China Reits are not for all
China has taken a long-awaited step towards opening its real estate investment trust (Reit) market, publishing rules for a pilot programme. The regulators are understandably starting small, but the guidelines don’t do enough for companies that need to list Reits the most.
The China Securities Regulatory Commission and the National Development and Reform Commission jointly published a set of pilot rules for infrastructure Reits last week — their first attempt to introduce Reits onshore.
The move is notable. Despite boasting a huge real estate market worth trillions of renminbi, China does not have any publicly traded Reits.
The closest to a public Reit was the Rmb3bn ($423m) Penghua Qianhai Vanke Reit that was listed in July 2015, jointly by Penghua Fund Management, China Vanke Co and Shenzhen Qianhai Development Investment Holdings Co. But that was widely seen as a quasi-Reit, as it had some digressions from Reits in the international market. It lacked a diversified portfolio and its trustees did not have ownership of the underlying assets.
Many Chinese financial institutions have hailed the new pilot rules as a ground-breaking step. But for now, at least, the rules are unlikely to kick off a vibrant Reit market in China.
For starters, the regulators have closed the market to a group of companies best suited to list Reits — cash-strapped real estate developers.
Residential and commercial real estate assets are explicitly banned from being parts of Reits. Instead, only infrastructure projects qualify, making the product more in line with infrastructure investment trusts rather than Reits.
This is in stark contrast to the international market, where shopping centres, offices, hotels and apartments typically tend to form part of a Reit portfolio.
China’s regulations will cause a mismatch between demand and supply.
Tight funding restrictions have been imposed on domestic developers in recent years, as China tries to keep the sector’s leverage and the associated risks under control.
With bond issuance under the regulators’ tight grip, developers have increasingly been forced to tap the securitization market for funding.
For instance, new issuance of residential mortgage-backed securities, commercial mortgage-backed securities, supply chain asset-backed securities (ABS) and private quasi-Reits reached Rmb850.8bn ($120m) in 2019, more than three times the 2017 volume, Wind data shows. These four types of products accounted for 36% of the total onshore ABS issuance last year.
By opening another avenue for these property companies to raise funds, through the listing of Reits, some of the funding pressure can be eased.
Instead, China’s Reit market is open to firms that have little need for Reits to get funding — experienced companies that develop infrastructure projects.
They are considered relatively cash rich with less restrictive funding conditions. Even if they do need to raise debt, they would have big state-owned banks, or even policy banks, at their doorsteps offering loans and providing bond underwriting services, onshore bankers told GlobalCapital China. Putting their infrastructure projects into a Reit-like portfolio holds limited appeal.
It’s understandable that China wants to kick off this new market with the best assets. Under the new rules, only eligible infrastructure projects can be used as underlying assets.
What makes a project eligible? Among other things, they must have clearly defined ownership, have been in operation for more than three years and should be generating a stable income flow, the regulators said.
But here’s where yet another problem arises.
A handful of senior bankers in China said they are unclear how many projects would tick all of these boxes and would be able to take advantage of the programme — raising some doubts over the efficiency of the pilot.
The Chinese regulators are undoubtedly moving in the right direction by opening up the Reit market as an alternative funding channel for some companies. Their caution is also typical of the country’s approach to other market-opening initiatives in the past, as GlobalCapital China has written about extensively.
But if China wants to unleash the full potential of its Reit market — while making more progress on curbing speculation around property — it needs to take much bolder initiatives, and take them fast.