The 2008 Olympics may be three years away, but right now the odds seem good that Beijing will set records in at least one event: the property value high-dive. With millions of square meters in new commercial real estate projects slated for completion in Beijing before 2008, some experts foresee a dramatic drop ahead for the city's real estate market.

Economists generally give the Communist government high marks for growing the increasingly capitalistic People's Republic into the world's fourth largest economy. However, the government's eagerness to spruce up the capital in time for the 2008 Summer Games may have led it to make some major miscalculations with respect to Beijing real estate.

“The market should return after three or four years to a degree of equilibrium, but in the short term it is going to be a heavily oversupplied market,” says Michael Thompson, the Shanghai-based president of Cushman & Wakefield Asia Pacific.

First, a tacit agreement with developers not to build in the city in order to reduce pollution and congestion during the Olympic year seems to have increased development now, observers say. Many developers have apparently concluded they have no choice but to move ahead because of state rules that require government land buyers to build within a certain period after purchase, and because of tightening credit requirements.

In the office sector alone, Jones Lang LaSalle estimates that 3 million sq. meters, or 32 million sq. ft., will be added to the market between now and 2008. “This is like building Manhattan overnight,” says Anna Kalifa, head of research for LaSalle's Beijing office.

Demand is growing quickly in the city — last year the market's office absorption grew by 800,000 sq. meters, and this year JLL forecasts 1 million more — but still not quickly enough to absorb all that slack. During the fourth quarter of 2005, vacancy rates grew by 3.4% to a total of 14.2%, reports JLL. As a result of the rising supply, JLL estimates average office rents will fall by 12% in the coming year, from a current rate of $26 per sq. meter.

Other problems also threaten to drag the market down. Two of the biggest: building quality and the practice of what is called “strata-title” sales in office and retail, the condo-like selling of units to individual owners. Since some office buildings now have as many as 1,000 landlords, Kalifa says this practice has created a number of operational problems — especially since no secondary market has emerged for all those units.

One problem on the retail front is the lack of professional planning and management. The giant Golden Resources Mall, for instance, at 570,000 meters, 50% larger than the Mall of America, is by many accounts a failure. Kalifa says that a bad tenant mix, a shortage of eateries, and its sheer size have all hurt its results. “If you go there, it's pretty empty,” she says. “It's unpleasant to go to frankly because it's so large.”

Defaults are already rising for real estate loans all over the country, according to Jack Rodman, a Beijing-based partner for Ernst & Young, who predicts $65 billion in real estate loans issued between 2002 and 2005 will eventually default. “With prices no longer appreciating 20% to 30% a year, many investors have begun to default on multiple speculative property investment,” he says.

Foreigners who want to bet on Team Beijing appear to have two main options. The first is to invest exclusively in top-drawer properties. Kalifa estimates there are only a few shopping centers and office buildings in Beijing that are built to true Class-A international standards and professionally managed. Demand is expected to stay strong for those assets. Landlords of Class-A centers experienced a 26.5% rent growth last year, according to JLL, even as other owners struggled.

One exception to the demand for quality may be the luxury apartment rental market, where vacancy rates now top 25%. While the number of expatriates who are expected to fill those buildings is likely to grow, Kalifa warns that “an entire market depending on a very small group of people could backfire.”

The second option is to wait until the dust settles after the Olympics, when distress levels become acute enough that more developers will need to make deals. Thompson predicts that 2009 will be a good year to start looking.