The worldwide economy may be in a trough, but the manufacturing sector in China still expanded for a sixth consecutive month in August 2009 to a 16-month high. With the manufacturing sector still strong, it is a good time for foreign companies to enter the Chinese market, with lower leasing prices and skilled staff available.

 For a manufacturing company it is even more important than for any other business to find the right location and facilities that suit the company’s needs (and are affordable). It is recommendable to do thorough market research to find the best location and have consulting staff on board to help in the decision-making process.

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Industrial property

 Similar to the commercial sector, the industrial property market is also becoming a market of increased choice. Although the location of industrial premises in China is limited to government-approved zones, there are already more than 150 of these zones and parks in the greater Shanghai area alone and costs can vary significantly from zone to zone. Apart from the varying of price and location, zones have also traditionally been differentiated by the tax concessions that they have been able to offer occupiers.

 Since January 2008, however, the income tax system has been unified all over China and this means that all entities are liable to pay 25% profits tax, no matter which zone they are established in. However, zones can be differentiated by whether they are state, municipal/provincial or township zones, depending on which level of government issues approval and according to their industry focus.

 The choices available in industrial real estate are now much more varied. The market, which was once solely the domain of government-owned development zones, is expanding to include private-sector developers from both China and abroad. While foreign manufacturing companies that entered the market early tended to build and own their facilities, the current trend is increasingly moving towards renting or sale and lease-back arrangements. This has mirrored the trends in North America and Europe where companies prefer to use their capital in their core business as opposed to the real estate market.

 Many manufacturing firms require a more customised building than the standard offerings of the development zones. Therefore, development zones generally also offer acceptable quality ‘build-to-suit’ programmes, with buildings constructed specifically to meet the requirements of the occupier and sold or rented to the client for longer-term rental periods of five to 10 years. But a number of zones are now running low on capital and their criteria for offering such a build-to-suit solution will usually depend on the size of the client’s registered capital.

 This has presented an opportunity for private developers to build industrial parks within development zones and also to provide their own build-to-suit programmes. Many of these park developers are local manufacturing companies who purchased land for their own use and have decided to develop industrial parks to take advantage of China’s economic growth. The rates charged by these local developers tend to be relatively inexpensive, but the quality of the facilities they provide can vary dramatically.

 This issue of quality is now being addressed by a small number of specialist international firms that are developing high-quality build-to-suit solutions. Their costs are higher than those generally charged by the local developers, but they often offer more flexibility, less risk due to their expertise and international operations, and the higher quality of facilities they provide is very much in line with the requirements of foreign occupiers. They may also offer sale and lease-back arrangements, enabling clients to free up capital.

 As foreign companies in China expand, merge with others, are acquired or close down, their local operations or facilities may come onto the market. Consequently, there is now a growing secondary market in industrial property that may present opportunities for a company to find facilities that match its needs at a more attractive price. There may also be a significant time-saving for the company in getting its facility into production.

Business park concept

 The success of the business park concept overseas in which custom-built premises are set in attractive landscaped parks has largely been lacking as an option for international firms looking to set up in China. That is now about to change with the addition of more and more such parks to the country’s set of commercial property options. The Shanghai Business Park, for example, is a joint venture with the highly successful Caohejing High Tech Park and Arlington. Arlington is Europe’s largest business park operator with 23 parks in the continent, including a collaboration with EuroDisney just outside Paris.

 Typically, business parks suit clients looking for long-term, quality premises, such as corporate headquarters or R&D and IT centres, which require a high degree of customisation and quality of construction to meet their intended purposes.

Build-to-suit option

 The key decision confronting firms wishing to set up their industrial site in China has traditionally been between buying (or leasing) existing premises or constructing their own site. Although leasing may reduce the amount of capital outlay and allow a firm to move more quickly into operation, in practice, finding an existing industrial building in the right location that will fit all the needs of the company when converted is not easy. As a result, many firms find the build-to-suit option more appealing. The property can be tailor-made to meet exactly the requirements of the company, ensuring maximum efficiency and productivity. Available sites are generally more numerous, giving the company greater flexibility in its choice.

 However, the challenge for many firms wishing to take this option is a practical one. They will want to negotiate a good deal on the land and on the construction terms in what is probably a new market for the company. There is also the problem of finding a local contractor that can build to the international requirements they may have, and upon whom they can rely to deliver the premises to specification and on time. Then, as already mentioned, there is still the drawback that the company is tying up its capital in non-productive industrial real estate: a sector that has a poor secondary market. But there are now a small number of international firms in the market that are positioned to address these issues. These companies are seeking out build-to-suit projects that they can operate on a sale and leaseback basis.

 It is not uncommon that foreign investment enterprises are ‘tricked’ into setting up in certain regions as they are promised lower tax rates and other such preferential treatments by the local government bureaus. But once the company is established, these government officials often forget their promises and the beneficial treatments originally offered are no longer valid. This is why it is essential to obtain all information provided by local governments in writing and to obtain tax advice prior to the establishment phase in order to understand the requirements of operating a manufacturing structure in China and also how to remain in compliance and avoid basing company decisions upon false information.

Klaus Koehler is managing director of consultants Klako Group.

PRACTICAL TIPS

  • Wholly foreign-owned enterprises (WFOE) – Establishing a manufacturing entity in a trade development zone: A manufacturing company that is exporting 100% of its goods overseas should consider the trade development zones due to the facilities and services on offer. As the company is not selling on to the local market, but is using China as a manufacturing base, components can be imported duty free and then processed. China components can be added on duty free and then be re-exported while claiming value-added tax back on the China-sourced components.
  • Foreign-invested commercial enterprises (FICE) – Establishing a manufacturing and distribution entity in domestic China: A manufacturing FICE is actually a manufacturing WFOE with an import and export licence, allowing it greater flexibility to do trade business outside of the product category being manufactured. Additionally, a manufacturing FICE does not have to be in a trade development zone, providing the company freedom to register the manufacturing site anywhere in domestic China.