There's a reason why the hawkers outside Shanghai Central Station shake their heads and move away when you tell them you're going to Hefei. Sure, it's scenic there, but who wants to go to an Anhui backwater? So while they push tickets for spacious, futuristic looking buses plying the route to Hangzhou and Suzhou hourly, there's the lone option of an evening train west to Hefei.

It takes an unfeasible 11 hours to get to the western outpost by train, at least seven by car. That's the catch-22 faced by corporate real estate managers scouting locations in China: businesses won't go where there's no transport; and until there's business there, no one will be willing to run a decent bus or train service.

Although the Chinese economy has doubled every 10 years since 1979, the lion's share of activity has been concentrated on the east coast. With less than 1 percent of China's land and 5.8 percent of its population, the Yangtze River Delta accounted for close to 20 percent of China's GDP, 22 percent of taxation and 35 percent of imports and exports in 2005.

Those kinds of figures excite investors and governors alike. New Horizon is the kind of company most industrial parks in China like to see coming. The American-German joint venture chose the east coast city of Suzhou for its entrance into Asia, after charging consultancy firm Deloitte to scour all of China for suitable sites. "What we were looking for in a site was to be near our customers and well serviced by utilities," explains Michael Arthur, plant manager at the venture, which makes hygiene products.

New Horizon also wanted to be in the Yangtze Delta "because it's central to Asian markets. We had to follow our customers here, and we want to serve the Asian market." Since the firm will be exporting much of its Suzhou output, the company demanded bulky warehouses and sturdy loading bays be added to the buildings. "We wanted everything on one site so we bought a big piece of land and started with 11,000 square metres in phase one." Cost wasn't an issue, says Arthur. "We were more concerned about customer needs and to be able to sell in local currency."

But there's another reason why well-travelled investors like Arthur settle in Suzhou. "My wife's opinion matters. We have to live here!" says Arthur about his choice. His company's neighbour in Suzhou, Crown Equipment, could have gone to several regions around China, but similar reasons drew the Ohio-based firm to Suzhou, after a long search.

Convenient ports and Suzhou's good conditions for expatriates kept the firm from going inland for cheaper land and labour, says Mark DeGrandchamp, the company's director of quality and overseer of the firm's move into China. "The farther west you go, the infrastructure and utilities are less stable. The majority of zone managers don't speak English." Crown narrowed its options to three industrial zones, and in the end opted for a 135,000 square foot site to house 150 employees at the Suzhou New District.

The world's number-one manufacturer of electric fork lifts, Crown came to China to stave off local competition on its hand-pushed electric carts. Rather than lose valuable clients like major retailer Wal-Mart, and unwilling to outsource, the firm's conservative background made transparency and decent infrastructure priorities in choosing a site in China. The company also wanted to be close to suppliers and ports. After short-listing 27 industrial zones in seven provinces and visiting seven of the zones, DeGrandchamp settled on Suzhou.

More demand than land

Phil Schneider, partner at Deloitte Consulting, is used to advising the likes of New Horizons and Crown. "Puxi is as far west from Pudong as many US and European companies are prepared to go!" he jokes. But things are starting to change. "Key coastal areas are oversubscribed," says Schneider. "Thus, costs go up on all their supply lines - or they go to the interior. A lot of areas there are starting to get action but can't even come close to what's on the east coast. Some of the zones there are taking in 200 to 300 investment projects a year, and they're running out of land."

With more demand from investors than spare land, east coast industrial zones can afford to say no. "It's a sellers' market," says Schneider. "The pressure is on investors to get into the zones quick if they want to be in." In its searches, Crown, too, found its options limited by zones that could afford to be choosy. Even though the firm boasted US$1.6 billion in revenue last year, many locations in China didn't want to talk. "Forklifts are not an encouraged industry," concedes DeGrandchamp. Zones are getting "very, very selective" in what they are targeting, agrees Schneider. "They want brand names and non-polluting industries."

So why not go to Hefei? There's plenty of land and manpower - and the air is fresher than on the east coast. Land prices are certainly lower in the interior, judging by a scan of any national real estate agent's books. Rents of RMB1.2 to RMB1.3 per square metre per day in Guangzhou's industrial parks compare with RMB1.8 to RMB2 in Shanghai and RMB1.5 to RMB1.8 in Beijing's zones, according to Jones Lang LaSalle. Rents at state industrial parks in northerly Harbin and west in Chengdu average at RMB0.9.

But there are other challenges. Like Anhui, few interior provinces can boast the highways and airports of the east coast. Talent is also in shorter supply. "Managers are not as learned in interior provinces. It's very hard to find managers with experience in Western companies. You have to pay them to come out from east coast cities," explains Phil Schneider. But he quickly adds that the interior regions are developing talent fast. "Skilled technical labour is more available than ever around the country. There's an enormous number of graduates coming out of Chinese universities, so in three to five years there will be an awful lot of graduates with experience."

It's still easier on the east coast, but state-level parks from Chengdu to Urumqi are trying hard to get it all on site and deserve credit, suggests Schneider. True, amenities for expatriates just don't compare with Beijing and Shanghai. "There are no international schools there, so you pay more in incentives to expatriate staff." Rapid progress is being made in logistics and warehousing in lesser-known interior cities, a lack of which was long a cause for foreign investors to turn instead to the Pearl and Yangtze river deltas and to Beijing. And while Shanghai hosts almost 150 regional headquarters, and multinationals squeeze into Guangzhou's crowded industrial parks, China's government is lavishing cash on roads and railways so poorer regions get to dip their beaks too.

Key location

Former Chinese president Jiang Zemin's "Go West" policy in 1999 promised multinationals better infrastructure, urban services and environment if they'd only head west. Then China's entry into the WTO triggered the Northeast Revitalization Plan in 2003 to reinvigorate the industrial rust belts of Liaoning, Jilin and Heilongjiang provinces. Post-WTO opening of business sectors previously off-limits to foreigners - distribution, banking and insurance - is also driving investment inwards from the east coast.

"There are fewer restrictions on where you can locate and find joint venture partners," says Schneider. "Beijing and Shanghai are evolving into the New York and San Francisco of the region and welcome only high order economic activities. You have to ask where your client will be and if you want to be in a market where the competition is keen. It's a business decision." There are political considerations too, he adds. "If you're in the energy business, you need to be able to cross the road to see the minister."

Studies by the China offices of real estate agencies show nimble industries like IT and telecommunications are already shifting to second-tier cities like Chengdu and Dalian. They're also tugging amenities along with them. Perched by the sea, the lushly landscaped Dalian Ascendas IT Park offers a shopping centre, fitness club and kindergarten in buildings designed by a respected American architectural firm. Amenities have drawn big-name multinational firms. Tax incentives have helped, too. Like two years of full-tax and three years of half-tax exemption starting from the first profit-making year and a cut in income tax from 33 to 10 percent if export value reaches 70 percent of total production value.

"Incentives, particularly tax breaks, are still the number-one factor for investors in deciding location," says Alice Wood, senior associate director at the Beijing office of real estate advisors DTZ Debenham Tie Leung. "Land prices are a secondary consideration." Higher labour costs and turnover make labour more important in choosing a location. "Park authorities are targeting specific industries, but they are also looking for tenants who can generate a lot of tax revenue, employ a lot of people and bring suppliers or subsidiaries into the area."

Playing catch-up

So bring your heavy, not-so-fancy manufacturing and you'll get a good deal in most provincial cities - even though you may be far from a port - but smart second-tier cities are succeeding by offering industry-specific incentives to distinguish themselves to investors looking for preferential policies and large domestic markets. Deloitte's Schneider picks Chengdu and Dalian as proof that interior provinces can get their share of the action. "Dalian is really taking off. Chengdu has universities and amenities, and you could see direct flights to the USA from here soon. Cities do well because you can get there." Since opening in 1998, Dalian Software Park has drawn 37 percent of its tenants from abroad, among them Dell and Panasonic.

The capital of Yunnan province, Kunming, is also betting that better transport will mean more investment. A new international airport will be the country's fourth-largest when completed in 2008, and 200 kilometres of highway are being upgraded and stretched south to Vietnam and Thailand. The country has become a beachhead for ASEAN members seeking a way into the China market and for domestic and foreign investors keen to move goods in the opposite direction.

Amenities are coming, too. A new city on the eastern shore of Dianchi Lake, "set amidst mountains and water" and 15 kilometres from the city proper, is the city's joust at attracting international investment and tourism. The icing on the cake, the China-ASEAN Free Trade Zone, is set to open within the decade.

Companies like Crown Equipment, entering China for the first time, usually opt for the safety of first-tier and east-coast cities, with convenient air connections to the world. But as incentives for manufacturers are squeezed out of the east coast, so too is land availability. Finding a suitable building wasn't easy for Crown's DeGrandchamp. "We narrowed it to 17 buildings and 18 greenfield sites. Initially we didn't want to go greenfield but found that buildings here are built more for lightweight electronic assembly, so we had to build our own." A scarcity of vacant sights and a "mismatch" between quality of available buildings and demand from foreign investors was partly responsible for a 2005 decree from China's State Council demanding tighter control on land use, says Alice Wood.

Given that a government audit of industrial zones last year closed 1,000 illegal zones across the country, foreign investors in first-tier cities will have to be more careful about land use, warns Deloitte's Phil Schneider. "There are always new mechanisms to slow transfer of land. If you don't fulfil the investment commitments in your memorandum of understanding with the local authority, the land will be taken back."

Horses for courses

Cost-minded foreign investors seeking to expand out from the first tier to pick up skilled labour in less costly locations typically prefer real estate over greenfield sites, notes Alice Wood, "but while all cities provide land, the ability of local developers to deliver premises on time varies. The abilities of other vendors to supply services such as housekeeping and maintenance can also vary."

Different cities will win business for different reasons, but for comfort first-timers will stick to the tier-one cities. "It's horses for courses," says Wood. And even with the rise of new players like Chengdu and Dalian, the first tier is holding its own. With little new supply coming on stream, rents in Tianjin will stay strong - 61 out of 66 previously suspended projects are being reactivated - says Johnny Zhao at the Tianjin office of DTZ Debenham Tie Leung. He puts the reprieves down to "the upgrade of supporting infrastructure".

In Shanghai, rising land and labour costs have dimmed the metropolis's lustre in manufacturers' eyes. But the new Yangshan deepwater port and an expanded Pudong airport give the city the kind of logistical edge of which other cities can only dream. But the glass isn't half empty, says Schneider. "Think of how China changed in the past five to 10 years. That's how fast the interior cities can catch up."

Pros and cons

China's regions each have something to offer - and something holding them back

Shanghai's glassy Pudong financial district may be the number-crunching heart of China's economy, buffered by the awesome manufacturing power of the surrounding Yangtze Delta. It's also proof that China has become a collection of regional economies, each very different. Since Deng Xiaoping put China's economy on its way in 1978 by switching from a command to a market economy, Shanghai and the east coast have raced ahead. The country's once-proud industrial powerhouse, northeast China (Heilongjiang, Liaoning and Jilin provinces) however, has seen its share of national industrial output drop from a remarkable 17 percent in 1978 to only 9 percent by 2002. Thus the government's Northeast Revitalization Plan, launched in 2003.

Lacking the northeast's heavy industry and petrochemicals talent, western China's vast provinces (Gansu, Guizhou, Qinghai, Shaanxi, Sichuan and Yunnan, as well as the autonomous regions of Guangxi, Inner Mongolia, Ningxia, Tibet, Xinjiang and the mega-municipality of Chongqing) account for 71.4 percent of China's landmass, but only 16 percent of its total economic output in 2003. Rich in natural resources but hitherto lacking in infrastructure, the region has become the focus of a giant highway-building boom under the government's "Go West" campaign, formalized in 1999, with roads linking markets in neighbouring provinces and even next-door countries.

While the east is rich in cash and technology and the west has natural resources, central China is merely a bridge between the two, with coalmines, cornfields and plenty of workers. Cooperation, rather than competition, will drag the three laggards forward, suggests Wang Wenchao, mayor of Zhengzhou. As business costs on the east coast go upwards, investors are looking to the centre, he says. A glance at car making Wuhan city in central Hubei province is proof he has a point: it's become the Detroit of China.

Government strategies to ignite northeastern and western provinces share much in common: massive infrastructure projects channelling foreign investors to low-rent, low-tax industrial parks. There's also been more spending on education and on environmental projects such as reforestation and waterway protection. There are some suggestions that efforts are paying off: statistics for 2005 put Yunnan as the fastest-growing provincial economy in China, followed by northwesterly Shaanxi. Chongqing and Chengdu are opening up to foreign direct investment and capital from east-coast cities.

Clearing the path

The Construction Working Group, which in addition to construction and design also covers the property development sector, detailed its main regulatory concerns and recommendations for new policy in the EU Chamber's 2005 Position Paper last September. Although many of the Group's proposals pertain to construction, there was a clear emphasis on the need for allowing foreign property developers to register in mainland China as wholly foreign-owned enterprises. "There is currently no clear regulatory path for wholly foreign-owned property development companies to be established and licensed in China," the recommendations read. The Working Group also urges the Ministry of Commerce to amend the main relevant piece of regulation, commonly known as Circular 159, to allow foreign property developers' experience overseas to be counted when they enter the market. As it stands, Sino-foreign joint ventures must begin at the lowest level of qualification, regardless of the foreign party's history outside of China.

Tiers in heaven

EuroBiz speaks with Andrew Slevin, General Manager of property consultants Knight Frank Petty (formerly Chesterton Petty) about the western migration:

EuroBiz: Outside the first tier, where is office space taking off?

Andrew Slevin: We're certainly looking at places like Ningbo, Nanjing, Qingdao and Tianjin and seeing quite a significant improvement in the quality of the office buildings being built. Up until three or four years ago, most of the buildings in those markets were distinctly Grade B. We're now seeing genuine Grade A buildings being built. That said, rentals are still extremely low and it's still marginal to be putting up a Jin Mao Tower or something similar. We may see one or two of that type of building being put up more out of somebody's ego, but I don't think that makes sense economically at the moment.

EB: How does the current situation compare with a few years ago?

AS: We have places like Dalian, where there was massive oversupply a few years back. Now a lot of that has been turned around, and those buildings that were swimming in distressed assets are now being acquired and construction has been restarted. I think that's a sign of increasing confidence in second-tier cities.

EB: What about in cities away from the coast?

AS: Once you get inland, like in Chongqing and Wuhan, we're starting to see more interest there from foreign companies. Some are putting back offices there, some are seeing west China as a different market completely.

EB: What effect, if any, are the government's various cooling measures in first-tier cities having?

AS: Most of them were aimed at knocking speculation out of the residential sector. I think they've been very effective - we're seeing a lot of sanity return to the market. On the commercial and office side, there are much longer change periods, and as a result the office market is sort of countercyclical - the supply tends to lag behind the demand significantly. That works fine - we're seeing high demand and very low vacancies, and as a result, rents are under significant pressure. The downside is that when demand tapers off, you could end up with oversupply, but that's a cycle that's replicated in virtually every market.