Securitising China real estate: a tale of two China-centric REITs
Michael C.H. Quek and Seow Eng Ong
Department of Real Estate, National University of Singapore, Singapore
Abstract
Purpose – There is currently no real estate investment trust (REIT) listed in China. As of date, only two REITs – GZI REIT of Hong Kong and CapitaRetail China Trust (CRCT) of Singapore – have securitised Chinese property assets. The purpose of this paper is to examine the driving forces and the obstacles surrounding China REITs, and evaluate REIT securitisation as an exit strategy for Chinese properties. Design/methodology/approach – The paper analyses the performance of the two cross-border REITs and investigates whether REITs holding Chinese assets outperform other listed REITs. Research limitations/implications – CRCT outperforms GZI REIT as well as some of the other Singapore REITs, while GZI REIT ranked second lowest in terms of price performance when compared to other Hong Kong REITs. The limited history of CRCT suggests that when a well-structured REIT holding Chinese assets can perform very well. We also infer that performance is closely linked to portfolio composition and diversification, growth story and originator reputation. Originality/value – The study shows that there is indeed a strong local demand for China REITs, and that REITs can provide an alternative source of real estate financing for Chinese developers and promote a better regulated Chinese real estate market. Keywords Real estate, Investments, Trusts, Securities, China Paper type Research paper

Securitising China real estate

247
Received April 2007 Accepted July 2007

1. Introduction Asia has witnessed two major phenomena over the past decade. The first is the emergence of the China real estate market and the second is the rapid growth in real estate investment trusts (REITs). The Chinese economy has outperformed most developed economies over the past decade, and this is commensurately reflected in the performance of the China real estate market. REITs in Asia have grown exponentially since the first REIT was introduced in 2001. The commonality in these two phenomena – China-centric REITs – is the focus of this paper. Currently, two REITs are listed on portfolios of assets from China – the Guangzhou Investment (GZI) REIT and the CapitaRetail China Trust (CRCT). Both REITs were well received upon listing and were highly oversubscribed. The GZI portfolio comprises four office/retail buildings concentrated in the Guangzhou region, while CRCT holds seven retail malls spanning five cities across China. While both REITs promise stable distributions through sustainable long-term growth, they follow different business models and strategies. The first objective of this paper is to examine REIT securitisation – both on- and off-shore – as an exit strategy for Chinese properties. The second objective is to evaluate the performance of the two REITs holding Chinese properties. Our study shows that there is indeed a strong local demand for China REITs, and that REITs can provide an alternative source of real estate financing for Chinese developers and

Journal of Property Investment & Finance Vol. 26 No. 3, 2008 pp. 247-274 q Emerald Group Publishing Limited 1463-578X DOI 10.1108/14635780810871623

JPIF 26,3

248

promote a better regulated Chinese real estate market. CRCT outperforms the GZI REIT as well as some Singapore REITs, while the GZI REIT ranked second lowest in terms of price performance when compared to other Hong Kong REITs. The limited history of CRCT suggests that a well-structured REIT holding Chinese assets can perform very well. We also infer that performance is closely linked to portfolio composition and diversification, growth story and originator reputation. 2. Overview of China real estate market Between 1990 and 2005, China experienced an overall average GDP growth of 9.7 per cent, far in excess of growth rates in developed economies. Based on forecasts by the Economist Intelligence Unit (EIU), China will still continue to experience a GDP growth rate of around 4-6 per cent higher than average world GDP (see Figure 1). The growth of China’s urban population is both a driving force behind and a consequence of rapid economic development. Over the past ten years, the urban population has grown by 21 million per year (see Figure 2), at an average annual rate of 4.8 per cent. By 2005, urban residents totalled 562 million, accounting for 43 per cent of the population. EIU projects China’s urban population to grow at an average of about 3 per cent (19.3 million) per year over the next decade. By 2015, urban residents are estimated to number 755 million, accounting for 54.4 per cent of the total population. The urbanisation rate is expected to rise by 1.1 per cent per year. The growing population and urbanisation rate will spur demand for new homes in urban city centres. With growing demands and economic affluence, investment in Chinese real estate has been increasing rapidly as well in China at an average growth rate of 25.5 per cent (see Figures 3 and 4, based on official statistics from the China National Bureau of Statistics). “Other sources” of funding[1] account for the highest percentage of real estate funding for Chinese real estate investments (Figure 4). Around 29 per cent of the funding was self-raised by the developers themselves. They include listed property companies who are able to raise funds through the issuance of shares and state-owned

Figure 1. GDP growth: China versus the world

Securitising China real estate

249

Figure 2. Urbanisation rate of China

Figure 3. Real estate investments in China

Figure 4. Sources of funding for Chinese real estate investments

JPIF 26,3

250

developers funded by the government. The majority of the small- to medium-scale Chinese developers still obtain financing through commercial banks. Domestic lending by China’s commercial banks accounts for roughly 22 per cent of funding for real estate investments. Foreign-injected funds have been increasing over the years. This could be due to the entrance of many foreign institutional investors in the 2000s. Some of these players include Morgan Stanley Real Estate Funds, Hines, ING Real Estate, Deutsche Bank, Macquarie Bank, Goldman Sachs, Merrill Lynch and Lehman Brothers. Singapore’s Government Investment Corporation (GIC) and CapitaLand also entered the market back in the late 1990s. These foreign institutions entered into the China real estate market via active acquisitions of commercial properties (Sing, 2006). However, foreign institutions account for only 1.5 per cent of the total market. Commensurate with economic growth, the annual disposable income per capita of Chinese citizens has been growing at 9-12 per cent annually since 2001 (see Figure 5). Retail sales have also been growing steadily over the years, with a high of RMB 7,641 billion ($US932 billion) of sales in 2006 (Figure 6). The increasing disposable income growth and higher retail sales signalled a higher purchasing power on the part of the Chinese. The increased consumer spending power is a key factor underpinning the strong demand for the two China-centric REITs. 3. Brief review of securitisation in China and Asian REITs Ooi et al. (2006) examined the growth of REIT markets in Asia. Favourable regulatory changes by governments have provided the necessary catalyst for REIT growth. Two main factors driving the success of REITs in the USA and Australia are their tax exemption status and high dividend payouts. The ability of Asian REITs to replicate these factors will stimulate further growth of REITs in Asia. The introduction of REITs has also improved the liquidity and efficiency of the real estate market, as well as the corporate governance of real estate organizations in these countries. However, as more REITs are listed on stock exchanges across Asia, investors will be given a wider variety of choices. Hence discernment will be required to pick the right REITs, since

Figure 5. Annual disposable income per capita

Securitising China real estate

251

Figure 6. Retail sales in China

the availability of quality properties to acquire will be reduced. New REIT markets (e.g. China, India) are also expected to emerge in the near future, bringing further depth to Asian REIT markets. Ooi et al. (2006) also noted that REITs in Japan and Singapore had performed very well, with price appreciation dominating the total returns for most listed REITs. Newell et al. (2005) conducted a study on the dynamics of direct and indirect real estate markets in China. The study examined the risk-adjusted performance of the direct and indirect real estate markets in China from 1995 to 2002 and revealed evidence of portfolio diversification benefits for both the direct office markets and real estate companies in China against the stock market. Other than the above, there has been limited study of securitised China real estate. 4. Securitisation in China Although the China real estate market has flourished, the main route of raising funds by developers is through traditional debt financing. Commercial bank loans typically fund up to 70 per cent of the project cost, while the remaining 30 per cent[2] is required by banking regulations to be funded by the developer’s own equity. The lack of a secondary market for real estate related mortgages meant an over-reliance on commercial bank lending by developers The Chinese securitisation market truly started in 2005 and is still in its infancy. Securitisation projects are mostly focused on industrial securities rather than real estate assets. On 13 June 2003, the People’s Bank of China (PBOC) issued Circular 121 with the aim of tightening financing in the real estate sector in order to promote a more sustainable growth. The Circular 121 imposed stricter controls on loans originated by commercial banks for real estate related activities like project developments, land banking, construction and individual home mortgages[3]. Following this circular, new restrictions were introduced by commercial banks, requiring developers to obtain four official permits (namely project commencement,

JPIF 26,3

252

land use planning, construction and land use right) before banks could disburse loans. These were tough measures, as only the financially strong and well-established developers, or politically linked state-owned companies, could afford the 30 per cent registered capital up front and obtain the necessary official permits in advance. This restriction effectively restricted the main source of funding for these real estate developers and forced them to explore alternative sources of funding for real estate projects. In response to the need for alternative financing by Chinese developers, real estate trust companies emerged to fill this financing gap. Real estate trust companies, which are also known as “quasi-REITs”, operate like mortgage trusts. They are not listed entities but raise capital through private arrangement. The operations of these trust companies are governed by provisions in the “Trust Investment Companies Management Guidelines” published by the People’s Bank of China on 5 June 2002. However, there are a number of prohibitions with regards to direct or indirect acceptance deposit savings, capital issuance, foreign debts/loans borrowings, and number of units (no more than 200). A recent amendment to the Trust Investment Companies Management Guidelines was released on 24 January 2007 by the China Banking Regulatory Committee to be enforced on 1 March 2007. The new ruling brings good news for trust companies as the cap of 200 investors will be lifted for institutional investors. The new ruling now only limits individual investors of trust companies to 50 persons, and they must have an annual income exceeding RMB 200,000 and net worth of more than RMB 1 million. This raises the barrier for individual investors, making it harder for the public to invest. These Chinese “quasi-REITs” definitely still lack the market transparency and public availability associated with listed REITs. The implementation of credit tightening policies following the Circular 121 issued by China’s central bank in 2003 has forced real estate developers to seek alternative financing sources. Trust companies have come in to provide short-term bridging facilities to help real estate developers overcome the liquidity crunch caused by the retreat of commercial banks from real estate lending. However, the supply of loans by trust companies is limited and is subject to tight regulatory controls by the China Banking Regulatory Commission (CBRC)[4]. An alternative and more direct way for real estate developers to raise funds is through the direct sale of real estate assets held in their portfolios for long-term investment. However, developers may be reluctant to part their high-grade income-generating properties in prime location through the direct sale option. As a form of securitisation, REITs may therefore offer a more acceptable alternative for divestment where developers can raise funds and yet retain claims on the cash flows by keeping a controlling stake in the REIT units. 4.1 Barriers in developing a REIT market in China Potential barriers that hold back the development of a REIT market in China are discussed below. 4.1.1 Security of legal title. There is no sound legal system to ensure that the investor can obtain the legal title of the acquired properties. Investors could face great hurdles in obtaining the certificates of title of the properties if the vendor disappears or is

uncooperative after receiving the purchase price. There is always a risk that the vendor may use the purchase price for other purposes, instead of discharging the mortgages. 4.1.2 Lack of professional fund and asset management expertise. Development of an active REIT market requires the support of a strong pool of well-qualified and experienced fund and asset managers. This is currently lacking in China. In the short term, experienced fund and asset managers could be brought in by allowing foreign REITs to operate in China. Transfer of knowledge and expertise could be systematically arranged so that a pool of domestic expertise could be developed, which is essential for the long-term development of the REIT market in China. 4.1.3 Different property valuation techniques. The method of pricing of real estate assets adopted by developers or vendors in China can be different from the practice of international purchasers. This might eventually lead to disagreement on the final acquisition price. Vendors in China usually adopt the market comparable approach, which can be distorted due to the lack of efficient market information. On the other hand, international fund managers usually adopt the income approach by utilising the discounted cash flow method. 4.1.4 Lack of market transparency. Even with the current open door policy towards economic development in China, transparency in the real estate market is still very much lacking. Limited or unavailable information hinders institutional investors from conducting extensive due diligence work which is required to satisfy legal and financial requirements before a REIT listing. 4.1.5 Absence of legislative framework for REITs. Currently, there is no regulatory framework facilitating REIT listings in China. It is therefore important for relevant Chinese authorities to work closely to formulate a set of guidelines governing REIT listing and operation in China. 4.1.6 High taxation. Taxes are the main expenses for foreign investors when evaluating the options of investing or setting up REITs in China. Major taxes applicable to foreigners, foreign investment enterprises (FIEs) and foreign enterprises (FEs) doing business in China are summarized in Table I. 4.2 Benefits of REIT securitisation in China REITs are designed to encourage public ownership of commercial real property, through a tax efficient pass-through vehicle. In China, business tax, land appreciation tax and other associated documentation taxes on acquisition and disposal of real estate assets, and urban real estate taxes levied on rental income could reduce the after-tax cash flows available for distribution to REIT investors. The high taxation costs incurred in multiple categories of taxes will adversely affect the returns of investment in REITs, and make them less competitive in the face of other Asian REITs. Tax transparency is hence a necessary first step by the Chinese government to attract REIT listings in China. Other drivers of REITs in China include a large pool of quality real estate assets, strong potential demand from Chinese institutional investors and the ability of REITs to stimulate a better regulated property market in China through the influx of other real estate professional services that comes along with a REIT market. The success of a REIT listing in China will be both beneficial to the Chinese developers as well as the overall property market.

Securitising China real estate

253

JPIF 26,3

Category Tax on income

Type of tax Enterprise income tax (“EIT”) Standard tax rate is 33 per cent, but the tax rate could be reduced to 24 per cent for enterprises located at the coastal cities or 15 per cent for those located at the special economic development zone (Note: Currently, separate EIT systems are applicable to foreigners, FIE and FE, as contrasted with those applicable to local Chinese and domestic companies) Withholding income tax on payments to non-residents A concessionary rate of 10 per cent is currently applicable to interest, rental, royalty and other income Individual income tax (IIT) Progressive rates range from 5 per cent to 45 per cent Value-added tax General tax rate is 17 per cent, certain necessities are taxed at 13 per cent Consumption tax Tax rates range from 3 per cent to 50 per cent Business tax Tax rates range from 3 per cent to 20 per cent Land appreciation tax Enterprises or individuals who generate gains realized from transfer of the real property and its attachments will be taxed at the progressive rates ranging from 30 per cent to 60 per cent Urban real estate tax A tax imposed on the owners, users or custodians of houses and buildings at the rate at either 1.2 per cent of the original value with certain deduction or 12 per cent on the rental value Deed tax Transferees or assignees of the ownership of land use rights or real properties will be taxed and the general tax rates are ranged from 3 per cent to 5 per cent

254

Tax on transactions (turnover tax)

Tax on specific objective

Tax on property

Tax levied by finance department

Table I. Major taxes applicable to foreigners, foreign investment enterprises (FIEsa) and foreign enterprises (FEsb) doing business in China

Notes: aFIEs include Chinese-foreign equity joint ventures, Chinese-foreign contractual joint ventures, and wholly foreign-owned enterprises established in the People’s Republic of China (PRC). bFEs include foreign companies, enterprises and other economic organizations that are not Chinese legal entities, but have establishment or places in the PRC. Source: PriceWaterHouseCoopers

However, before a REIT listing can take place in China, legislative support from the Chinese government is crucial. A regulated framework and pro-taxation policies will boost investors’ confidence in the market. Also, other issues like legal titles, market transparency, property valuation methods and lack of professional expertise need to be looked into. Already, things are on the way to make REIT listing a reality in China. According to the Shanghai Daily (2007), authorities from the Shanghai Stock Exchange (SSE) are already reviewing the possibility of a REIT listing on the Shanghai Stock Exchange. The SSE set up a specialised research unit in March 2007. No timetable has been given, but SSE is determined to become one of the REIT hubs of Asia and further its development of derivatives. Also, China Business News (2007) reported that the mayor of Tianjin City has announced the submission of a REIT proposal to the central government for approval. The Chinese REIT will be known as “LingYue” REIT, and will focus on industrial properties. LingYue REIT is the product of LingYue Asset Management Company, a conglomerate of various major state-owned enterprises. The initial plan will be to procure a series of industrial properties using the model of asset-backed securities (ABS) before converting it into a REIT structure when a REIT listing can be made on the Chinese stock exchange. However analysts are skeptical on Ling Yue’s claim of being a REIT as the legislative framework is still needed for a REIT listing. Hence they predict it will still take some time for a “true” China REIT. Both the recent announcements by Shanghai Stock Exchange and LingYue REIT signify a closer step to the reality of a China REIT listing. 5. China-centric REITs In this section, we examine two REITs – Guangzhou Investment (GZI) REIT and CapitaRetail China Trust (CRCT) – that have been listed in Hong Kong and Singapore, respectively. In particular, we examine the portfolio composition, dividend yields, IPO and ex-IPO performance to gain insights on how investors view China-centric REITs. 5.1 Guangzhou Investment (GZI) REIT GZI REIT was the first REIT made up of a portfolio of properties from China. Property developer Guangzhou Investment Company Limited (GZI), an investment arm of China’s Guangzhou municipal government entity, packaged four prime shopping and office buildings in Guangzhou into a REIT for a $US230 million initial public offering (IPO) in Hong Kong. When GZI REIT was listed on 21 December 2005, it was the third REIT to be listed on the Hong Kong Stock Exchange and created a novel template for investors to tap into the value of commercial properties in China. GZI REIT was oversubscribed by 496 times in the public offering and 74 times in the institutional placement. It offered an attractive dividend yield of 6.54 per cent to unit holders, the highest among listed Hong Kong REITs back then. The four properties under GZI REIT are commercial properties, with office and retail components, located in the city of Guangzhou, Guangdong province of China. The competitive strengths of the properties include good location in Guangzhou’s Tianhe Central Business District and Yue Xiu district and the high occupancy rates achieved by the established commercial buildings. Given the prime location of the

Securitising China real estate

255

JPIF 26,3

256

properties in Guangzhou, the manager is confident of delivering a good distribution payout to unit holders. The properties will be initially focused in the Guangdong province of China before plans will be made to expand to the other provinces of China. Guangzhou is located along the Pearl River and is the capital city as well as the economic, scientific and cultural centre of Guangdong province. The Guangzhou economy is the PRC’s third largest city-level economy and enjoyed double-digit growth in the past 15 years, averaging 15.3 per cent per annum. With continued buoyant fixed asset investment, solid domestic demand, robust trade activities and high inflows of foreign direct investments, the outlook for the economy remains positive. These factors have combined to increase demand for commercial properties in Guangzhou and the properties are well positioned to benefit from such demand. GZI REIT believes that in such an economic environment, GZI REIT has considerable potential for growth. Presently, GZI REIT has three commercial buildings (office and retail) located in Guangzhou’s Tianhe CBD and one commercial building (White Horse) in Yue Xiu district. Figure 7 shows the location of the Tian He and Yue Xiu districts in Guangzhou. According to GZI’s prospectus and announcements, GZI REIT plans to grow its assets through active asset management. The manager will endeavour to increase the property yield of GZI REIT’s property portfolio and, correspondingly, the NAV per unit by actively managing the portfolio. Some of the measures which the manager intends to take include optimising rental and occupancy rates through managing lease renewals effectively, strengthening the properties’ competitive positions and capitalising on Guangzhou’s economic growth through procurement of other Guangzhou commercial properties. While GZI listed four projects for future acquisition in its prospectus, it has not exercised any of its rights to procure the properties to date even though the construction for one project (Yue Xiu New Metropolis) was completed at the end of 2006. The next property in line for completion will be the two office blocks behind Victory Plaza retail mall, which are expected to be completed at the end of 2007. In addition, all the identified future properties available to GZI REIT through GZI are located within Guangzhou. This might not be an attractive portfolio to investors as all the existing and future pipeline of commercial properties are all located in the same city, meaning little diversification. 5.2 CapitaRetail China Trust (CRCT) CapitaRetail China Trust (CRCT) was the second listed REIT that comprised a portfolio of Chinese properties. CRCT is the fourth REIT by CapitaLand Limited, after the successful listing of CapitaMall Trust (July 2002), CapitaCommercial Trust (April 2004) and Ascott Residence Trust (March 2006). It is the fourteenth REIT listed on the Singapore Stock Exchange and is made up of a portfolio of seven retail properties across five cities in China. CRCT’s public offering was oversubscribed by 39 times and attracted an institutional placement of 196 times. It was listed on 8 December 2006 in Singapore and successfully raised over $SG218.4 million (approximately $US142 million). CRCT offered a dividend yield of 5.42 per cent (first year) and 5.78 per cent (second year) to unit holders. The seven retail malls are geographically spread out

Securitising China real estate

257

Figure 7. Map of Guangzhou and its major districts

across five cities in China, namely Beijing, Shanghai, Zhengzhou, Wuhu and Huhehaote. The competitive strengths included quality retail properties in strategic locations, geographical diversification (reduces CRCT’s dependence on any single regional market), stable and quality tenant base (well-established brand names of anchor tenants like Wal-Mart, Carrefour and Beijing Hualian Group), favourable lease structure with upside potential (up to 20 years with annual step-up in base rent) and the potential for future asset enhancement to the properties. The sponsor of CRCT, CapitaLand Limited, is one of the largest listed real estate companies in Asia. The sponsor has extensive experience in creating, managing and investing in property funds and real estate financial products. It has leveraged on opportunities within the asset base of the CapitaLand Group in the origination of, and investment in, several REITs including CapitaMall Trust, CapitaCommercial Trust and Ascott Residence Trust. The sponsor also acted as the strategic partner to Hong

JPIF 26,3

258

Kong’s first REIT, The Link REIT, and holds an approximate 4.0 per cent stake in The Link REIT, which listed on 16 November 2005. CapitaRetail China Limited’s partnership with SZITIC and Beijing Hualian Group allowed CapitaRetail China Trust to secure seven retail malls for the initial offering. The partnerships also paved the way for CRCT’s attractive acquisition pipeline of 20 retail malls across 24 Chinese cities by year 2010. Being the second cross-border REIT to contain a portfolio of Chinese properties, CRCT had the advantage of tapping onto GZI REIT’s template when structuring its offering. The same professional team of lawyers, which was critical in structuring GZI REIT, was also hired to help with the legal structuring of CRCT (Paul Hastings, 2006). Furthermore, CapitaLand had already gained experience and credibility after successfully floating three REITS in Singapore and assisting Hong Kong’s Link REIT. Hence CapitaLand was definitely well positioned to structure CRCT. A strong acquisition growth strategy had already been highlighted in CRCT’s prospectus, where there is a potential to triple CRCT’s initial portfolio of seven properties and increase CRCT’s presence to more than 24 cities in China (see Figure 8). This is possible as CRCT has been granted rights of first refusal over properties from CapitaRetail China Development Fund (the “Development Fund”) and CapitaRetail China Incubator Fund (the “Incubator Fund”). The sponsor has secured, for investment by the Development Fund, a portfolio of 19 retail mall developments through a equity joint venture with Chinese state-owned Shenzhen International Trust & Investment Co., Ltd and its subsidiaries and associates (the “SZITIC Group”). Through the sponsor’s strategic alliance with the Beijing Hualian Group (the sixth largest retail group in China), the Incubator Fund may invest

Figure 8. Map showing location of malls under CRTC’s acquisition pipeline

in a potential pipeline of retail malls to be anchored by the Beijing Hualian Group, including the prime Xihuan Plaza Retail Mall in Xizhimen, Beijing, which was acquired at approximately $US162.4 million. 6. Performance of GZI REIT and CapitaRetail China Trust As mentioned earlier, both GZI REIT and CRCT attracted a huge subscription for its offering. Overall, GZI REIT was oversubscribed by 117 times and CRCT by 167 times, far exceeding the interest generated by fellow listed Hong Kong REITs (H-REITs) and Singapore REITS (S-REITs). Both REITs saw a price increase on their first day of IPO listing, with GZI REIT seeing an increase of 13.82 per cent and CRCT an increase of 59.29 per cent. This section will analyze the performance of GZI REIT and CRCT and determine which REIT performed better (see Table II for a brief comparison). 6.1 Subscription level Table III and Figure 9 show the overall subscription rate (averaging demand from both public offering as well as institutional demand) of the various H-REITs and S-REITs during their IPO offering. Both REITs attracted an overwhelming demand that far exceeded what their peer REITs achieved. 6.2 Dividend yield The yield of the various REITs (reported distributable income of individual REITs by their listing IPO price) is compared with other yield indices in Table IV and Figure 10. Indices providing stable yield distributions include the ten-year government bond yield and fixed deposit rates. The NAREIT Asia REITs yield index computes the average yield of REITs in other parts of ASIA (Japan, Australia, Singapore, Hong Kong, New Zealand and South Korea). GZI REIT promised a higher dividend yield of 6.54 per cent in its prospectus as compared to Link REIT’s 5.53 per cent and Prosperity REIT’s 5.31 per cent. Its actual annualised distributions in the first year increased by 0.18 per cent to 6.72 per cent, which was higher then Link REIT’s actual yield of 6.09 per cent but less than Prosperity REIT’s actual yield of 7.48 per cent. Presently, the H-REIT that promises the highest yield to unit holders is Hong Kong Henderson Land Development’s Sunlight REIT at 8.49 per cent. One point to highlight is the high ten-year government bond yield and fixed deposit rates in Hong Kong. On the day of GZI REIT’s listing, GZI REIT’s promised distribution yield to unit holders was only at a difference of 2.25 per cent for the ten-year government bond yield (at 4.29 per cent) and 2.09 per cent difference for fixed deposit rates (at 4.45 per cent). The average H-REIT promised yield was 6.26 per cent (calculated based on yield promised on IPO and IPO prices) and 4.33 per cent for government bond yield, a difference of only 1.93 per cent. With this small difference in yield, investors would rather choose to park their investments in other higher yielding vehicles such as stocks or conversely invest in government bonds if they want a stable return. This might explain why investors’ response to H-REITs has been lukewarm recently, following the lacklustre performance of both Champion and Sunlight REITs (the fourth and fifth H-REIT listings). The average promised yield for the 15 S-REITs was 6.5 per cent (calculated based on yield promised on IPO and IPO prices) while the Singapore ten-year government

Securitising China real estate

259

JPIF 26,3
Date of IPO listing Location of REIT listing Sponsor company

GZI REIT 21 December 2005 Hong Kong Guangzhou Investment Company (GZI) (Guangzhou Municipal Government Entity)

CRCT December 2006 Singapore CapitaLand Group (One of Asia’s largest listed property developers, successful prior listing of three REITS in Singapore. Subsidiary of Temasek Holdings of Singapore) Barbados Retail malls

260
Location of offshore companies to hold project companies Property portfolio Number of properties available Location of properties

British Virgin Islands Commercial buildings (mixture of office and retail) 4 All located in Guangzhou

7 Across five Chinese cities: Shanghai (1), Beijing (3), Inner Mongolia (1), Henan (1) and Anhui (1) Province Competitive strengths of the Quality commercial buildings Quality retail properties in portfolio located in prime areas of strategic locations Guangzhou Geographically diversified in High occupancy rates achieved five cities across China Well-established anchor tenants Favourable lease structure with upside potential Asset enhancement strategy Growth strategy First right of refusal granted for First right of refusal granted for investments by GZI to GZI REIT projects under CapitaRetail China Development Fund and by year 2010 Acquisition pipeline of for foura Incubator Fund by year 2010 commercial properties under Acquisition pipeline of 20a other development by GZI retail assets across 24 Chinese Active enhancement of existing cities, potentially tripling properties CRCT’s initial portfolio Initial focus on commercial Active asset enhancements properties in Guangzhou $HK4,005,000,000 RMB3,451,000,000 Asset value at IPOb ($US513,461,538) ($US441,304,348) Size of IPO offering 583 million units 193.3 million units Value of IPO offering raised $HK1,792,725,000 $SG218,429,000 ($US229,836,538) ($US141,837,013) Subscription rate for IPO 117 (overall) 167 (overall) offering (number of times 496 (public offering) 39 (public offering) oversubscribed) 74 (institutional placement) 196 (institutional placement) Price performance on day of IPO Increased 13.82 per cent Increased 59.29 per cent listing Promised dividend yield to unit 6.54 per cent (first year) 5.42 per cent (first year) holders (as of IPO prospectus) 5.78 per cent (second year) Percentage of distributable 100 per cent for first three years At least 90 per cent Income promised to unit holders (2006, 2007 and 2008 financial year. Thereafter at least 90 per cent) Table II. A brief comparison of GZI REIT and CRCT Notes: aMalls located in the locality. b$US1 ¼ $HK7:80, December 2005; $US1 ¼ RMB7:82, December 2006) Source: GZI & CRCT Prospectus, Datastream, author’s compilation

No.

Name of REIT

Public offering 19.0 260.0 496.0 6.5 8.3 2.0 1.7 10.6 26.3 12.3

Institutional placement 19.0 19.0 74.0 3.5 5.0 3.1 2.0 13.7 17.5 33.4

Overall subscription level 19.0 43.0 117.0 3.8 5.3 5.0 5.0 3.7 N/A 9.6 44.0 35.0 3.9 N/A N/A 2.2 2.0 2.0 167.0 7.6

Securitising China real estate

Hong Kong 1 The Link REIT 2 Prosperity REIT 3 GZI REIT 4 Champion REIT 5 Sunlight REIT Singapore 1 CapitaMall Trust 2 Ascendas REIT 3 Fortune REIT 4 CapitaCommercial Trust 5 Suntec REIT 6 Mapletree Logistics Trust 7 Macquarie MEAG Prime REIT 8 Allco Commercial Trust 9 Ascott Residence Trust 10 K-REIT Asia 11 Frasers Centrepoint Trust 12 CDL Hospitality Trust 13 Cambridge Industrial Trust 14 CapitaRetail China Trust 15 First REIT

261

6.0 6.6 11.3 39.0 26.3

2.0 1.9 1.8 196.0 6.6

Note: N/A, IPO subscription rate unavailable as REIT offering was conducted via “distribution in species” Source: Company data, newspaper reports, author’s compilation

Table III. IPO subscription rates of H-REITs and S-REITs

bond yield was 3.29 per cent. This works out to a difference of 3.21 per cent, which is 1.28 per cent higher than the difference of average H-REITs’ yield to the Hong Kong government bond yield. CRCT promised a dividend yield of 5.42 per cent in its first year to unit holders. This was actually the third lowest promised yield among the other 14 S-REITs during their IPO. CRCT’s promised dividend yield was only 2.38 per cent higher than the government bond and 3.62 per cent higher than the fixed deposit rates. Despite this, in terms of subscription rate and price performance, it outperformed other S-REITs which promised higher yield. 6.3 Price performance on first day of IPO Table V and Figure 11 show the IPO price performance on the first day of listing. GZI REIT is compared to the other H-REITs and CRCT with other S-REITs. GZI REIT achieved a positive price increase of 13.82 per cent on the first day of IPO. This, however, was less then the first-day IPO price increase achieved by the earlier Link and Prosperity H-REITs. One thing to highlight was the subsequent poor price performance of Champion REIT (listed on 24 May 2006) and Sunlight REIT (listed 21 December 2006).

JPIF 26,3

262

Figure 9. IPO subscription level of H-REITs and S-REITs

CRCT, however, performed very well on the first day of listing, with a price increase of 59.29 per cent, placing it as the second best performer out of 15 S-REITS. This result is just behind fellow CapitaLand’s Ascott Residence Trust of 69.12 per cent. 6.4 Price performance after IPO compared to other REITs in their country Figures 12 and 13 show the price performance of GZI REIT and CRCT after their IPO, compared over a period from 21 December 2005 (GZI REIT’s IPO listing) until 30 March 2007. GZI REIT and CRCT’s price performances were compared to the other H-REITs and S-REITs, respectively. The broader stock market index for the respective countries – i.e. the Hang Seng Composite Index and the SGX All Shares Index – are included as a reference to the stock market’s performance.

No. Name of REIT 25 16 21 24 21 17 19 12 11 9 December 2004 28 July 2005 6.00 20 September 2005 5.12 30 March 2006 5.77 31 March 2006 28 April 2006 5 July 2006 19 July 2006 25 July 2006 7.50 8 December 2006 11 December 2006 5.42 8.62 N/A N/A 1.80 1.80 3.04 3.06 5.08 5.04 5.50 6.37 5.85 6.71 8.15 8.99 5.22 9.37 6.50 1.80 1.80 1.80 1.80 1.80 3.59 3.51 3.57 3.64 3.61 5.49 5.53 5.56 5.64 5.57 6.01 1.80 3.54 5.46 5.71 1.70 2.93 6.35 1.70 5.68 5.82 6.81 6.37 0.69 1.29 3.41 2.75 2.65 July 2002 November 2002 August 2003 May 2004 7.06 8.00 6.50 7.66 8.60 7.03 0.81 0.75 0.81 3.80 2.90 3.43 November 2005 December 2005 December 2005 May 2006 December 2006 5.53 5.31 6.54 5.46 8.49 6.09 7.48 6.72 N/A N/A 4.44 4.39 4.46 4.74 3.99 4.38 4.29 4.29 4.88 3.83

Date of listing

Expected yield for first year (per cent, Based on IPO price) Ten-year government bond (per cent)a NAREIT Asia REITS (per cent)a

Actual yield for first year (per cent, based on IPO price)

Fixed deposit rate (per cent)a

Hong Kong 1 The Link REIT 2 Prosperity REIT 3 GZI REIT 4 Champion REIT 5 Sunlight REIT 5.66 5.00

Singapore 1 CapitaMall Trust 2 Ascendas REIT 3 Fortune REIT 4 CapitaCommercial Trust 5 Suntec REIT 6 Mapletree Logistics Trust 7 Macquarie MEAG Prime REIT 8 Allco Commercial Trust 9 Ascott Residence Trust 10 K-REIT Asia 11 Frasers Centrepoint Trust 12 CDL Hospitality Trust 13 Cambridge Industrial Trust 14 CapitaRetail China Trust 15 First REIT

Notes: aRates as of date of REIT listing. N/A, company reports on distributable income not yet available

Securitising China real estate

263

Table IV. Dividend yield of H-REITs and S-REITs compared with other yield indices

JPIF 26,3

264

Figure 10. Dividend yield of H-REITs and S-REITs compared with other yield indices

From Figure 12, we can clearly see that during the period, The Link REIT was the best performing H-REIT, constantly performing at least 40 per cent above its IPO price. The performance of the other four H-REITs was lacklustre, with GZI REIT being the second best, performing close to its IPO price while the others all performed below their IPO prices. On the whole, the price performance of H-REITs has been poor, with three out of five H-REITs performing below their IPO prices.

No.

Name of REIT

IPO price 10.30 2.16 3.08 5.10 2.60 0.96 0.88 4.75a 1.00 1.00 0.68 0.98 1.00 0.68 1.04 1.03 0.83 0.68 1.13 0.71

Price at end of first trading day (local currency) 11.80 2.60 3.50 4.30 2.43 0.99 0.93 4.65a 1.18 1.10 0.88 1.05 0.98 1.15 1.49 1.05 0.86 0.68 1.80 0.73

IPO price performance (per cent) 14.56 20.37 13.82 (2 15.69) (2 6.54) 3.13 5.11 (2 2.11) 18.00 10.00 29.41 7.14 (2 2.00) 69.12 43.27 1.94 3.01 0.00 59.29 2.11

Securitising China real estate

Hong Kong 1 The Link REIT 2 Prosperity REIT 3 GZI REIT 4 Champion REIT 5 Sunlight REIT Singapore 1 CapitaMall Trust 2 Ascendas REIT 3 Fortune REIT 4 CapitaCommercial Trust 5 Suntec REIT 6 Mapletree Logistics Trust 7 Macquarie MEAG Prime REIT 8 Allco Commercial Trust 9 Ascott Residence Trust 10 K-REIT Asia 11 Frasers Centrepoint Trust 12 CDL Hospitality Trust 13 Cambridge Industrial Trust 14 CapitaRetail China Trust 15 First REIT Note: aIn $HK Source: Datastream (author’s compilation)

265

Table V. Price performance on first day of IPO

For S-REITs, CapitaMall Trust was the top performer, witnessing a four-fold price increase since its IPO. Approximately four months since its listing, CRCT performed well with a price increase of over 2.7 times and outperformed several S-REITs in terms of price performance to rank in fifth place. Unlike H-REITs, the majority of S-REITs performed above their IPO prices. Although GZI REIT was the second best performing H-REITs, its price only rose close to 20 per cent above its IPO price in the initial few months and started dipping after the third month to perform at around its IPO price level. On the other hand, CRCT enjoyed superior performance, rising more than 250 per ent above its IPO price within a span of two months and outperforming ten other S-REITs by its fourth month. 6.5 Price performance after IPO compared to other price indices A comparison was made (see Table VI and Figures 14 and 15) between the performance of GZI REIT and CRCT compared with other price indices. Stock market indices like Hong Kong’s Hang Seng Index and Hang Seng Composite Index (the broader index) and Singapore’s Straits Times Index as well as the SGX All Shares Index were used to compare the REITs against the stock market performances. The S&P/Citigroup REIT Index is a REIT index compiled by Standard & Poor’s and is used

JPIF 26,3

266

Figure 11. Price performance on first day of IPO

as a comparison of GZI REIT and CRCT against the overall REIT market performance of Hong Kong and Singapore, respectively. NAREIT stands for the National Association of REITs (NAREIT). The NAREIT Asia REITs index tracks the performance of REITs in the major Asia-Pacific countries, including Japan, Australia, Singapore, Hong Kong, New Zealand and South Korea. NAREIT Asia Non-REITs index was included as a benchmark of the performance of other property stocks. By comparing both REITs in their initial four months of listing, the price returns of GZI REIT increased by almost 20 per cent above its IPO listing but started to fall nearing the second month and descended below the S&P/Citigroup H-REIT price index. On the other hand, CRCT was already outperforming all the other indices by over 50 per cent within the first few weeks of listing. Its price performance index continued to ascend rapidly and by the second month, it already outperformed all the other price indices by over 200 per cent, exceeding 270 per cent by 30 March 2007. In comparison with other price indices, it is evident that CRCT outperformed GZI REIT in the initial months of listing.

Securitising China real estate

267

Figure 12. Price performance of H-REITs from 21 December 2005 until 30 March 2007

Looking at GZI REIT’s performance from IPO until 30 March 2007, we can see that after the fourth month, GZI REIT was starting to perform below all the other price indices. Since then, GZI REIT has been underperforming all the other indices for the majority of the time. Due to the short time frame of data for CRCT, it is uncertain whether CRCT might face a similar weakened performance after the initial few months. 6.6 Cumulative market adjusted returns for GZI REIT and CRCT In order to determine whether GZI REIT or CRCT provides better excess returns for investors, a cumulative market adjusted returns graph was plotted for GZI REIT and CRCT for the period 21 December 2005 to 30 March 2007 (see Figure 16). The market measure was based on the broader stock indices of the Hang Seng Composite Index for GZI REIT and SGX ALL Shares for CRCT. GZI REIT performed slightly above the mean of 1.0 in the initial few weeks before dipping below the line. Since then, the cumulative excess returns have been dropping steadily, reaching around 0.6 on 30 March 2007. On the other hand, CRCT’s excess return index dipped slightly below the mean in the initial few weeks before climbing exponentially in the subsequent few months to reach more than 1.5 times its mean. This analysis showed that CRCT provided a much higher excess return from the stock market for investors as compared to GZI REIT, whose excess return is heading South. 7. Conclusion China’s phenomenal rate of economic growth and its emergence as one of the world’s largest economies continue to drive real estate development and prices. This fundamental transformation creates tremendous opportunities for the real estate industry in China, which is still funded primarily through domestic bank loans.

JPIF 26,3

268

Figure 13. Price performance of S-REITs from 21 December 2005 until 30 March 2007

Date (weekly) 100.00 103.27 102.03 101.33 102.67 102.11 102.77 105.53 107.16 106.86 110.70 111.65 113.70 113.02 115.88 105.32 112.56 106.14 118.14 104.88 111.39 104.41 101.79 104.43 99.86 101.81 105.79 101.29 102.40 100.40 101.71 105.11 103.54 100.00 100.00 100.00

GZI REIT

HangSeng Index

Hong Kong HangSeng Composite S&P/Citigroup REIT Index Index (Hong Kong) NAREIT Asia REITS

NAREIT Asia Non-REITS 100.00 107.43 109.92 98.28 98.26 93.83 96.46 99.41 96.68 (continued)

100.00

113.82

117.07

111.38

110.57

21 December 2005 12 January 2006 24 January 2006 15 February 2006 21 February 2006 13 March 2006 22 March 2006 3 April 2006 12 April 2006

111.38

110.57 110.57 106.50

Securitising China real estate

269

Table VI. Price performance of GZI REIT and CRCT (approximately four months from IPO)

JPIF 26,3

270

Date (weekly) 100.00 101.94 104.21 109.95 112.31 112.98 108.34 109.72 108.79 112.78 116.20 111.44 109.60 110.50 114.20 114.13 111.37 115.34 122.95 120.07 117.15 119.38 120.13 123.16 104.11 111.32 101.25 101.44 100.00 100.00

8 December 2006 20 December 2006 02 January 2007 24 January 2007 08 February 2007 20 February 2007 28 February 2007 9 March 2007 20 March 2007 30 March 2007

Source: Datastream, S&P/Citigroup REIT Index, NAREIT, author’s compilation

Table VI. Straits Times Index Singapore S&P/Citigroup REIT Index SGX All SHARES (Singapore) 100.00 101.98 107.38 109.05 115.81 115.06 112.85 111.33 113.00 112.46 NAREIT Asia REITS NAREIT Asia Non-REITS 100.00 99.35 102.58 107.49 111.78 114.95 112.87 114.11 113.99 115.87

CapitaRetail China Trust

100.00

158.41

185.84

255.75

253.10

267.26

261.06 256.64

255.75

276.11

Securitising China real estate

271

Figure 14. Price performance of GZI REIT compared to other price indices

Figure 15. Price performance of CRCT compared to other price indices

Although plans are still under way to introduce REIT legislation in China, two China-centric REITs have been listed offshore in Hong Kong and Singapore. Both REITs were very well subscribed at offering and posted good first-day returns. However, CRCT strongly outperformed GZI at and after IPO. Our study shows that there is indeed a strong local demand for China REITs, and that REITs can provide an alternative source of real estate financing for Chinese developers and promote a better

JPIF 26,3

272

Figure 15. GZI and CRCT cumulative excess returns

regulated Chinese real estate market. CRCT outperforms GZI REIT as well as some of the other Singapore REITs, while GZI REIT ranked second lowest in terms of price performance when compared to other Hong Kong REITs. The limited history of CRCT suggests that a well-structured REIT holding Chinese assets can perform very well. We attribute the outperformance to portfolio composition and diversification, growth story and originator reputation. Therein are valuable lessons to be learned for potential REIT originations.
Notes 1. Other sources include funding from state-owned enterprises, undeclared financing by state-owned banks and equity investments by investors whom wish to remain anonymous for tax reasons. 2. This was increased to 35 per cent in 2004. 3. One of the main rules stipulated that developers would have to put in 30 per cent of the total investment from their own capital prior to application for bank financing, a ratio that was increased to 35 per cent in 2004. 4. A noticed issued by the People’s Bank of China in September 2005 regarding the possibility of enacting Circular 212 may dampen the growing real estate trust sector. The new Circular 212, not yet officially enacted, proposed to enforce equally strict requirements like that in Circular 121 for developers borrowing from trust companies. This means that developers will also need to finance 35 per cent of the project with equity and be required to obtain all four certificates before they are allowed to borrow from trust companies. If this rule is enacted, Chinese developers will once again be short of another financing alternative.

References China Business News (2007), “Tianjin’s LingYue REIT will be the first REIT in China”, China Business News, January, p. 12.

Newell, G., Chau, K.W., Wong, S.K. and McKinnell, K. (2005), “Dynamics of the direct and indirect real estate markets in China”, Journal of Real Estate Portfolio Management, Vol. 11 No. 3, p. 263. Paul Hastings (2006), “Paul Hastings advises GZI REIT on first Chinese property REIT to list in Singapore”, available at: www.paulhastings.com/NewsDetail.aspx?NewsId ¼ 284 (accessed 16 January 2007). Shanghai Daily (2007), “Shanghai Stock Exchange may launch REITs”, Shanghai Daily, 1 February. Sing, T.F. and various authors from Pacific Star and Chinese Real Estate Chamber of Commerce (2006), A Practical Guide to Real Estate Investment Trusts (REITs): Prospects for establishing a REIT Market in China. Further reading Ascott Residence Trust (2006), “Opening speech by Ms Ho Ching”, 31 March 2006, available at: www.temasek.com.sg/news_room/press_speeches/31_03_2006.htm (accessed 20 February 2007). Brueggeman, W.B., Chen, A.H. and Thibodeau, T.G. (1984), “Real estate investment funds: performance and portfolio considerations”, Journal of the American Real Estate and Urban Economics Association, Vol. 12 No. 3, pp. 333-54. Chen, J. and Peiser, R. (1999), “The risk and return characteristics of REITs – 1993-1997”, Real Estate Finance, Vol. Spring, pp. 61-8. China Banking Regulatory Commission (2007), available at: www.cbrc.gov.cn/chinese/home/jsp/ index.jsp (accessed 22 February 2007). Chinese Real Estate Information Centre (2005), available at: www.realestate.cei.gov.cn/ (accessed 27 January 2007). Clayton, J. and MacKinnon, G. (2001), “The time-varying nature of the link between REIT, real estate and financial asset returns”, Journal of Real Estate Portfolio Management, Vol. 7 No. 1, pp. 43-54. Eichholtz, P.M.A. (1997), “Real estate securities and common stocks: a first international look”, Real Estate Finance, Vol. 14 No. 1, pp. 70-4. European Public Real Estate Association (2007), “FTSE EPRA/NAREIT Asia Index data”, available at: www.epra.com/indices.jsp (accessed 8 February 2007). Ghosh, C., Miles, M. and Sirmans, C.F. (1996), “Are REITs stocks?”, Real Estate Finance, Fall, pp. 46-53. Glascock, J.L., Lu, C. and So, R.W. (2000), “Further evidence on the integration of REIT, bond, and stock returns”, Journal of Real Estate Finance and Economics, Vol. 20 No. 2, pp. 177-94. Han, S.S. (1998), “Real estate development in China”, Journal of Real Estate Literature, Vol. 6, pp. 121-33. Hartzell, D.J., Stivers, H.M., Ludgin, M.K. and Pire, T.J. (1999), “An updated look at constructing a public and private real estate portfolio”, Real Estate Finance, Summer, pp. 49-57. Ibbotson Associates (2006), “Portfolio diversification through REITs”, NAREIT, September/October. Liang, Y. and McIntosh, W. (1998), “REIT style and performance”, Journal of Real Estate Portfolio Management, Vol. 4 No. 1, pp. 69-78. Liang, Y. and Whitaker, W. (2000), “Style attributes of equity REITs”, Real Estate Finance, Spring, pp. 31-6.

Securitising China real estate

273

JPIF 26,3

274

Liang, Y., McIntosh, W. and Webb, J.R. (1995), “Intertemporal changes in the riskiness of REITs”, Journal of Real Estate Research, Vol. 10 No. 4, pp. 427-43. Mueller, G.R. and Laposa, S. (1996), “PREIT returns: a property-type perspective”, Real Estate Finance, Spring, pp. 45-55. Mueller, G.R., Pauley, K.R. and Morill, W.K. (1994), “Should REITs be included in a mixed-asset portfolio?”, Real Estate Finance, Vol. Spring, pp. 23-8. National Association of Real Estate Investment Trusts (2007), “NAREIT Index data”, available at: www.nareit.com (accessed 8 February 2007). Paul Hastings (2005), “Paul Hastings advises GZI REIT on first Chinese property REIT to list in Hong Kong”, available at: www.paulhastings.com/NewsDetail.aspx?NewsId ¼ 85 (accessed 16 January 2007). People’s Daily Online (2006), “Total assets of Chinese insurance industry to hit 2 trillion yuan this year”, 15 November, available at: http://english.people.com.cn/200611/15/ eng20061115_321560.html (accessed 21 February 2007). Pramerica Real Estate Investors (2005), “Global REITs: a new platform of ownership”, available at: www.investmentmanagement.prudential.com/view/page/8483 (accessed 20 January 2007). PriceWaterHouseCoopers (2007), “Overview of PRC taxation system”, available at: www.pwchk. com/home/eng/prctax_corp_overview_taxation.html (accessed 12 February 2007). Reuters (2007), “Insurers poised to spur China commercial property”, 28 February. Standard & Poor’s (2007), “S&P/Citigroup REIT Index data”, available at: www.globalindices. standardandpoors.com/sandp/index.jsp (accessed 20 February 2007). State-Owned Assets Supervision and Administration Commission of the State Council (2003), “Enterprise statistics and auditing in year 2002”, p. February, available at: www.sasac. gov.cn/eng/eng_qytj/eng_qytj_0001.html (accessed 12 February 2007). Surveyor Times (2006), Selection of Papers from HKIS Annual Conference 2006, Surveyor Times, Hong Kong, pp. 37-44. (The) Standard Newspaper (2007), “Home run: Initial public offerings soared in 2006, particularly in December, when 17 listings floated shares”, The Standard Newspaper, 2 January. Trombly, M. (2006), “Weak legislation hindering China’s securitization market”, Asset Securitization Report, 26 June, pp. 22-3. Zhu, J. (2004), “From land use right to land development right: institutional change in China’s urban development”, Urban Studies, Vol. 41 No. 7, pp. 1249-67. Corresponding author Michael C.H. Quek can be contacted at: michquek@gmail.com

To purchase reprints of this article please e-mail: reprints@emeraldinsight.com Or visit our web site for further details: www.emeraldinsight.com/reprints