The trade war with the US is still ongoing and China’s GDP growth is slowing. However, officials at the National People’s Congress meeting in early March have pledged only moderate policy easing this year. Reducing financial risks is a key policy aim of president Xi Jinping, so it is not surprising officials are reluctant to allow a sharp rebound in lending – even if this comes at the cost of slower growth.

Some economists have taken a negative view. Macroeconomics research firm Capital Economics predicts GDP growth of only 4-4.5 percent this year, for instance. The participants at PERE’s annual China roundtable in Hong Kong, held on the same day as the NPC meeting last month, were far more sanguine.

Stanley Ching 

Senior managing director 
and head of real estate
CITIC Capital 

Ching has led the real estate team at CITIC Capital since the unit was established in 2005. Since then the business has raised 12 funds across most asset classes and risk profiles and has $2.2 billion of assets under management. 

Stanley Ching, senior managing director and head of real estate at Hong Kong-based private markets manager CITIC Capital, says: “We are long-term investors in real estate, so these factors are really of less importance to us than the long-term factors of urbanization, the growing middle class and rising domestic consumption. China can survive with 5 percent growth, even 4 percent growth, but there will be growth. Those three major trends will not change.

“Even in the worst-case scenario, where there is no trade agreement, there will be growth. There will be a short-term impact, which means maybe we can get decent assets at a very reasonable cost. Domestic consumption will suffer a little bit in the short-term because confidence in the economy will weaken, but it will come back.”

The roundtable expressed confidence in the Chinese government’s financial management, particularly recent tax incentives for consumers and banks being encouraged to lend to small and medium-sized enterprises.

Shane Taylor, head of Asia-Pacific strategy and research at CBRE Global Investors, the real estate investment management business of global property broker CBRE, says: “Some of the methods, such as middle-class tax cuts and incentives, were something of a change from the past, but very sensible: putting more disposable income into the pockets of households. We think that’s a very good thing because the investment thesis for us in China is very much about domestic consumption.”

There can also be upsides from instability of course, as Chris Wu, managing director, investment and development at Hong Kong-based developer Chongbang Group, says. “In the short term, the upside is a stable renminbi. As long as the trade talks are happening, we believe that is within the interest of China and interest of world trade, to have a stable renminbi.”

Tightening credit is the big thing

A little upheaval can be good for real estate investors. “China’s ongoing deleveraging will create potential opportunities for foreign players because it is more difficult for local companies to borrow money,” says Amélie Delaunay, director of research and professional standards at real estate funds body Asian Association for Investors in Non-listed Real Estate Vehicles (ANREV).

 “The combination of deleveraging and new asset management regulations will throw up opportunities for at least a couple of years” 

-Stanley Ching 

That is providing opportunities for foreign investors to out-compete, or even to become lenders themselves. For example, Singapore-headquartered manager CapitaLand announced in February it raised $556 million for a China mezzanine credit fund, which will lend to prime assets in first- and second-tier cities. More opportunistically, a number of private equity real estate firms, including Infrared NF and PAG have undertaken offshore mezzanine lending to cash-strapped China developers.

Data from real estate transactions research firm Real Capital Analytics show foreign investment in China real estate held firm last year, while domestic investment slumped. The foreign share of acquisitions of income-producing properties rose to 32 percent from 29 percent in 2017.

Ching says: “The tightening of credit is still the big thing affecting investment opportunities for us. We are in the process of setting up a special situations investment strategy; this will target good assets which may have trouble due to the tightening liquidity. We have seen more opportunities since the second half of last year and the combination of deleveraging and new asset management regulations will throw up opportunities for at least a couple of years.”

Ching has led the real estate team at CITIC Capital since the unit was established in 2005. Since then the business has raised 12 funds across most asset classes and risk profiles and has $2.2 billion of assets under management. 

However, Ching believes there is only a limited window for private equity investors to exploit the funding gap. “Offshore lending is not the most efficient way for developers to borrow, but at the moment, due to the deleveraging, there is demand and some developers are prepared to pay high interest rates.”

Amélie Delaunay 

Director of research and 
professional standards
ANREV  

Delaunay is responsible for managing ANREV’s fund indices and a series of industry surveys on fund managers and investors. She joined the association in 2013. 

Delaunay is responsible for managing ANREV’s fund indices and a series of industry surveys on fund managers and investors. She joined the association in 2013. 

 The panel agreed that the attitudes of investors towards China vary dramatically depending on how large they are and how much experience they have in China. Delaunay says: “The ANREV/INREV/PREA Investment Intentions Survey 2019 showed around half of investors looking to invest in China and two-thirds of European investors wanting to be there.”

“There is a divergence between the way that large and small investors invest in China. Smaller investors will look at funds, but the large investors tend to go in directly at the platform level.”

Investors which are less knowledgeable about China and which are less keen on investing there tend to cite a lack of transparency.

Delaunay says: “My biggest challenge in China – and the region – is definitely to improve transparency. The main reason investors are not investing in funds is because of the lack of transparency and marketing information.”

Unfortunately, investors and investment managers do not always see that sharing information is more than a zero-sum game. “We try to make people understand that sharing information will benefit them in the long-term,” says Delaunay. “Look at Australia, it is one of the most popular destinations for capital and that is partly because it is so transparent.”

“Last year, the transaction volume of standing, stabilized real estate in China was actually higher than in Japan or Australia” 

-Shane Taylor 

However, Taylor argues that China offers more stability and more liquidity – two important factors for real estate investors – than people think: “When we compare China to some of the other countries around the world where we invest, China is actually one of the more stable and more predictable economies, and with a political body that’s comparatively quite predictable and stable.”

“Going forward, it will be seen more as a core market. For example, last year, the transaction volume of standing, stabilized real estate in China was actually higher than in Japan or Australia.”

Shane Taylor 

Head of Asia-Pacific
strategy and research
CBRE Global Investors 

Taylor’s employer has been investing in China since 1996. The firm has around $100 billion of assets under management globally, $6.2 billion in Asia-Pacific and more than $800 million in China. He joined CBRE GI in 2006 and moved to Hong Kong in 2011. 

 

Wu is even more bullish, stating: “As far as I am concerned, China already has core real estate; it is what we are in the business of creating at Chongbang. And China offers both income and very high growth.” China is currently operating within another window that should be set to close, as there is no real estate investment trust (REIT) structure. However, a number of “quasi-REITs” have been launched to help the government test out the market. “The government has asked a number of developers to come up with a plan for real estate investment trusts,” says Ching. “China’s REIT age is definitely approaching; think how much capital that will absorb.”

REITs will be an important investment avenue for China’s domestic institutions, which are relative neophytes when it comes to real estate. Ching says: “There is going to be a big impact from domestic institutional investors, which are still very new to real estate.”

Wu adds: “Chinese domestic institutional capital is going to be one of the largest capital sources in the world. I’m a little bit frustrated that it hasn’t happened quicker, because the more it internationalizes, the better China will understand the world and the world understands China.”

“China already has core real estate; it is what we are in the business of creating” 

-Chris Wu 

Net sellers

Last year saw a dramatic slowdown in the amount of capital invested overseas by Chinese institutions and developers. In 2018, Chinese investors deployed $7.5 billion of capital into offshore real estate investments versus $35.4 billion in 2017, according to CBRE research. Indeed, Chinese investors became net sellers of real estate in the second half of the year. Investors were reacting to a raft of policy measures since 2017 intended to increase financial stability.

However, the panel remained relatively sanguine about the decline, suggesting that policy-led waves of enthusiasm – or the opposite – would continue in the future, with 2017 and 2018 likely to be seen as unusually high and low points in the longer term. Furthermore, the restrictions may already be loosening.

Ching says: “We have heard from some of our Chinese investors, including SOEs, that they have the green light to invest overseas. However, it must be done in an orderly way. You can’t just buy trophy buildings and investments, they have to be related to your core business. For example, if you don’t do anything in the hotel sector at home, why would you buy a hotel portfolio in Europe?”

China has a population of around 1.4 billion people and more than 120 cities with a population above 1 million – in short, it is a hard country to generalize about when it comes to real estate opportunities. CBRE GI’s Taylor says: “China has progressed to the point where we have a sufficient amount of data to take a strategic, top-down allocation approach to which cities and sectors we want to move into and out of at different points in the cycle. These cycles appear not to be necessarily synchronized.”

Most international investors are focused on the first-tier cities of Beijing and Shanghai – some also consider Shenzhen and Guangzhou to be first-tier as well as larger second-tier cities. However, the roundtable said investors need to consider the satellite cities of first-tier cities as having good investment potential, even if they are smaller.

Shanghai: Yangtze River Delta-based strategies were extolled at the
roundtable

For example, the Yangtze River Delta area around Shanghai includes major second-tier cities such as Hangzhou and Wuxi, as well as smaller cities. The Greater Bay Area of southern China contains Guangzhou, Shenzhen and Hong Kong, but also smaller neighbours Dongguan and Zhongshan. The YRD has a total population of more than 100 million and the GBA a population of more than 70 million. Chongbang’s strategy is to develop retail-led mixed-use developments within the ‘Golden Triangle’ of the YRD and Wu says: “It is important to look at cities economically and not just administratively. We don’t think of cities such as Kunshan as second-tier cities near Shanghai, but as extensions of Shanghai. You can get from Kunshan to Shanghai in 19 minutes; it takes me 35 minutes to get to the office and I live in Shanghai.”

Domestic boosts

Both Wu and Ching’s employers are best known for real estate and both declared China’s ambition to boost domestic consumption and middle-class spending power would benefit that sector. Wu also noted that, while retail real estate seems to get the lion’s share of bad press worldwide, some people are not taking notice. “Over the past two years, retail investment volumes have fallen in the region and in China, but during that time, Blackstone has been buying retail in China and elsewhere. That is smart money at work.”

Chris Wu 

Managing director,
investment and development Chongbang 

Chongbang was founded in 2003 to invest in and develop retail-led mixed-use projects in China, branded as Life Hubs. Chris has been with the firm since 2013 and has been living and working in China since 2000. 

 

The rise of e-commerce has been more dramatic in China than any other nation, both due to the size of the market and to the enthusiasm for online and mobile shopping. The warehousing sector has been the major beneficiary, hence logistics being “the darling of investors,” as Delaunay says.

Logistics is certainly CBRE GI’s darling, and the main focus of its investment in China real estate. It is also a focus for CITIC Capital. Ching says: “We like logistics; there is still a great shortage of stock and demand is growing from e-commerce. It is the only sector in China which is undersupplied and the only one the government is not encouraging investment in, because it does not generate high tax revenues.”

That lack of government encouragement, which stems from warehousing employing a small number of staff per square foot compared with other land uses, is both a boon and a curse for real estate investors. Taylor says: “We track land sales and pricing data every month. It’s quite dramatic how that pool of land for potential logistics investments is shrinking and so we believe it has a scarcity value.”

The China residential sector is often considered best left to domestic developers, which have the scale to build and sell huge numbers of units. However, niches related to the residential sector are newly popular with private equity investors. One example was Charleston-based sector specialist manager Greystar Real Estate Partners, which last month held a $450 million first close for its first China rental residential fund.  This sector is seen as having long-term potential, especially for investors that can bring asset management skills lacking in the local, build-to-sell biased, market, the roundtable agrees.

CBRE GI is also getting involved in this sector and Taylor says: “The rental apartment sector is going to be a great institutional product in the future and there is positive rental growth potential. But it is very hard to underwrite in the short term, when you compare it with other property types. We will use quite long-term capital to invest in it; we are not necessarily looking at exiting in five years’ time, but to hold for longer.”

The other related niche sector is senior living; China’s demographics have been skewed by the one child policy, which ran from 1980 to 2015, and which has contributed to a rapidly aging population. Traditionally, the elderly live with, and are looked after, by their children, but this is not always possible in modern China. For example, a married couple of only children with a family of their own might find themselves responsible for the care of four grandparents but using only one income.

CityOn Xi’an: one of Blackstone’s counter-trending investments

Ching says: “We are also looking at senior living, which has long-term potential. But we are still trying to figure out what is the best business model. We know this is a big opportunity and there’s no obvious market leader in this sector. We will probably find a partner we can work with at a platform level, but this is something we probably won’t do this year.”

Delaunay says: “Interestingly, residential was a major China pick for investors 10 years ago, but not since then. Now, however the interest has returned, but in the for-rental sector.”

Beyond the increasing rhetoric about a country sophisticating and stabilizing at a rapid rate, tangible indicators like that might, in fact, offer the better indication of China’s growing maturity. Certainly, it is these such demographically-underpinned factors that are giving PERE’s China roundtable the confidence to look through the near-term geopolitical or macroeconomic headwinds.

Tech disrupting real estate is ‘passé’ 

The roundtable promoted considering technology in a broader context and not real estate-specific 

Real estate is universally acknowledged to be behind the curve when it comes to technology. However, proptech is growing in importance, and nowhere as dramatically as in China.  

Chris Wu of Chongbang is somewhat dismissive of those who muse about the disruptive power of technology in real estate. “Thinking about technology as a disruptor to real estate is a bit passé. It is better to think about the new ecology created by technology and how your real estate operates within it. Mobile technology and e-commerce allows you to do more with real estate.” 

He cites the example of Hema, a supermarket brand operated by Alibaba, which offers members-only shopping with the ability for goods to be delivered, cooked and eaten onsite or cooked and delivered. Its stores generate more sales per square foot than other grocery stores. But to focus on that and the potential to squeeze more rent out of Hema is to miss the point, says Wu. 

Hema: driving its rent misses the point 

“Covenant strength in retail real estate, comes from being dominant in your catchment area. Hema as a tenant helps me achieve that dominance because it is a membership organization, so its members become my members.” 

Another cliché about China that becomes less true each day is that it is not an innovator, that it only uses technologies others develop. In a number of fields, such as AI, mobile shopping and mobile payment, China is a leader. It is also a major focus of innovation for logistics and thus for the logistics real estate business.  

Shane Taylor, head of strategy and research, CBRE Global Investors, says: “In logistics, what we’re finding in China, is that the technological and organizational advances there are so rapid and so significant that we’re learning a lot from managing China logistics that we can now apply to our Japanese, Korean and other global logistics platforms.”