After years of waiting, financial regulators appear to be moving forward approving onshore Real Estate Investment Trust (REIT) vehicles in China. According to local media, CITIC Securities has recently become the first firm to receive approval to raise a REIT that will eventually be listed in Shenzhen and pay dividends from two office buildings the company owns in China.
The concept of the REIT was first introduced in the U.S. in 1960 with the intention of creating an ownership structure similar to a mutual fund which would allow for investment in commercial property without buying assets directly. The popularity of REITs did not really take off, however, until the early 1990’s with the first REIT IPO “boom”, when more than 100 private real estate firms launched REITs. In the late 1980’s, the U.S. experienced a period of overbuilding coinciding with deregulation and a large increase in short-term construction financing. With debt drying up in the early 1990’s, many over-leveraged developers were forced to find private equity investments or go public to raise equity using the REIT structure.
In many ways, China today resembles the situation in the U.S. when REIT securitisation took off for the first time. A huge boom in commercial construction over the past five years was encouraged by growing levels of debt which the government is now working to reign in without damaging growth. Many developers have been forced into the shadow banking sector and trust lending in order to refinance existing debt. So now that REITs are on the horizon and property firms are being forced to find new sources of financing, will China see a similar REIT “boom”?
Several obstacles still stand in the way of REITs in China. The first obstacle is that the legal and regulatory framework must be set up to avoid double taxation on assets incorporated in a REIT. The second obstacle is more psychological. The government in China is currently working hard to reign in credit and cool down the real estate sector and may view REITs as just another source of financing for developers that have already stretched themselves too far.
In my opinion, REITs would be beneficial and should be encouraged by policy-makers in China. First, equity REITs must invest for the long term and need to generate stable returns, which is a force for stability in the market that discourages purely speculative investment and encourages greater risk management. Second, as listed vehicles, REITs must provide regular financial disclosures and this would lead to greater transparency in the market for both investors and regulators. Third, a REIT market could provide investors in China with a source of higher investment returns and a way to access the commercial real estate market without being forced to buy property directly. Globally, REITs control over $1 trillion in commercial assets in more than 30 countries, and if China recognises the benefits of REITs, the market could see tremendous growth in the years to come.
