Dubbed “the godfather of China’s real estate industry”, Meng Xiaosu has been lobbying since 2005 for the introduction of real estate investment trusts (REITs). The former chairman of China National Real Estate, the largest state-owned developer, Meng has argued that REITs could free up capital for more affordable housing projects. But the idea has been put into deep-freeze for nearly a decade. One of the reasons, Meng once told Beijing News in an interview, is that the asset class sounds too similar to the shadowy trust industry, and several attempts to create a REIT market were shelved as part of crackdowns on shadow banking activity.
But regulators might be ready to embrace the idea at last. China Business Journal reports that four cities – Beijing, Shanghai, Guangzhou and Shenzhen – will take part in a pilot REIT programme which will be launched early next year. The initial securitisation packages are likely to comprise assets from public rental housing projects.
But it may not prove straightforward.
One of the issues making it difficult to put social housing projects into REITs is the lack of yield and their limited upside performance because their tenants are poor (investors like to buy into REITs that have the potential to raise rents).
Another challenge revolves around tax advantages, which are traditionally part of why REITs attract investors.
“A REIT’s trust structure gives investors a far better return because they are sheltered from taxes. It is one of the most efficient ways to return money to shareholders,” Stephen Metcalfe, a specialist REIT fund manager at Coriolis Capital Management tells WiC. “Typically, most countries set a minimum cap in terms of the amount of rental income, which must be paid back to shareholders,” he adds. “In Singapore’s case it is 90%, but many REITs have pay-out ratios of 100%.”
Local governments may not be so keen on losing fiscal revenues to tax-efficient REITs or to see developers focusing on rental properties. Sales of real estate provide an important source of their tax revenue. As the South China Morning Post points out, Chinese developers pay land appreciation tax of 30% to 60%, corporate income tax of 25% and a host of other taxes.
But the introduction of a REIT sector could be a healthy development. For example, it might help property developers move away from their existing business model. Rather than just trying sell flats, they might rent and manage buildings, selling them off as REITs.
As such, REITs would not only provide a new financing tool for cash-strapped developers, but they might also make the industry less reliant on bank financing.
They will also free up cash for the bigger players, which are increasingly broadening out their portfolios to become landlords. As potential REIT managers and sponsors, these firms will still have some skin in the game. But by listing a REIT, they will also bring in institutional and retail investors that do not currently invest in the sector.
At a real estate forum in Jinan last month, deputy housing minister Qi Ji told participants that China should encourage institutional funds and private capital to invest in the rental market and encourage real estate developers to offer long-term leases at their projects. As Metcalfe explains, “REITs could become an important investment vehicle for retail investors and take some froth out of the Chinese housing market. Instead of buying an apartment outright, they could invest in a REIT instead. This could be a really good way to rationalise the market.”
REITs can also help smaller investors to get exposure to the property market. Few individual investors can afford to buy a retail mall as an investment vehicle. But they will be able to afford to buy a unit in a publicly listed REIT, which specialises in the sector.
China’s REIT sector has the potential to become the world’s largest. Given the stable income the structure provides, it should also become a significant opportunity for the region’s pension funds to park their money.
China’s investable property assets topped $3 trillion in 2013, Johnny Shao from global property consultancy CBRE told the South China Morning Post, and he expects the figure to double by 2020.
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