China inches closer to Reit market launch but doubts linger
A long-stalled proposal to allow real estate investment trusts (Reits) in China re-emerged this week. The plan, slated for the first half of this year, is expected to help de-gear the balance sheets of Chinese homebuilders and tide them over a possible liquidity crunch. But as the plan has been on ice for a decade, questions abound as to its effectiveness — and whether it will find willing buyers and sellers, writes John Loh.
China’s top leadership is close to introducing Reits in four pilot cities – Beijing, Shanghai, Guangzhou and Shenzhen – reports suggested this week, as the country grapples with a slowing housing market and developers face a funding squeeze.
“There have been talks about the proposal for a number of years,” said Moody’s senior analyst Franco Leung. “If it goes ahead, the move will help boost the liquidity and financial flexibility of property developers.”
China’s leaders have been signalling for months that they were keen to start a Reit market. A central bank statement last September said that a Reit pilot scheme would be promoted to support the funding needs of property developers.
Then, in November, Professor Qin Hong, director of the Policy Research Centre of China's Ministry of Housing, said the country’s real estate assets were ready for securitisation, signifying growing momentum from the government for the plan.
Companies have already made some tentative steps. Last April, Citic Securities unveiled China’s first Reit-like vehicle listed in Shenzhen backed by two office buildings worth Rmb5bn ($816.51m) in Beijing and Shenzhen.
But with the product only offered on a private basis to institutional investors, and with a finite investment timeline of three to five years, that Reit hardly acts as a reliable yardstick for how to list future property trusts, analysts said.
Also, the pilot scheme is likely only to include affordable rental housing in the Reit’s portfolio, while excluding commercial properties, in a bid to encourage the construction of low cost housing.
If the proposal takes off this year, then China would be the first country in Asia to establish a housing trust, said a credit analyst. “There is no precedent for it in the region. Most Reits are formed by commercial or office properties,” he said.
But analysts foresee several challenges that could hamper the take-off of Reits, one of them being how much leeway the government will allow in tax matters.
“Reits are usually levied little to no tax to incentivise asset owners to inject their properties into a trust structure,” said a property analyst. “This is provided that the bulk of a Reit’s profits are returned to shareholders as dividends.”
For its part, Fitch Ratings believes that the market for Chinese Reits will remain nascent in the short to medium term, even if regulations are loosened, as many of China's investment properties are of poor quality, with low rental yields of less than 4%. This compares to onshore borrowing costs of above 6%, making returns for Reits unattractive.
“It’s a cool idea,” said a Hong Kong-based economist who tracks China. “But I’m interested to see where the cashflow will come from in these Reits. Will there be any implicit guarantees from the government since this is a state-initiated project?”
The prospect of limited returns means that investors will have to look to capital appreciation rather than dividend yields to book profits, analysts reckon. But that goes against the rationale of Reit investments, which are typically bought for their high yields.
There are also concerns over whether backing Reits with low cost homes can deliver an attractive enough yield for investors. But throwing commercial properties into the mix would not be much help, since the current oversupply and weak tenant mix makes them poor candidates for Reits, said Fitch in a November report.
This, coupled with the fact that China is not a natural home for Reits, means the market will take time to develop. “Hong Kong, Singapore and Japan come to mind when we think of Reits in Asia, not China,” said the credit analyst.
A number of benefits could accrue from a successful implementation of the plan. For one, analysts expect it to free up government finances and relieve funding stress on Chinese homebuilders.
“Ultimately the proposal looks like it is meant to ease the government’s balance sheet,” said the credit analyst. “Already state-owned enterprises are diverting some of their funds for the development of public infrastructure.”
It could also be a meaningful way to stir homebuilding activity versus the current model, whereby the governments hires contractors to undertake housing projects.
“The key to the success of Reits in China is pricing and whether the government can package them attractively enough to capture private capital,” the analyst said. “We believe Chinese developers will be keen to explore Reits as long as it makes commercial sense and helps them monetise their assets.”