By Samuel Shen, Yawen Chen and Clare Jim
SHANGHAI/BEIJING/HONG KONG (Reuters) - Chinese real estate companies have found a new tool to raise money - selling units in real estate investment trusts (REITs) backed by rental apartments. There is just one problem - in some cases the rental income may not be enough for the returns that REITs issuers indicated they will pay investors.
Over the past six months, nearly half a dozen developers have successfully applied to local stock exchanges for quotas to issue rental apartments REITs totaling 16 billion yuan ($2.53 billion). So far, 2.2 billion yuan of such REITs have been issued.
In March, for example, Poly Real Estate Group (SS:600048) raised 1.7 billion yuan issuing REITs with an indicated annual yield of 5.5 percent for the senior tranche of the securities. Hong Kong-listed developer CIFI Holdings Group (HK:0884) attracted investors with a tranche in its first batch of REITs that promised returns of roughly 6 percent.
The authorities are looking favorably on any real estate companies who have robust plans to develop or acquire rental apartment buildings as this fits with President Xi Jinping's pledge to reduce the speculative nature of the property market and help provide affordable housing for those who don't have enough money to buy.
Chinese developers have in the past couple of years been issuing REITs backed by other form of properties such as office buildings and shopping malls. The market has expanded to 68.7 billion yuan from virtually nothing four years ago, according to consultancy China Securitization Analytics.
But the rental apartment REITs market, and the home rental market itself, have not developed fully - and there is a mismatch between the cost of developments and what renters are willing to pay.
George Yang, a veteran investor in the U.S. apartments market, said he is concerned that rental income would fail to satisfy investors, given China's frothy property prices.
"Whether in the U.S. or Singapore, a net rental yield of 7 percent is the make-or-break threshold for REITs," said Yang, managing director of JIC Capital Management Ltd.
But in China, average rental yields - the rate of income return over the cost of investment - are merely 2-3 percent, lower than the financing cost of 5-6 percent. In some cases, they are lower, or even negative.
As a result, he says, he doesn't see how the model works in China. In Yang's eyes, China REITs are just another questionable way of borrowing by developers seeking to skirt tougher lending rules imposed in recent times by Beijing. He says the securities are backed more by the developers' credibility than rental income.
Public disclosure by REITs’ issuers about the underlying properties are limited, which is not the case in developed markets, such as the United States. China's REITs are not yet publicly traded. They only change hands among institutional investors.
"Nobody really does due diligence to evaluate the risks," said Joe Zhou, head of research at real estate consultancy Jones Lang LaSalle in China. He said even those who wanted to do it would find it difficult to get detailed information about the underlying assets.
Some investors are less concerned about the dividend as they are buying the REITs in hopes of gains in the value of the assets.
"Some investors are eyeing ... the prospect of connecting to the retail market," said a senior executive at CIFI, referring to expectations that China will open the REITs market to retail investors, potentially boosting valuations.
"When there's more liquidity, investors' demand for yield will go down," said the executive.
CIFI itself is issuing REITs as a product that is sold in two structured tranches to investors with drastically different risk appetites - one for those who seek guaranteed fixed returns, and the other for those who bet on asset appreciation.
REIT FAILURE FEARS
The government is hoping that a booming REITs market can create a financial tool to help developers weaken their reliance on the traditional model of build-and-sell, said Wang Xi, executive vice president at developer Yanlord Land Group Ltd (SI:YNLG).
Liu Qiao, professor of finance and dean of the Guanghua School of Management at Peking University, forecast that China's rental apartment REITs market has the potential to expand to as much as 1.5 trillion yuan - but he warned that there are huge challenges ahead.
"One major problem is a shortage of assets with relatively high yields. You also need tax incentives to support the market," Liu said.
He also said he is worried that the market could be killed off in its infancy if there is a major REIT failure.
In November, China Young Professional Apartments Ltd, which was established as a specialist apartment rental firm and converts office buildings into apartments, raised 270 million yuan issuing REITs.
In March, it partnered with China Construction Bank to launch a 2 billion yuan fund to acquire properties which its founder Wang Gehong hopes will eventually be securitized in the form of REITs.
But Wang says other developers will struggle to back their REIT plans with actual rental apartments.
"Developers are applying (for REITs quotas) to raise 1 billion, 2 billion, 10 billion yuan, but where are the apartments?" he asked.
"It's difficult for developers now to issue bonds or get loans, so suddenly they find this really handy tool to raise money."
($1 = 6.3210 Chinese yuan renminbi)