Are REITs Coming to China? Cross-Border Insights from Green Street's Jim Sullivan
Two REIT conferences recently took place in Beijing, China. Both were designed to educate market participants about the REIT structure and the “best practices” that have contributed to the rapid expansion of the REIT market in the U.S. and several other countries around the world. China is the second largest economy in the world, and its commercial real estate market is expanding rapidly. However, China currently does not have a REIT regime. The creation of a REIT structure in China could lower the cost of capital for real estate companies in the market while also providing an efficient and liquid investment vehicle for institutional and retail investors.
NAREIT and the Asset Management Association of China (AMAC), a trade association for the mutual fund industry in China, co-hosted one of the two REIT conferences. The “Seminar on REIT Regime and Investments” was designed to educate the audience about REITs and the structural features that have proven successful in the U.S. and other markets. The audience was comprised primarily of mutual fund portfolio managers and government/stock market officials. Speakers from the U.S., in addition to Green Street, included global REIT portfolio managers and tax/legal experts.
The second conference was hosted by China REITs Alliance, a trade association focused on creating a Chinese REIT structure. At its annual conference in Beijing, over one hundred real estate owners, developers, and public real estate companies from China and Hong Kong, gathered to network and learn more about the REIT attributes that are most important to investors. Development strategies were also of interest, and residential is the “red hot” sector as rapidly rising home prices have created a frenzied market environment. It is important to note that “residential” refers to individually owned homes and condos, as there is no institutional apartment market in China.
Residential developers in China are often required to build neighboring office, retail, and hotels as part of their land use agreements with the government. A common theme throughout the conferences was that REITs could provide an exit strategy for developers to shed these commercial properties. Commercial real estate trades far less frequently in Asia than in the U.S. Thus, portfolio growth can best be achieved by developing new buildings rather than buying real estate from another owner. That being said, the land use rights that are granted to developers are a complicating valuation factor. In Hong Kong and mainland China, the government usually owns the land and developers are granted either 50-year or 70-year land use rights for commercial and residential development, respectively. There is no precedent yet as to what happens at the end of those agreements and how economics will ultimately be split between the government and building owner.
The conference participants provided optimism that the creation of a REIT regime in China may happen in the next few years. One key driver could be the desire for the government to execute more public/private partnerships. REITs are viewed as an interesting potential source of capital to supplement existing bank mortgage lending. Structural considerations that legislators will need to work through include property rights and government taxation. In the case of the latter, real estate is a big tax generator in China, so the government can be expected to be particularly circumspect regarding the overall tax impact caused by the implementation of a REIT structure.
The issue of disclosure and transparency received a lot of attention at both conferences, and the shortcomings in these areas for some existing public real estate companies throughout Asia was mentioned frequently. Another key point of discussion was internal versus external management. The externally advised structure is the norm in Asia, with fees to management often being tied to earnings growth. Interestingly, relative prestige among public companies is often measured by the absolute size of company revenue, not by the shareholder-return track record.
Many of the conference attendees were familiar with existing publicly traded real estate companies in Hong Kong and China, which are typically development-focused entities. Many of these companies trade at persistent NAV discounts due to a variety of factors, most notably the conflicts of interests that arise through the externally advised structure. The U.S. contingent at the conferences certainly gave the audiences an alternative public real estate model to consider – one that would be internally advised, development light, provide great disclosure, establish alignment of interest, and focus on NAV/sh growth. That was the Kimco IPO model in ’91 that launched the modern REIT era in the U.S., and it provides a great road map for any country – including China – that is considering the creation of a REIT regime.
This article originally appeared in GlobeSt on December 5, 2016.