In 2016 China’s leader Xi Jinping famously stated that houses are for living, not for speculation. Now, through a regulatory reform pilot program in Shanghai, Beijing is signaling that industrial land is for industrial activity, not speculation or other purposes.

The Shanghai regulatory reforms, introduced in recent months and expected to be extended nationwide in some form, target the industrial land secondary market where investors have enjoyed some freedom to make speculative investments, but have often used opaque means such as equity transfers to skirt land use laws and other regulations.

Such speculation and rule bending has led to mismatches between industrial land supply and demand, market data inaccuracies and other problems, the upshot being inefficiencies in utilization of industrial land resources. With the recent years’ decline in China’s property market raising the importance of industrial production as a core source of employment and tax revenues, such industrial land use inefficiencies are a natural target for reform.

The new regulatory framework

The Shanghai reforms promote more efficient industrial land utilization by preserving overall supply, stabilizing prices, and preventing excessive speculation. Specific measures include:

• Price controls: transaction prices in the secondary market must now remain within a ±20% range of comparable industrial land transaction prices in the same area during the same period. If the transaction price falls below the -20% limit, the government has first right of purchase; if it exceeds the +20% limit the transaction may be disallowed.

• New mandatory transaction platform that must be used for any transfer of industrial land parcels in the secondary market. The platform has a comprehensive range of functions and is intended to improve transparency, efficiency, and transaction security while providing professional support services to market participants.

• Transfer approval requirements: both whole-site land transfers and equity transactions resulting in a change of controlling shareholder are subject to review and approval by district governments and relevant authorities. Transferees must align with local industrial development priorities, and changes to the designated industrial use of the land are strictly prohibited.

• Valuation guidelines: new, clearer guidelines for the valuation of industrial land used as collateral will prevent unreasonable overvaluation.

• Leasing management: Shanghai is also exploring the establishment of a standardized rental pricing system and a mandatory leasing registration mechanism for industrial land and facilities.

Uneven impact on businesses

The new regulations will benefit some companies, while forcing others to change strategies or exit the country.

Those that stand to benefit include any firm that requires actual production and R&D facilities. These firms may enjoy new advantages such as land parcels and existing properties that are more favorably priced and easier to buy or lease, reduced entry barriers and stronger government support.

Yet the reforms will increase pressure on companies whose business models rely primarily on land appreciation, or for whom industrial-to-commercial land conversion is a key strategy. Such firms could be investment holding platforms, land banking entities and certain other types of businesses with limited manufacturing or operational requirements. These may see their profitability significantly constrained under the new framework.

Strategic adjustments required

The greatest impact, it seems, will be on industrial real estate investors such as industrial property developers, industrial REIT investors and land investment funds. Historically, the development model for such firms was:

Acquire Land → Hold for Appreciation → Transfer

The new reforms will accelerate an existing trend that sees this model changing into:

Acquire Land → Develop → Operate → Generate Rental Income

In other words, Shanghai (and in the future China at large) appears to be transitioning industrial real estate use from a Development Model to an Asset Management Model. Those developers that thrive as asset managers are those with:
• Tenant attraction and leasing expertise
• Industrial ecosystem services
• Long-term asset management performance

We also note that the new reforms mean greater risk for companies holding undeveloped land, and their greatest risk is probably not the reform initiative’s price controls that have dominated public discussion on the topic. It is, rather, that they may now be confronted with more milestone assessments and more pressure to make progress on development. Such firms may see more frequent and strict performance evaluations, production commencement requirements and potential land recovery measures.

For these landholders, the central question is no longer: “Can I sell the land at a profit?” but rather: “Can I justify continuing to hold the land at all?”