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| Boot: Strategic opportunities | |
An increasing number of China property funds have been set up during the past year and the fact that many of them have chosen a second dip proves the vast opportunities in this market. In the face of a highly regulated environment in China, many of these funds have achieved profit by adopting an opportunistic approach.
The Pacific Alliance China Land (PACL) fund, a US$400 million close-ended private equity fund, listed on the AIM market of the London Stock Exchange on November 22 2007 and invests in a wide range of projects as part of its strategy, including existing properties, new developments, distressed projects and pre-IPO and IPO real estate companies.
Patrick Boot, managing partner of PACL, says that the fund’s investment strategy allows flexibility in a changing regulatory environment with government policies designed to slow the economy, while an opportunistic approach taps all investment opportunities amid the credit crisis.
“Companies need capital to expand their business, so they look for strategic partners and this gives us strategic pre-IPO investment opportunities. We are looking for developers who need cash to fund new land acquisitions or complete development projects; so this is a development type of investment opportunity. Also, we are working on bridge-type financing, when developers are caught in special situations where they have urgent cash requirements,” points out Boot. “We also see asset acquisition beginning to take place because of the credit crisis and there is tremendous pressure for developers to raise money. What they sell are complete properties or close to complete properties.”
PACL is currently 60% committed, with investments including a US$20 million investment for a 4.9% stake in the Hainan Airport Group, and strategic pre-IPOs in two mid-sized residential developers, one based in southern China and the other in Shanghai. The fund targets a mixed portfolio, with 50% to 60% in residential buildings, 20% to 30% in retail properties and the rest in offices and others. The fund also targets a 30% internal rate of return (IRR) with a minimum of 20% and pays a dividend of 6%.
PACL focusses on second-tier cities, as Boot points out, since property prices in these cities have more upside potential, owing to the fact that they have not increased much during the past five years. On the other hand, GDP of these cities has grown faster than first-tier cities. The fund is now looking at cities like Qingdao, Dalian, Tianjin, Chengdu and Hangzhou.
The fund has also participated in two bridge financing projects, explains Boot. “Bridge loan capital recycles quicker, so we can deploy that into other strategies as the situation changes.”
He expects PACL to be fully invested by the end of this year, when the fund will invest the reserve capital that it
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| | Van den Berg: Market is in infancy | |
has set aside for the second half of the year, a time when the credit crisis in China is expected to peak. “That will provide us some great buying opportunities (in distressed developers),” says Boot. The Pacific Alliance Group, an Asian alternative asset investment manager that manages over US$4.5 billion assets across the region, plans to raise a China real estate LP fund with a size of US$1 billion towards the end of this year, which will adopt an investment strategy similar to that of PACL.
ING Real Estate, one of the leading global real estate investment managers that owns a total business portfolio of over 100 billion euros (US$159 billion) plans to launch a second private equity fund in the middle of the year, with a size of around US$600 million to US$700 million. The first fund, called the ING Real Estate China Opportunity Fund (COF), which was launched in December 2006 with an initial capital of US$350 million and later enlarged to US$500 million at the end of 2007, has already been fully invested in January 2008. This may well show how positive the overseas investors are towards the China property market.
After having established its presence in China in 1996, ING Real Estate initially invested for its own balance sheet. COF was the first time ING Real Estate raised third party funds to invest in the China property market. Funds of COF have been raised from international institutional investors in Asia, Australia, Europe, Middle East and the US, as well as from high-net worth clients of ING private banking. The fund’s original equity size was US$ 350 million but this was subsequently enlarged at the end of last year to almost US$ 500 million. Richard van den Berg of ING Real Estate, points out, “when we went back to investors (to enlarge the fund), we told them that we have got a couple of good opportunities to deploy the money immediately, and most of them were enthusiastic. When investors invest in China, most of them are generally looking for the higher returns and COF caters to that.”
Investment approach
The Dutch company’s opportunistic investment approach for COF, focusses mainly on mid-range residential housing pre-development projects in first and second-tier cities and executes through joint ventures (JVs) with local developers in that city. Van den Berg explains that the reason for choosing mid-range residential housing is because of the strong demand by end-users and support from the government and as such it is less affected by regulatory policies than high-end housing.
He adds that under the tightening policies, investors who want to buy high-end speculative houses will not be able to secure mortgage or mortgage on favourable terms. That is why COF chooses to invest in developments whose target end-user buyers are less dependent on financing with mortgage loans. 80% to 90% of its buyers are end-users from which around 20% make payments in cash, and the rest pay with a mortgage averaging around 50%.
COF has invested in nine pre-development projects in cities like Shanghai, Wuhan, Changsha, Chengdu, Chongqing and Foshan through JVs with different local developers, including Sanghai Forte Land, Raycom International, Gemdale Corporation and Longhu Real Estate. In almost all the JVs, ING Real Estate owns a sizable minority stake of 40% to 50%.
“We invest throughout the country to diversify risk. However, we are investment managers and not developers, nor do we have the ambition to be a nation-wide developer. Our strategy is to work together with strong local partners and by owning a sizable stake in the JV, our interests are aligned.” Van den Berg says that the company looks to join in the projects as early as possible even at the stage at the land bidding. Because of our own experience and knowledge of the Chinese real estate market, we are able to take the same risks as our local partners with the only exception being development projects with a (large) component of relocation involved.
Having built a relationship with different developers during the past two years, the second China Opportunity Fund, or “COF II” will also look at opportunities in retail buildings and office properties besides residential housings, although the investment strategy adopted will be more or less the same.” Nonetheless, the second fund targets a slightly lower IRR of 22%, whereas the first fund’s target return is 24%. Van den Berg says the reason for this is that yield depreciates as the market matures and competition increases.
According to Van den Berg, the China property fund market is still in its infancy and there is huge potential in private equity fund space because the government is yet to open up the market for real estate funds financed with local money. When the time arrives, he says, ING Real Estate will be in a good position to share its experience and knowledge in running real estate funds and it is committed to invest more funds in China.
