China has approved its first onshore real estate investment trusts, in an attempt to channel fresh capital into infrastructure projects and give its ailing economy a much-needed boost.
A pilot scheme will be rolled out in the second half of 2020, after final guidelines are published at the end of June by the National Development and Reform Commission (NDRC), the state asset regulator. It will focus on infrastructure projects in five parts of the country: the industrial belts around Shanghai, Hong Kong and Beijing, the southern island of Hainan, and the new Xiong’an economic zone south of the capital.
Eng-Kwok Seat Moey, DBS
The scheme will be limited in scale at first. Only mutual funds will be allowed to sell Reits on the Shanghai and Shenzhen exchanges. Issuers will be permitted to include infrastructure assets with long payback periods – industrial parks, data centres, toll roads – but must preclude traditional real estate like malls, offices and hotels.
Even so, it marks a step-change for China’s capital markets. It lets onshore investors engage in an asset class that tends to generate steady income streams in good times and bad, and it offers authorities a chance to release air from an overinflated property sector.
Investors are unlikely to pass up the opportunity. Eng-Kwok Seat Moey, head of capital markets group at DBS, describes the potential of the C-Reits market as “huge”.
In June 2019, Zhang Zheng, a professor at Peking University’s Guanghua School of Management, put its long-term value at between $566 billion and $1.7 trillion.
That would make it larger than the US market, which has 200 listed Reits with a combined market value of $1.27 trillion. Australia has 28 listed Reits with a total market cap of $125 billion, making it Asia’s largest market.
Testing the waters
When China first floated the idea of C-Reits in 2005, it faced “high asset inflation, especially in the property sector, and its real estate markets were highly geared”, notes DBS’s Moey. Fearing yet more property speculation, the idea was scrapped.
But the world in 2020 is very different. Two key reasons to move now are to get debt off the books of state-owned enterprises and local government financing vehicles, and to finance a new round of economy-boosting infrastructure construction.
John Lam, UBS Global Research
“We are likely to see the first infrastructure Reits hit the market within the next 12 months,” says John Lam, head of Hong Kong and China real estate at UBS Global Research.
The first listed property-backed Reits should then start to appear two or three years from now.
Bankers say one of the first to test the waters will be Yuexiu Property Company, based in the southern city of Guangzhou. The firm meets the NDRC’s key listing criteria. It has a clearly defined ownership – its main shareholder is Guangzhou Yuexiu, the investment corporation of the municipal government – and it has been in operation for more than three years and generates a stable flow of income.
It also has form, having floated its offshore property investment trust, Yuexiu Reit, in Hong Kong in 2009. The Reit owns property in Guangzhou and in the central city of Wuhan, birthplace of the Covid-19 pandemic.
Distribution income fell 10.4% year-on-year in 2019 to Rmb761 million ($106 million), while its shares slumped in value by a third in the year to May 27. Notable shareholders include BlackRock, Norges Bank and the Vanguard Group.
The parent company also owns – via another Hong Kong-based subsidiary, Yeuxiu Transport – a slew of toll roads, expressways and bridges in central China. Analysts expect some of these assets to slot neatly into an onshore Reit.
Right time to launch
After years of delay, in which Reits issuance surged in Singapore and even found a niche but receptive audience in India, Beijing has finally committed to the asset class. It has approved quasi-Reits before, of which the closest thing to a real property investment trust is Penghua Qianhai Vanke Reit. Listed in 2015, it crucially lacked a diversified portfolio, while its trustees did not own the trust’s underlying assets.
China has been waiting for the right time to launch this market for years, bankers say. Its decision to do so pre-empts Covid-19 – the NDRC and the China Securities Regulatory Commission have been engaged in active planning for at least a year. Both agencies decided, with the country facing a sharp economic dip, that the right time was now.
It could have gone further. Experts point to a refusal to cave in on tax exemptions, and to a conservative gearing level, which it fixed at 20%.
“We would have liked to see a ratio of 30% to 35%,” adds DBS’s Seat, noting that Singapore set its gearing level at 35% of total property value when it launched the asset class in 2002. She adds: “Malaysia, Thailand and Hong Kong have tested out the higher levels and it works.”
But bankers are happy with what they see. For years the tracks rattled but nothing appeared. Now China has opened the door to C-Reits, all eyes will be on the first sale. If it goes well, and bricks-and-mortar is added to the mix, the market, says Abby Wang, a financial services partner at KPMG in Shanghai, “will grow exponentially”.