Part and parcel

Flat returns promised by Reits?

Throughout its modern history, China has been famed for its mass campaigns, most notably persuading its population to eradicate rats, flies, mosquitoes and sparrows during the so-called Four Pests Campaign between 1958 and 1962. But the government may have met its match when it comes to persuading those with cash to give up property speculation for the safer and more reliable income generated by real estate investment trusts, or Reits.

At the end of April, the China Securities Regulatory Commission (CSRC) and the Ministry of Housing issued new guidelines in an effort to kick-start a pilot project to support the rental leasing market. The government wants to create the framework for a new type of capital market security: one that will give property developers an alternative channel to raise finance and offer retail investors the opportunity to plough money into the residential sector without having to buy a house first.

This is part of President Xi Jinping’s bigger campaign to get developers to build houses “for inhabitation, and not for speculation”, including more subsidised rental properties for the general public.

Developers are less keen, given the slower returns from rental properties, but some have started dipping their toes into the water. For instance, Vanke, one of the largest property developers, built 100,000 residential leasing units in 2017 and plans to bring a further 100,000 to market during 2018.

However, if Vanke wanted to parcel those apartments up and then list them on a public stock exchange via a Reit, it would immediately run into problems. That’s because the new capital market guidelines don’t cover some of the key issues, which specialists say need to be addressed first. Most importantly, the government needs to give the sector a boost through the tax regime. In Singapore, Asia’s Reit hub, the sector is exempt from corporate taxes. In China it is not.

There are also no rules governing the percentage of a Reit’s income that has to be paid to an investor in the form of dividends (in Singapore it is a minimum of 90%). Nor do the guidelines spell out the limitations on a Reit’s business activities.

And then there is the question of whether they make an attractive investment. Reit investors typically expect returns of about 3% above benchmark government bonds. In China’s case that would mean a yield close to 7% given that 10-year government bonds are currently trading around the 3.63% mark.

In comparison, rental yields average about 2% to 3% according to George Yang, managing director of JIC Capital Management. He also tells Reuters that these levels are well below developers’ average 5%-6% finance costs. There are only a few areas, such as Shanghai’s Pudong, where rental yields are higher.

Liu Qiao from the Guanghua School of Management worries the sector could implode before it gets off the ground unless the government addresses some of these concerns. He penned a report late last year estimating that China’s rental market could generate income of up to Rmb4.6 trillion ($7.25 billion) by 2030 as the number of individual landlords expands from 190 million to 300 million.

For developers the new Reit market is a money-raising opportunity – especially when bond quotas and commercial banking loans to the sector are being restricted. Domestic newspapers report that six developers have applied to issue rental apartment Reits totalling Rmb16 billion. So far two have gone ahead, although Joe Zhou from Jones Lang Lasalle China flags concerns about the deals, which are not publicly traded and “nobody really does any due diligence on to evaluate the risk”.

Do Reits have a chance in China? Residential Reits have not taken off across the rest of Asia because the region’s wealthy have such a strong predilection for buying physical properties. Moreover, Reits generally underperform when interest rates are rising – as they are now.

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