Real estate: China boom or bubble?

The US banking and financial sector, AVCJ sources indicate, is still held back by incalculable exposure to depreciating commercial real estate assets, impeding lending and leverage provision. By contrast, China’s real estate sector has been impacted relatively little, and if commentators and regulators alike are concerned about anything, it is that runaway stimulus-driven prices may lead to a new real estate bubble.

China’s real estate momentum

The world’s biggest country in terms of population, China with its 1.2 billion, alongside India with its 1 billion, is one of the countries in which rapid economic growth also necessitates an increase in housing quality and supply as the number of middle-class households rise. As Dr Zhu Min, Deputy Governor of the People’s Bank of China, pointed out while speaking in Hong Kong recently, in the PRC, everyone in China, even fresh graduates with only a year or two in the workforce, wants to own their own home.
In previous months, news reports proliferated of the formation of China-focused real estate funds. So did others of officials trying to rein in players already active in the sector, such as the 78 non-realestate SOEs whose participation in the real estate market was recently slapped down by central authorities. This followed all-time high prices paid in a residential land auction in Beijing earlier in the week. The China Banking Regulatory Commission, the PRC’s official banking regulator, has now told the country’s banks to stop lending to developers already sitting on undeveloped land banks, as well as begun limiting credit to the 78 recalcitrant SOEs, as the country’s real estate prices saw a 10.7% rise in February, the highest in two years.
Private equity players have been here before. Many aggressive foreign private equity real estate investments were made in 2006-07, ahead of the Beijing Olympics. In 2006, foreign private equity real estate funds were involved in 31 deals with a total value of over $3 billion. In the first quarter of 2007, real estate was the largest investment sector for private equity in China. However, this trend of foreign investors leading the market has petered out recently as investor majors such as Morgan Stanley, Credit Suisse, and Lehman Brothers withdrew their real estate operations from China.

A delayed return by outside investors

In spite of the mass exodus that began at the end of 2008, outside players are either returning to the market or rebuilding their operations. Last month, the private banking arm of US bank Citigroup, in partnership with Chinese conglomerate China Resources, launched two real estate funds with a special focus on investing in Chinese shopping malls. The JV was said to have a target figure of about $500 million for the planned funds, the CR China Retail Real Estate Income Fund 1 and CR China Retail Real Estate Development Fund 1, expecting to have annual returns of 12-15% and 20 % respectively.In addition, one of the largest asset managers, Franklin Templeton, said that its real estate arm plans to raise $300 million for its second Asian real estate fund, and that the fund will look at China as a market focus.
Within March, AVCJ reported two significant new appointments in the Asian realty sector. Ex-Asia-Pacific head for Citi Property Investors David Schaefer joined UK real estate consultancy DTZ Holdings to steer its plan of forming an Asia Pacific-focused property fund. Prudential Property Investment Managers, part of the asset-management unit of UK-based insurer Prudential PLC, appointed Scott Girard, the current CIO of Prudential Investment Management, as its new Asia CEO. Prudential Property Investment Managers Asia has more than $2.28 billion in funds.
Another significant indicator was that Palm Springs, a luxury property developer based in Hong Kong, was said to be in talks to sell a stake worth $100-200 million to a private equity fund, after the developer failed to launch its planned IPO. It aimed to raise up to $1 billion.

The post-Olympic market

The opportunities are there, but for foreign players at least, no longer quite so rich. “We are seeing opportunities coming to the China market, but it is not the same level as in 2006 and 2007,”said Richard Marriott, Regional Leader of Lenders and Investor of EC Harris, to AVCJ. The firm’s global team advises clients, including the top ten international real estate investors, on their asset management.
Singapore-based Marriott said, “We certainly see that funds [who are fundraising] are looking at Asia, and see great opportunities in investing in China’s properties.” But, he continued, “Funds are there, but opportunities are less.”
Projects launched in China in 2006 and 2007, with investors hoping for strong capital growth, are having trouble refinancing now, due to the tightening loans from local lenders. And local developers are finding their funding sources drying up, now in need of fresh capital to continue their projects. With the current lending situation, capital from private equity funds seems to be one of the few alternative solutions.
That said, with current PRC government policy in effect, foreign funds are not allowed to acquire Chinese assets directly, and can only participate through a joint venture with local firms. “For the past two years, we have observed that a number of foreign private equity players and real estate investors were trying to form joint ventures with experienced local firms,” Marriot said. “Our view is that finding the right local partner is a key for international investors in China.”

Opportunities and opportunism

Meanwhile, opportunistic deals are going on in logistics and Tier 2 cities such as Tianing, Chongqing and Dalian. John Fadely, a partner at Clifford Chance, told AVCJ that price inflation in Tier 1 cities continues to be an impediment for offshore real estate funds investing in China. Fadely also noted that several PRC developers are strapped for cash and looking for partners, which may continue to provide opportunities for foreign sponsored real estate funds. However, he added that China-focused offshore real estate funds still haven’t gained significant traction in terms of fundraising, and that those with focused strategies and smaller fundraising targets seem to be having more success for the time being.”
Industry analysts have predicted that home prices in China will increase by as much as 20% by the end of 2010, despite government efforts to cool the market. Shanghai appears to be the strongest market in the country and residential prices may jump by as much as 20% over the next year, compared with the final quarter of 2008, according to Stanley & Partners Investment Management.
Fadely also emphasized that local developers are struggling to find cash and are looking for partners. However, he noted that Western real estate funds coming into China are few and far between, and added that PIPE investments appear to be the preferred approach. He has seen a number of emerging homegrown real estate investment firms in China, but these groups have little experience.

Distress potential

Another seasoned private equity real estate investor said, “If we look only at growth rates, China seems a very attractive destination for real estate investments, but the stock market is fragile, and the risk for returns would be high in China.”
In theory, financial problems among Chinese developers should lead to distressed opportunities.
According to RICS Research, the UK-based research centre, the US and Japan are set to see the biggest rise in distressed sales in the first quarter of 2010, and distressed markets are said by real estate professionals to be growing worldwide. The report also noted that the biggest pick-up in distressed sales was reported in China, followed by Spain, Japan and the Republic of Ireland. However, the pace of increase moderated across the majority of markets in 2010 compared to the third quarter of 2009.
However, distressed assets are currently an anomaly on the PRC market, according to industry sources. One lawyer said, “Distressed assets may well be largely driven by the government policy. Now, local investors are coming to help refinance property projects.”
Legally, Chinese banks are not allowed to make direct investments in properties, but they could pour capital into the sector through joint ventures with third parties. Most recently, the No.6 PRC lender by assets, China Merchants Bank Co., and the No. 7 lender, Minsheng Bank, were reportedly looking at a partnership to form local real estate funds.
“Real estate is a local business in China,” Fadely concluded significantly.

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• Topics
• Real estate
• Real estate
• Real estate
• Greater China
• Morgan Stanley