When Continental Mortgage Investors became the world’s first real estate investment trust (Reit) to debut on the stock market in 1965, the plan was that the new asset class would capture a wider group of property investors, bringing a new funding source for developers. It didn’t quite turn out that way (initially at least).
Within a few years, commercial banks had begun packaging Reits that were invested in short-dated mortgages and leveraged to the hilt. By the mid-1970s, many collapsed as inflation rose and the property market buckled. Continental Mortgages itself went bust in 1976 in a familiar tale of how the financial sector’s search for fee income can sometimes end in disaster.
China is well known for using pilot programmes to test the efficacy of new financial products. But even by its cautious standards, it has taken an extraordinarily long time for Chinese Reits to get going.
The regulators have been looking at the asset class for almost two decades and, after a few stops and starts with quasi-Reit like instruments, finally released draft guidelines in late April, followed by a one-month consultation period. The first deals are now imminent.
China has some way to go before surpassing Singapore’s $100 billion Reit market capitalisation, or America’s $1.34 trillion, although analysts believe that ‘C-Reits’ could easily end up at double US levels.
However, there is a snag. Investment bankers and property developers were disappointed when they saw how different C-Reits will be to their peers in other parts of the world. To start with, they won’t even include real estate, unless it’s industrial assets like warehouses and data centres. And much of their purpose is predicated on reducing local government debt. The aim is to give local governments access to equity finance (rather than relying on bank loans) and a wider pool of investors (asset managers and retail, rather than other SOEs) to help fund infrastructure projects.
Estimates vary about just how much China’s local governments owe in debt, but some calculations peg the total at upwards of Rmb54 trillion ($7.62 billion), equal to about 60% of GDP.
Reits normally allow property companies to package mature assets – those that generate rents from commercial, retail or residential projects – into closed-end funds that distribute income to investors via dividends. Developers win because the IPO proceeds of the Reits can be used to fund new projects, while investors benefit from dividend yields (normally 1-3% better than government bonds) and potential capital appreciation as developers inject new assets.
However, China is largely restricting the asset class to infrastructure-related investments. A minimum 80% of the Reit’s net asset value has to be invested in a single infrastructure-related asset backed security (ABS). That ABS also has to be built around a project with a transparent shareholder structure and stable cashflows.
The arrangements for the Reit sponsors and managers will also be very different to other countries. Typically, the property owner would take on the role. But in China, the managers won’t be the local governments behind the infrastructure deals, but mutual funds. The government wants to ensure that these funds have some skin in the game themselves (they are required to subscribe to 20% of an offering and hold it for five years). They’re also instructed to set up infrastructure investment management teams staffed by at least three professionals with five years experience.
There are additional restrictions on where these infrastructure assets can be located – a move designed to prioritise a quartet of key growth areas. The favoured spots are: the Yangtze River Delta and Economic Basin, the Greater Bay Area, Hainan (site of a new free trade port masterplan) and Jingjinji (the Beijing-Tianjin-Hebei triangle).
Another rule for the new Reits prevents local governments from using them to build up even more debt. The leverage-to-value ratio is capped at 20% and that debt has to be used for the renovation of existing projects rather than the acquisition of new assets.
None of this has been a hit with the investment bankers. It remains to be seen whether the Reits are going to prove more popular among local governments and the wider investment community.
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