Are China's smaller cities a bargain for investors?

By Kevin Lim and Langi Chiang - Analysis

SINGAPORE/BEIJING (Reuters) - Wuhan, Chongqing and Chengdu aren't exactly names that roll off the tongue for foreign investors in China's real estate, but these cities may offer more bang for the buck than their more-famous coastal cousins or capital Beijing.

Helped partly by the government's "Go West" policy and their less export-focused economies, Chinese cities in the country's interior have posted higher per-capita-income growth than Shanghai, Beijing, Guangzhou and Shenzhen in the past year.

Along the coast, the port city of Tianjin is fast becoming the business center for northern China as authorities move to revitalize what was once the country's industrial heartland. Dalian and Shenyang are other northern cities growing rapidly.

Michael Klibaner, head of research at Jones Lang LaSalle in Shanghai, said burgeoning growth in these second-tier cities would push up local demand for real estate and raise the capital value of commercial and residential properties.

"From a property perspective, these cities derive more demand from domestic companies than many Tier-I and coastal cities," Klibaner said.

Nicole Wong, head of Hong Kong and China property research at CLSA, said the best way to tap the faster growth in Tier-2 and 3 cities would be to buy shares of major Chinese developers which have expanded there, such as China Vanke (000002.SZ) and China Overseas Land (0688.HK).

"Rather than buy physical property, it's much better to have exposure to the experienced developers. You'll have the best players mirroring the difference in growth rates by changing their geographical exposure to have a heavier presence in second-tier cities," she said.

China's 600-plus cities are divided into six different categories with a top tier comprising the most developed metropolises of Beijing, Shanghai, Guangzhou and Shenzhen.

A second tier of around 15 large cities, comprises the independent municipalities of Tianjin and Chongqing and many of the provincial capitals.

Tier-1 cities now account for about 32 percent of Vanke's projects in terms of gross floor area, down from 40 percent in 2002. For China Overseas, the ratio has dropped to about 33 percent from 71 percent.

Jones Lang LaSalle estimated Tier-1 cities accounted for about 27 percent of commercial real estate activity in China in 2007, down from 37 percent a decade earlier. The percentage could fall to below 10 percent by 2010 as smaller cities develop.

"The construction sectors in first-tier cities have become somewhat mature, with housing starts in Beijing and Shanghai consistently falling since 2004," Australian securities firm, Macquarie Securities, said in a recent report.

China has been busy building roads, rail and other infrastructure in its interior and north since 2000 to narrow the income gap between cities along its southeastern seaboard and the rest of the country.

That process has quickened in recent months after the launch of China's near $600 billion economic stimulus package last year.

Chinese cities such as Tianjin, Chongqing and Wuhan last year reported economic growth in the mid-teens compared with the 9 percent-plus expansion in Beijing and Shanghai.