The house always wins

In 1980 there was only one property developer in Shenzhen – a city that’s now bigger than neighbouring Hong Kong economically. That firm would develop into today’s state-owned heavyweight Shenzhen Special Economic Zone Real Estate & Properties Group (SSR).

In its inaugural year – with Shenzhen’s then newly designated as a special economic zone – SSR jointly developed China’s first ever commercial residential project, Donghu Liyuan. The finance was provided by a newspaper publisher from Hong Kong and the project targeted real estate buyers from the same city with family or business connections to the mainland.

Purchasers of homes in the groundbreaking project had to brave a few risks. Political hardliners in Beijing were already attacking SSR as a traitor to China’s socialist roots and personal safety on the streets of Shenzhen was another worry for potential buyers at the time. To address their concerns, SSR designed Donghu Liyuan as China’s first xiaoqu, or gated residential community, and set up a separate company to manage it. It marked a starting point for the property management market – a fast-growing sector that has given rise to several dozen listed firms in recent years. And there could be more to come as two more heavyweights plan lucrative IPOs for their property management units.

How big is the market?

Translated literally as ‘small district’, a xiaoqu typically extends across multiple residential blocs with communal facilities. They have become a common feature in many cities after years of rapid urbanisation among the world’s biggest population.

According to sector research specialist REITS Industry, total gross floor area (GFA) under management reached 17 billion square metres by the end of 2020. That number is expected to nearly double in the next 10 years. Assuming an average monthly management fee of Rmb3.52 per square metre, a Rmb5 trillion market ($773 billion) is in the making, REITS Industry estimates.

The commercial opportunity is huge but it is also very fragmented. According to another research house called China Index Academy (CIA), there were about 130,000 property management service providers across the country at the end of 2019. But the market is consolidating. The share of the largest 100 firms was nearly 44% in GFA under management, CIA says.

The biggest players are adjuncts of the largest developers, many of whom built the biggest residential complexes in the first place.

Take Country Garden. It made its fortune by building supersized xiaoqu in Guangdong province, many of which featured their own common facilities and clubhouses, and even their own schools.

In recent years Country Garden has generally taken a top three spot (alongside Evergrande and Vanke) in terms of home sales. But its property management unit CG Services is the market leader, with 380 million square metres of GFA under management. It plans to push that up to more than 1.8 billion square metres under management by 2025.

CG Services went public in March 2018. After a 126% rise in the past 12 months, its market value was close to HK$250 billion ($32 billion) as of this week. That means it is now worth more than its sister firm Country Garden, which is worth about HK$200 billion.

Up to 50% of CG Services is controlled by Yang Huiyan, daughter of Country Garden’s founder Yang Guoqiang. Her stockholdings in the group means she is one of the richest women in Asia.

Is it a crowded sector in the stock market?

When Fantasia spun off its property services provider Colour Life on the Hong Kong bourse in 2014, investors were generally less interested in its business model than one of Fantasia’s shareholders: Zeng Baobao, a niece of former Chinese vice-president Zeng Qinghong.

It turns out that businesspeople with political connections are sometimes blessed with astute entrepreneurial insight as well. The sector has blossomed since then, picking up even more admirers in the wake of the Covid-19 outbreak.

Indeed, when millions of Chinese were banned from leaving their homes in the first half of last year, the gated communities were a major reason for the successful implementation of lockdown measures. Services provided by property management firms, which kept their residents safely housed and supplied, served as a reminder of the sector’s investment value.

Up to 18 Chinese property management firms went public in Hong Kong last year, taking the total number to 43. That group is expected to top 70 by the end of this year, Hong Kong Economic Times has estimated. Interest in the sector has increased to the point that indices compiler HSI Services has created a new index tracking the movement of the 30 largest players.

There are more listings to come. Next in line is Country Garden’s Guangzhou counterpart R&F Properties Services. The sister firm of Hong Kong-listed developer R&F, the company filed its listing prospectus last week. Local media reported that the IPO could raise up to HK$5.5 billion – not bad for a business that R&F seems to have sold to its controlling shareholders for Rmb300 million just a year ago.

China Vanke, the largest Chinese developer by market value, is also working with bankers to prepare an IPO of its property management unit that could raise about $2 billion, Bloomberg reported last week.

Why the rush to IPO?

China’s financial regulators haven’t approved a property developer’s IPO for years in a move designed to take some of the heat out of the real estate market, as well as curtail another unsustainable surge of construction of new projects.

The embargo hints at why the property tycoons have been looking for another route to market, although their property management firms have not been that well received by regulators in mainland China either.

So instead they have been rushing to IPO in Hong Kong, a city where investors have bought happily into real estate plays for years.

The fundraisings are much needed for the most leveraged of the Chinese property giants too, some of whom have been struggling financially since the introduction of the so-called ‘three red lines’ system in late 2020, which caps their ability to raise further debt (see WiC510).

Spinning off their property management businesses offers an alternative route for the most indebted players. For instance, the net gearing ratio at Evergrande had soared as high as 159% but a $2 billion IPO of its property management unit in Hong Kong last November helped it to lower its debt levels by nearly 20 percentage points.

In their newer form the property management businesses are attracting plenty of interest with their asset-light business models and the promise of more stable streams of recurring cashflow. Commitments from the central government that at least 10% of new residential land supply will be allocated for the construction of rental homes is also expected to increase demand for management services. Changes in 2014 to price controls and long-term service contracts are also allowing residential property managers more opportunity to increase their fees, offering the prospect of improvements in profit.

Indeed, businesses deriving profit from property management and related services have become such an accepted choice among investors that real estate bosses would look foolish not to tap the stock market sooner or later.

Case in point: Country Garden has been trading at less than five times its 2020 net profit, while its sister firm CG Service has been enjoying a price-to-earnings multiple of as high as 70.

Is it only about bricks and mortar?

In the past, heavily indebted home builders were a risky option for investors wanting to tap into the wider prospects of China’s real estate market. The property management business now offers an alternative route which isn’t as capital intensive nor as saddled in debt.

But this could also be a growth story – in this case involving the ‘consumption upgrade’ in the Chinese economy as property management firms tap into new categories of spending in areas including home improvement and leisure. Indeed, some of the biggest firms are already providing services including apartment decoration, healthcare and even wealth management.

For bigger fish such as Country Garden, the analogy is the business model of Apple and its iOS platform. Following the purchase of the iPhone, customers continue to pay for Apple’s services and the apps that it hosts on its App Store. Modern property management firms have been described as ‘operating system’ sales channels for the Chinese real estate firms. “Property management is actually a new industry. There’s still plenty of room for imaginative growth,” Beike Research Institute notes. “This is not only about the provision of value-added services, but the real-life connection to many more consumer needs.”

This kind of approach helps to explain why China’s internet behemoths have also targeted the country’s xiaoqu as cornerstones of the “community group buying” market (see WiC521). Property management firms are the gatekeepers to thousands of residential compounds, so the chances are that they will want a slice of the pie as group-buying grabs a greater share of the retail trade. That promises competition or cooperation with the internet giants in the months and years ahead.

How about the property kingpins in the commercial sector?

Much of the rationale for residential property management applies to the commercial property market too. And in this sector, there are few players larger than Wanda Group, once the largest commercial landlord in China.

In 2016 Wanda took its commercial property unit private, leaving the Hong Kong bourse. The goal was to relist it at a higher price in Shanghai or Shenzhen but Wanda failed to get the regulatory green light for the plan. Keen for new capital after a poorly executed campaign of cross-border investment, Wanda has been offloading its real estate projects and reverting to an “asset light” business model.

Now it sees another opportunity to monetise its property franchise again, setting up a new entity called ‘Wanda Light Assets’. The unit is tasked with managing 368 shopping complexes in China (plus a further 155 under construction; see WiC536).

Prior to the restructuring, Wanda’s commercial property unit had racked up about Rmb10.5 billion in net profit for the first three quarters of 2020. After adjusting for the impact of the Covid-19 outbreak, the new unit could report annual net income of at least Rmb15 billion, Securities Daily reckons. Other commercial property managers have been trading at multiples more than 100 times their earnings, the newspaper says, so Wanda Light Asset could be targeting an IPO valuation of between Rmb750 billion and Rmb1 trillion, listing most likely in Hong Kong.

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