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August 1, 2016

According to hotel investment news, just over one year after what was hailed as China’s first real estate investment trust (REIT) listed on a mainland exchange, the country’s second-largest developer is readying a new REIT for its hotel assets – to be listed in Singapore.

The decision by Greenland Group to pursue listing of the publicly-traded investment vehicle on a foreign exchange underlines the challenges facing Chinese companies seeking to use public equity markets as a source of funding for investment trusts, as mainland authorities struggle to bring the country’s tax regime in line with the needs of retail and institutional REIT investors.

Penghua Fund Management and China Vanke launched the country’s most REIT-like investment product in June of 2015, and the RMB 3 billion offering was quickly oversubscribed, primarily by mainland institutional investors eager to benefit from the cashflows derived from the Shenzhen business park properties held by the fund.

Even the Penghua-Vanke was still technically a closed-ended fund, however, and the investment vehicle did not qualify from the usual tax exemptions granted to real estate investment trusts in more popular REIT markets such as Singapore or the United States. Since the Penghua-Vanke debut, there has been little sign of new publicly-listed REIT-like vehicles in China, although the conversion of the country’s real estate industry to a VAT tax regime this year is giving investors hope for new progress towards more conventionally structured REITs.

While publicly-listed REITs, like those that Greenland Group is seeking to establish for its hotel assets, are typically traded on public stock exchanges, jurisdictions with successfully REIT regimes typically exempt the entities holding the REITs from paying tax; Opting instead to capture benefits from a more robust property sector, as well as from taxes on the income of the REIT’s unit-holders and managers.

Until the advent of China’s VAT-regime, however, local governments on the mainland have relied on taxing real estate transactions – including any sales of commercial projects, for a considerable chunk of their revenues – leading to a certain resistance to tax exemptions for listed trusts. With VAT kicking in during May, and the country set to take a step towards a tax on real estate assets this year with establishment of a nationwide register of property assets, there are hopes that last year’s Penghua-Vanke deal might be succeeded by more publicly-listed real estate investment vehicles.

The opportunity
While more tax revenue is usually welcomed by the government, mainland authorities are also looking for ways to encourage ongoing investments in the real estate sector, particularly after growth in investment opportunities in real estate slid to just one percent in 2015. REITs could be an effective way to attract more capital to the industry.

“If we see Chinese REITs develop into structures which closely resemble those seen in exchanges operating outside China, this will provide developers with an exit strategy as well as a conduit for financing,” says Johnny Shao, JLL’s Head of Capital Markets for Shanghai and East China. The veteran property advisor also pointed out that having the opportunity to sell projects to REITs in the future would enforce a new level of market discipline on mainland developers, who would quickly learn to think in terms of a project’s future saleability.

Opening the door for institutional investors
REITs could also provide an important avenue for institutional investors, both from the mainland and internationally, to gain access to China’s real estate markets through easily traded securities.
For institutional investors, mainland-based REITs would offer much-wanted exposure to cash flows from China’s growing stock of core real estate assets.

“The added liquidity that comes with REITs is attractive for global or regional investors who would like the flexibility to adjust their exposure to assets classes and regions from time to time,” JLL’s Shao pointed out. He added that, “REITs by themselves provide yields which are particularly attractive to pension funds, endowments and HNWIs.”

While the benefits to investors as well as to developers appear clear, Greenland’s choice to pursue its REIT in Singapore, which offers the most favorable tax regime in the region for the listed trusts, points to the biggest hurdle still standing between the world’s investors and mainland-listed REITs.

However, with China’s tax regime gradually moving away from a dependence on real estate transactions as a revenue source, and the government looking for ways to boost investments and capital flows in the property sector, there should be good reason for Beijing to look for ways for developers such as Greenland Group to list their assets on mainland exchanges, instead of taking their business – and the potential benefits – to Singapore.

Johnny Shao
JLL’s Head of Capital Markets for Shanghai and East China

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