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August 15, 2018

China’s road to establishing real estate investment trusts (REITs) remains slow, but the introduction of “quasi-REITs” is giving investors confidence that the market is moving towards securitization.

A host of experimental “quasi-REITs” have been launched to assist the authorities and real estate companies to test a variety of securitised real estate vehicles.

“It’s pretty challenging to estimate the timeline for a China REIT but in the short to mid-term we are unlikely to see a structure which is broadly the same as a U.S. or Singapore REIT,” says Steven Xing, head of alternative investments for Greater China at JLL.

The Chinese government is keen to introduce structures for the long-term ownership and management of real estate as this dovetails with its stated aim to encourage the rental housing market, says Xing.

“REITs owning multifamily properties would provide steady income for investors and high-quality housing for those who cannot afford to buy.” Rented housing which was a valid alternative to buying could also curb speculation.

REITs have been an important stage in the development of most mature real estate markets and offer a regulated, liquid and income-generating investment avenue to real estate. Developed nations have broadly equivalent structures that are tax-transparent, placing investors on a level footing with direct investors in real estate. While there are private REITs in a number of jurisdictions, the most recognisable REITs are listed and pay out the majority of their income in dividends.

India was the latest nation to introduce such legislation and its first REIT is expected to be launched by Blackstone Group and Embassy Group later this year. Longer-established REIT markets in Singapore and Japan have grown significantly in recent years.

A smoother transition
The quasi-REITs are the closest thing to a “conventional REIT” that can be launched in the current regulatory environment. REIT lobbying body the Asia Pacific Real Estate Association estimates there are more than 30 such vehicles, the first of which, Auchan Tianjin No.1 Store Capital Trust Scheme, was launched as long ago as 2003, although most have been launched in the past four years. The only publicly-tradable quasi-REIT was launched by China Vanke and Penghua Fund Management in 2015 and is listed on the Shenzhen Stock Exchange.

So far the quasi-REITs have been more like asset-backed securities, debt vehicles rather than the equity securitizations familiar to other REIT markets. The first rental housing ABS was launched last year by China Young Professional Apartments (CYPA), a Beijing-based operator which won regulatory approval to issue RMB270 million (US$41 million) worth of debt securities backed by its rental apartments. With rental housing backed by Beijing, more such initiatives are expected.

However, these debt structures are not the equity REITs familiar from other markets.

“A debt structure is more simple and manageable,” explains Xing. “Also, with prime yields in larger Chinese cities tending to be below four percent and the cost of debt well above, it is hard to structure an equity REIT which can pay an adequate dividend. Rents are climbing and values stable so the situation is improving but in the short term, yields are the greatest barrier.”

Strong capital value growth in recent years means developers would rather use a quasi-REIT to raise debt than give up ownership of assets. Speaking at a conference earlier this year, People’s Bank of China Governor Yi Gang said regulators continued to examine the best options for a China REIT, but noted: “In China, companies are not willing to sell the underlying assets of REITs sometimes because these assets are just too good.”

A skills shortage is also a barrier for REITs, says Xing. “There is a lack of professional management skills in Chinese real estate, which makes it hard to create vehicles for the long-term ownership and management of assets.”

Writing earlier this year, Peter Verwer, chief executive of APREA, which has been in discussions with Chinese regulatory authorities, said, “Our discussions with regulators and the State Council’s advisory committee on REITs, reveals a clear transition pathway from “quasi-REITs” to a more familiar international REIT model. Nevertheless, several thorny issues remain, including the viable tax treatment of securitised real estate, consumer protections and good governance rules.”

The lack of progress on a China REIT regime has caused the market to take alternative routes: there are seven REITs listed in either Singapore or Hong Kong which own only assets in Mainland China, making them perhaps the best proxy for a China REIT. The trusts own a total of nearly US$5 billion of real estate and according to APREA data, made total returns of 16 percent in the 12 months to May, making China the best performing REIT market (or at least market where REITs own assets) in Asia Pacific.

However, while these REITs offer liquid and regulated access to China real estate, they are small fry compared with the potential of a true China REIT. In January, a report from Peking University’s Guanghua School of Management estimated China’s REIT market capitalisation could grow to RMB12 trillion if a tax-efficient and lightly-regulated structure was in place.

Click to read more about why more property investors are looking to REITs.

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Steven Xing

Head of Alternative Investments - Greater China with JLL.

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