Chinese REIT market takes one leap forward, but asset selection challenges exist
July 20, 2015 / By Joseph Kim
On 8 June 2015, the China Securities Regulatory Commission approved China’s first publicly traded REIT, which was a milestone for REIT development in China. The Penghua Qianhai Vanke REIT (“Penghua”), which plans to raise RMB 3 billion by the end of July 2015, on the Shenzhen Stock Exchange, will be partly based on the earnings of an office complex located in the Qianhai special economic zone in Shenzhen. Although the new product does not possess all the conventional features of a REIT of developed markets, Penghua is a promising development for China’s REIT industry and a reminder of a challenge that the industry needs to solve.
Officially, Penghua will not be the first domestically listed REIT in China, but its features hold more promise than its predecessor and highlight a challenge for future REIT development in China. Compared to that of its predecessor, the Qihang Specific Asset Management Plan (“Qihang”), Penghua plans to offer its investors a yield that is at least partially determined by the rent income of the underlying assets of the REIT. According to the IPO prospectus, 50% of the REIT’s earnings will be derived from property rent income and the other half will be invested in other securities, such as stocks and bonds, to augment the yield of the product to make it attractive to investors. Qihang, on the other hand, has predetermined yields and a limited time frame of five years, more closely resembling a property linked note[1] than a REIT. Penghua will offer more liquidity by offering its shares to retail investors on the Shenzhen Exchange rather than to a select group of institutional investors.
Still, it is too early to call Penghua a “true” REIT. From a legal and tax standpoint, there are many areas that need to be developed to incubate true Chinese REITs. However, the largest challenge for Chinese REITs is the selection of the underlying assets to be placed in the REITs. So far, it is clear that neither the stabilised yield of the underlying assets of Penghua nor Qihang is adequate to contribute to a REIT product that will be competitive in the equity markets in China. This is not the fault of the respective REIT sponsors. Generally, assets that are placed in a REIT are high quality, stabilised assets in core locations with yields that sit near the low end of the investment yield spectrum. Despite China’s large institutional investment grade stock, there are slim pickings when it comes to “REIT-able” assets in the market. Hypothetically, if you were to take a Grade A, core CBD office asset located in Pudong, Shanghai, you would have a REIT product that is based on a sub 5% level NOI yield, which wouldn’t be competitive, given market alternatives. From this perspective, the logic behind yield augmenting for Penghua and Qihang makes sense.
The future of the Chinese REIT market hinges on further development across multiple dimensions, but a strong driver will be the selection of assets for future REIT offerings.
[1] A short-term loan backed by real estate. The loan interest is paid from the yield proceeds of the underlying real estate that is pledged. The debt instrument is structured to pay back interest and principal over a fixed time period.
