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Poor returns to limit China Reits even if rules eased
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THE market for Chinese real estate investment trusts (REITs) is unlikely to develop significantly in the short to medium term, even if regulations are loosened. This is because many of China’s investment properties are of poor quality with low rental yields of less than 4 percent, which would be offset by high domestic borrowing costs of above 6 percent, leaving little profit for REIT unit holders.
China’s high borrowing costs mean that return-on-equity enhancements arising from leverage are erased for unit holders of REITs. In such an environment, REITs become pure capital appreciation plays.
The authorities has been moving toward allowing REITs, with a central bank statement in September 2014 saying that a REIT pilot scheme will be promoted to support reasonable funding needs of property developers. In November, the director of the Policy Research Center of China’s Ministry of Housing said the real estate assets are ready for securitization.
China’s property market participants have long been studying the use of asset securitization to improve their funding structure and relieve repayment pressures from large borrowings from non-bank financial institutions. These borrowings from the shadow-banking sector amounted to 1.3 trillion yuan (US$211 billion) by the third quarter of 2014, data from the China Trustee Association showed.
We believe that China’s property developers would be keen to deleverage by partially selling their stakes in investment properties via REIT listings in China. However, the current listing regulation does not support the listing of REITs.
Poor candidates
However, even if the listing rules were changed, excess supply of commercial properties and weak tenant mix will continue to weigh on rental yields, which make the investment properties of many Chinese property firms poor candidates for REITs.
A significant discount on property valuation may be necessary to lure REIT investors, but this is not an attractive option for property developers. Alternatively, the prospect of strong rental growth could boost future rental yield, but We do not expect this to occur in the short to medium term.
Although these challenges would deter most developers from listing REITs when rules are loosened, some leading players that enjoy low funding costs could provide reasonable yields to investors, which would increase their chances of successfully listing REITs. For example, China Resources Land, Franshion Properties (China) Limited and Dalian Wanda Commercial Property Co own high-quality retail or office properties in prime areas in China.
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