a massive oversupply of shopping malls has led to significant vacancy rates that has prompted developers to offer select tenants free rents.

From Bloomberg:

Chinese landlords are forgoing rent and paying to outfit stores for mass-market fashion brands including Zara and H&M, a bid to blunt the impact of a boom in shopping-mall construction that threatens to push up vacancies.

Preferential leasing terms were reserved until recently for luxury brands such as Louis Vuitton and Gucci, which are coveted because they bring shoppers into malls. Now moderately priced labels are being enticed with offers as landlords work harder to fill shops, according to Cushman & Wakefield Inc. and RET Property Consultancy Ltd.

Consumer demand is cooling as China’s economy slows and President Xi Jinping reins in lavish spending by officials. Big mall operators, including China Resources Land Ltd. (1109)and Hang Lung Properties Ltd. (101), can withstand the slowdown at the expense of smaller ones such as Golden Eagle Retail Group Ltd. (3308), according to Credit Suisse Group AG and Haitong International Securities Ltd. Landlords focused on lower-tier markets will be under more pressure as smaller cities add retail space at a faster rate than larger ones.

The race to build malls have been based on the same flawed premise of inexhaustible funds by consumers:

Chinese developers built more malls and expanded into smaller cities as consumer spending and incomes grew, elevating China’s economy to the largest in the world after the U.S.

Half of the 32 million square meters (344 million square feet) of shopping centers under construction around the world are in China, according to CBRE Group Inc. (CBG) About 21 million square meters of retail space is expected to be completed by next year, a 38 percent increase in supply, according to broker Cushman, which tracks 20 cities in China.

Hardly mentioned here is how  developers were misled into projecting an eternal boom: negative real rates.

I would also suspect that many developers may be owned or affiliated with State Owned Enterprises (SOE) or even local government owned corporate vehicles as part of the political race to pad up localized economic growth via statistics.

Now, the stunning surge of vacancy rates:

Second-tier cities, including Chengdu, Shenyang, Hangzhou and Qingdao, may be stuck with the highest vacancy rates in 2014, according to Cushman. The financial hub of Shanghai, the capital Beijing and the southern industrial cities of Guangzhou and Shenzhen are considered the first-tier cities.

Vacancy rates in some less affluent cities could surge to more than 30 percent by next year from as low as 6.8 percent in the first quarter this year, Cushman forecasts.

There has been no mention of the mechanics of the financing of China’s shopping mall building spree. Although I would suspect that both the banking and the shadow banking system played a big role.

And rising vacancies points to growing risks of insolvencies or bankruptcies that would hit developers, banks and shadow banks, as well as, the many other industries connected to them. If the leash effect becomes large enough, then this may metastasize into a crisis.

The hissing sound from China’s shopping mall bubble looks like a neat guidepost for the Philippine version.