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By Roger S. Cline
Spring 1996 -

Shanghai, China's largest port city, has re-emerged as the country's financial and commercial capital in its drive to establish a market economy. Once known as the "Paris of the East," Shanghai stands at the mouth of the Yangzte River, a broad transportation route to the interior. Historically, Shanghai has been a city of extensive industry and commerce. Today, this city of 14 million people is fast becoming a financial and commercial magnet for the world's fastest growing region -- creating a strong counterpoint to Hong Kong's dominance and the part it continues to assume in Chinas trade and commerce.

Since 1949, Shanghai's industrial base has diversified from an earlier emphasis on the textile industry, and the city is also taking its place as an important retail center. A key factor that will positively influence future growth, and also benefit Shanghai's vibrant hotel sector, is the city's recognition that it must provide a functioning community to support it. A huge infrastructure development program has been launched with a focus on highways, bridges, metro and power projects.

Pro - Development Economic Zones

China designated Shanghai an "open" city following the promulgation of a series of pro-development economic policies in 1984. Several development zones were established in the city, the most important of which was Hongqiao, located on the southwestern fringe of the city in the direction of the airport. This area -- designed to attract foreign investment and occupancy -- has generally been the focus of new commercial development since the mid - 1980s, acting as a distant counterpoint to the city's traditional commercial center. Four international class hotels have been built in this area since 1988 in the vicinity of the International Exhibition Hall and Shanghai Municipal Palace.

In the late 1980s, an additional area -- twenty times the size of the original three development zones -- was designated to become one of the most significant commercial real estate development zones in China. Pudong, an enormous 350-square kilometer area of under-developed land, begins opposite the Bund on the eastern bank of the Huangpu River, and extends eastward toward the Yangzte estuary. This area has been designated a free trade zone focused on foreign business, finance and trade.

As a result, an evaluation of Shanghai's real estate market involves three major areas:
 

Shanghai's Office Market

Strong economic growth has fueled both the office and hotel sectors in Shanghai. Indeed, Shanghai's office supply has mushroomed, and will continue to do so in the next few years. The city had just 240,000 square meters of office space in 1994, but another 240,000 is scheduled for opening this year, with a equivalent amount coming on line in 1996. Plans also call for similar development in 1997 and 1998. Close to 40 projects, representing 5 million square meters of commercial space, are on the drawing boards, two-thirds of which are to be in mixed-use projects of one kind or another.

The prospect of a huge increase in office construction suggests that Shanghai is being set up for a major property collapse in the latter part of the decade. In the meantime, an expansive office market should continue to support the city's much calmer hotel industry.

The Hotel Sector: A Profile

Unlike the rapid expansion of hotel stock in Beijing, new development of properties in Shanghai has been constrained by a moratorium on construction that has reduced the risk of overbuilding in the hospitality sector. In place since 1988, the moratorium has not yet been formally lifted. Nonetheless, it has not inhibited plans for new hotel projects, some of which will be inevitably be approved.

Travel to Shanghai has grown at an annual rate of 12 percent since 1978, with some 1.25 million people visiting the city in 1993. Hotel occupancy, however, declined in 1994 as a result of government initiatives to restrain inflation, which have had a somewhat negative impact on commercial travel. Nevertheless, we estimate that demand for international class hotels in Shanghai will rise at an annual compound rate of 5 to 7 percent in the foreseeable future.

Shanghai is predominantly a business market with very little leisure tourism in the four- and five-star hotel categories. The Shanghai Tourism Administration controls the two major local groups in the hotel sector -- the Jinjiang Group and Huating Corporation. These two groups control approximately 5,000 rooms each, most of this inventory in the three- and four-star category. ln addition to hotel interests, these groups have diversified into other travel-related areas -- real estate and shipping. Jinjiang's flagship hotel, the Jinjiang Tower, dominates the skyline in the center of Shanghai, while Huating's 700-room Sheraton is located in the southwestern area of the city.

Perhaps the most significant real estate development since the late 1980s, Shanghai Center has launched the current round of development activity. Opened in 1989, Shanghai Center is a major mixed-use hotel, office, retail and residential complex located in the city center. It was developed as a joint venture of Portman Properties (U.S.), Kajima (Japan) and American International Group, a New York-based insurance group. The hotel component, operated by Shangri - La, comprises 630 rooms.

Other major hotel projects include:
 

Hotel Sector Economics

As a business market, Shanghai's hotel sector has been affected by the credit tightening that the Chinese government has enacted to control inflation, one of the greatest threats to both the national and metropolitan economies. The fluctuations of Hong Kong's stock market also can have an effect, since Hong Kong represents a major source of business travel into Shanghai. Last year, the decline in occupancy of approximately 10 percent, however, was more than offset by a dramatic increase in pricing as average rates climbed 20-25 percent.

Shanghai's first-class hotel supply comprises eight properties representing 4,955 rooms for an average size of 620 rooms. These properties achieved an estimated room occupancy of 71 percent in 1994, at an average U.S. dollar room rate of $123. Because of the emphasis on business travel, there is little seasonality to the first-class market with the average stay a relatively short 2.5 nights.

Japanese and Chinese travel (Taiwanese, Hong Kong and overseas Chinese) has dominated in terms of demand, representing approximately a third in each category. North Americans and Europeans represent 12 and 8 percent of the market respectively, with the balance coming from elsewhere in Asia.

While the moratorium on hotel development remains in force, rising demand and hotel profitability have been compelling factors driving planning of new projects. The Shangri - La group, for example, is planning the development of its Traders Hotel concept at the Railway Station in downtown Shanghai. In Pudong, there are several projects in planning that would involve Shangri-La, Hyatt and Mandarin Oriental.

Gross Operating Profit margins well in excess of 50 percent are not uncommon. Since such margins are close to double the rates of more developed markets, hotel developers can find much to attract them to China. Patience with the lengthy and costly development process, however, is essential. And companies contemplating a hotel venture in Shanghai must also be prepared to deal with an ambiguous and evolving regulatory environment.

Careful study of this rapidly changing and exciting city, therefore, is clearly warranted.

Roger S. Cline is Worldwide Director of Arthur Andersen's Hospitality Consulting Services. He is based in New York.

©Arthur Andersen