The New South China Mall in Dongguan, Guangdong province, has received much media attention, but not for the reason its owners hoped. The mall has space for 2,350 stores – making it the world’s largest such monument to consumerism – but it has been largely empty since it opened in 2005.

Shiny new malls sit vacant in other parts of China as well, disproving the mantra, “if you build it they will come.” The nearby city of Huizhou has 600,000 square meters of shopping malls, roughly half a square meter of shopping space for each of its 1.15 million residents. In the northern city of Shenyang, vacancy rates for shopping centers were more than 20% at the end of 2012, according to property management firm Jones Lang LaSalle.

Most observers in China this year have been paying attention not to commercial property but to the residential market. Beijing recently handed down even stricter regulations to keep China’s exorbitant house prices in check, and analysts are debating whether more rules will follow.

But these changes in the residential market are also likely to have powerful knock-on effects for commercial real estate. The restrictions have caused a number of developers to channel more investment towards commercial property, global real estate agency Knight Frank said in a recent report. Brokerage Cushman & Wakefield projects that newly constructed retail space will account for 56% of the inventory of China’s 20 largest cities in three years. The question is whether the market can absorb it.

Whacking moles

Chinese home prices have begun inching skyward again since the beginning of the year. Prices in 70 Chinese cities increased 1% between January and February, according to calculations by The Wall Street Journal, the highest monthly increase in two years. Compared with a year earlier, housing prices in February were up 1.75% on average.

To head off this growth, the State Council in March urged local governments to slow rising home prices by imposing higher down payments and mortgage rates for buyers of second homes. It also asked local governments to strictly enforce a 20% capital gains tax on second-home sales; in the past, many purchasers evaded this tax, paying 1-3% of the sales price to the government instead.

In the longer run, as the prospects of investing in the residential sector look less rosy, more funds are likely to flow toward the commercial market. This trend is already visible as restrictions have tightened on the residential sector in the last four years: China’s commercial property development and investment has grown by 46% in the past four years, far outpacing the 14% growth in the residential property sector, Sunny Zhang, China director at Cushman & Wakefield, wrote in an emailed response.

There are several reasons for this trend. First, developers, especially listed ones, are eager to maintain their growth rates, as are local governments. At least 10% of China’s GDP comes directly from real estate, but the industry’s economic impact is far wider considering related industries such as cement, machinery and home furnishings. For local governments, building high-end shopping malls helps improve their image, provides extra taxes and creates job. Finally, local governments still generate much of their revenue from land sales, so when the residential market slows down they are incentivized to shift their energy to the commercial market.

Finally, Beijing is unlikely to impose the same restrictions on the commercial market. The central government is desperate to control the price of residential property to keep its citizens happy but in comparison the commercial market has little connection to social stability.

How much is too much?

This shift in capital towards the commercial market should spark concerns about a potential property bubble. China’s commercial property market is just a fraction of the size of the national residential market, and it’s unclear exactly how much investment the market can absorb.

Steve McCord, the local director of research at Jones Lang LaSalle in Shanghai, argues that further investment in the commercial market is not a major issue, as China’s consumer markets are growing quickly. The balance between supply and demand of commercial property in Beijing, Shanghai, Guangzhou and Shenzhen should not change much between now and 2015, because the consumer base is growing in tandem with the supply of commercial real estate, he said.

In addition, the commercial market isn’t as suited to speculative investment as the residential sector, McCord said. Buyers tend to snap up residential properties relatively quickly, affording the developer quick returns. With commercial property, however, the developer can reap much larger gains with a “build and hold” structure in which the company maintains ownership and leases the property to various retailers.

Despite their seeming similarities, commercial and residential real are actually very different investment products. For this reason, JLL does not believe the majority of speculative capital will rush into offices, McCord said. Instead, restrictions are prompting individual investors and developers to find ways to send their money abroad, he said.

However, other analysts caution that some cities show signs of an emerging bubble in commercial property. Cushman & Wakefield argues that what it calls “tier 1.5 cities” – Hangzhou, Suzhou, Nanjing and regional hubs like Wuhan – have enough consumer demand to absorb supply. However, smaller cities where purchasing power remains more limited could suffer. Shifting trends in retail are compounding this problem. Chinese are increasingly shopping online, and international retailers are scaling back their brick-and-mortar expansion plans in China as they observe slightly slower growth.

Some investments are at risk “particularly due to the large amount of office and retail space in the development pipeline in Tier-2 cities,” Zhang of Cushman & Wakefield wrote. In the western boomtown of Chengdu, for example, nearly 75% of shopping mall stock was built in the last three years, and Cushman & Wakefield expects the city’s office stock to double within the next two years.

Location, location, location

China’s smaller markets are likely more at risk than its major cities from an influx of investment into the commercial property market. But regardless of what city a commercial property is located in, the difference between success and failure often comes down to other factors.

A lack of planning and an inappropriate location within Dongguan is what ultimately killed New South China Mall, McCord said. Whether a company can successfully carve out a niche in commercial property depends on how they manage their assets, including selecting tenants, maintaining the building’s appearance and positioning its brands correctly so it isn’t competing head-to-head with neighboring centers, he said.

Ultimately, the New South China Mall is an outlier by China standards, McCord argues. In Shanghai “we have two or three bad eggs out of 57 malls,” he said.

“To put things into perspective, the US has far more problematic malls than China right now … Some of them have vines growing on them and ceilings falling down and stuff like that. So we are still pretty good in China.”