Recent rules will mean more paperwork for foreigners buying property in China, but foreign investors won't be put off China's residential property market, says apartment buyer/manager Paul O'Driscoll

----By Mark Godfrey

It sounded too good to be true. Apartment blocks sprouting like crops of beanstalks across boom-time China were proving a great place for a motley crew of thrifty European policemen, doctors and teachers to park hard-earned savings. But then too many investors spoiled the soup, and on July 24 Beijing regulators announced a raft of new measures to restrict foreigners' property purchases and cool a real estate sector they feared was getting too hot to handle.

The government worried that large-scale purchases of residential property by overseas investors, including financial institutions, were keeping housing prices high in Beijing and Shanghai. Institutions had previously been allowed to invest in Chinese real estate through companies registered abroad. Although these companies paid more tax than foreign enterprises registered here, they could also repatriate rental revenue more easily. From now on anyone buying property in China for personal use will have to be resident here for one year. Circular 171, as the July regulations became known, sounded like bad news for someone like Paul O'Driscoll, whose firm, Asia Investors, has been guiding European investors - some of whom have never set foot in China - in investments of anything between EUR90,000 and EUR200,000 for 60- to 90-square-metre slots in new Chinese apartment blocks.

Yet a week after the July 24 announcement, O'Driscoll is looking out over Beijing's central business district on a hazy summer's day - and he's smiling. After spending hours poring over the new regulations he's not so worried anymore. "We will have to rethink our services," he says, looking to the future. "Rather than a straightforward purchase, foreign investors will now have to set up and register a company here which will hold the property and pay taxes. We had a couple of clients who had purchased apartments, but that sale couldn't go through in time. We're already setting up a company for them now."

Here for the long haul

O'Driscoll is also convinced his clients - mostly private European citizens with enough cash to spare for an apartment or two - weren't the target of the government's regulations. "The new rules were certainly not an anti-foreigner move as has been suggested. The target is large-scale speculation by Hong Kong and Taiwan investors, and mainlanders using Hong Kong investment vehicles.

Now developers are spilling the beans on how much and how they were selling. O'Driscoll points to a commercial-residential development he's been eyeing in downtown Beijing. "The developer, whom I've dealt with often before, told me that 40 percent of this particular apartment complex has been sold to customers from Hong Kong or Taiwan. But some of those investors are Beijing people with Hong Kong bank accounts."

Following the trail of money heading into China's residential real estate market - which accounts for only 12 percent of foreign investment in local real estate - O'Driscoll established Asia Investors in Beijing three years ago to buy and manage property for Europeans in China's capital. A steady growth clip in China's GDP figures over the past decade was logic enough for the Irishman, a computer engineer by training, to open an office in Beijing.

Asia Investors is growing, as O'Driscoll takes on staff to handle the extra paperwork which Circular 171 will demand. He's here for the long haul, but reckons the new rules will weed out the competition. "A lot of real estate agencies got worried when they heard the news. They thought the game was over. But if you are a serious agent it's not going to be the end of things." The new rules mean tax on real estate deals will be collected more efficiently, since buyers will be registered foreign-owned companies. "It's going to be easier to collect now. Some people bought with cash on the mainland and had rents paid into their Hong Kong bank accounts without any tax being paid. Now you have to pay your taxes, but that is a non-issue with our investors. These are serious people, they don't want to be caught fiddling around."

Ultimately, then, Circular 171 will mean more paperwork, but O'Driscoll has decided it's a pain worth bearing for quality foreign investors. "The long-term effect should be that the real estate market will be better regulated and property tax will probably be lower overall for everyone because now more people are paying their taxes."

Ironically the short-term effect of the regulations may however be a price increase, hardly what the government wanted. "Developers producing mass-market housing were often relying on family connections in Hong Kong and Taiwan to get cash, so now that it is more difficult the supply of housing will be cut and prices will climb." In the six months following the announcement, O'Driscoll predicts, investment from overseas will drop 60 percent, before climbing again in the subsequent six months. "But in the long term, yes, the new rules will take some heat out of the market."

A love affair with land

The repercussions of Circular 171 are being felt outside the capital, too. In the pretty northern coastal city of Qingdao, rows of new seafront villas have been snapped up by Singaporean, US, and overseas Chinese businessmen who have been in China for years and acquired several properties. They're just the kind of people property consultant Jeff Weidenborner sees as clients. And the real estate advisor and founder of Sienna Real Estate appreciates their plight. "It's hard to get money out of China, so many put it into real estate and the prices have gone up and up."

But buying residential real estate in China is not such a good investment, says Weidenborner, who spends most of his time brokering commercial floor space for corporations. "Buying apartments doesn't make sense for foreign investors because it simply takes too long to recoup your investment in rent. A lot of foreigners ask about buying but usually end up renting. Americans tend to look very closely at what they call the cap rate - that's how much you can get back on your investment in rent every year. In the US you'd expect to get 10 percent of the investment back each year. In China rents are so low it doesn't make sense, unless you're expecting house prices to keep rising and down the road you sell."

That's just what locals - with comparatively few other decent investment options for their money - are doing. Local speculators drive prices more than foreigners, and will remain unrestrained, says Weidenborner, who ought to know. He may have to move from his RMB5,000-a-month, 180 square metre ocean-view apartment, minutes from Qingdao's new Olympic Sailing Centre. His landlord bought the apartment four years ago for RMB8,000 per square metre but plans to sell next year for "not less than RMB20,000," he says. "He sees all the right signs. An InterContinental hotel is going up nearby and the government is busy shifting polluting industries out of town."

The landlord will probably get the price he seeks. Loose foreign money may be drying up, but prices in Qingdao are holding. "Price increases have slowed down very much, but to buy is still very expensive," says Weidenborner, pointing to a minimum RMB13,000 price tag per square metre set for the twin towers built in Qingdao recently by locally based Hisense corporation. Though a recent DTZ report showed that 93 percent of foreign investment in China's property market is flowing to Beijing and Shanghai, there's been a major push by foreign corporations into second-tier cities in the last couple of years, notes Weidenborner.

That gives foreign investors more choice, whatever the speed of recouping their investment in rent. Back in Beijing, Paul O'Driscoll is on the phone with a new sales pitch to clients in Europe. Beijing's makeover for the 2008 Olympic Games is reason enough for anyone to buy here, he says. "Beijing is becoming a better place to live and work. We will have the newest rail connections, the largest airport terminal in the world, new schools and hospitals, roads and telecommunications ..."

O'Driscoll has plenty of faith in China's future. "In investing, a well-established trend is your friend. The Chinese, like us Irish, have a love affair with land and bricks. All over Southeast Asia tens of millions of overseas Chinese also invest heavily in real estate. China is getting richer and they are investing their money in real estate - it is likely that they will continue to do so. This trend is the investor's friend."