Time to rethink property in China

Peng: Expect a comeback in the property sector within three years  

Crises often present opportunities. The classic example is China’s real estate industry.


Some investors believe that the sector will continue to be supported by strong fundamentals in the long term, and that the current policy-driven downturn has created a good entry point.


Referring back to a similar story in 2008, they believe that the growth in China’s property market is yet to end.

ATAbax Investment Manager, a newly-established real estate private equity fund and CBRE Global Investors, a global property fund manager, could not agree more.


ATAbax Investment is looking to invest in property projects that cannot be completed due to a lack of liquidity resulting from the tightening credit environment, while CBRE is expected to take advantage of the falling land prices to make its first investment in the China property market.


Liquidity snags create opportunities

“The monetary tightening policy and property cooling measures have created opportunities for real estate-focussed funds like ours in the second half of 2011,” says Greg Peng(蓬鋼), the former head of Greater China of Merrill Lynch’s property investment division. “We expect more to come in 2012.”


Peng, who left the US investment bank in January 2011, is now the president of ATAbax Investment Management, a real estate private equity fund founded by him and Abax Capital.

“2011 has been a bad year for Chinese property developers. Many projects were unable to obtain loans. Even projects that have been approved fail to get money, because there is no quota,” says Peng, noting that these are mostly small to medium-sized property developers that do not have sufficient resources to complete their projects.


Peng estimates that unlisted small to medium-sized property developers could account for somewhere around 50% of the total market share. Many of them have been facing liquidity problems and the situation will only get worse in 2012. These property developers acquired their tracts of lands five or six years ago at very low costs, but their pace of development has been slow because of a shortage of capital.


“They are purely profit driven, and not all that concerned about volume and speed like large, listed developers do,” explains Peng.


Since the second half of 2010, the Chinese government has shown a determination to curb property prices as part of its effort to combat inflation. A number of larger Hong Kong-listed mainland Chinese property developers managed to tap the bond market in the first half of 2011.


Other leading property developers including China Vanke, Longfor and China Overseas are reported to have cut their project prices in order to attract customers and maintain their sales volume.

Smaller property developers that were unable to either obtain bank loans or raise funds from the capital market have resorted to real estate trusts for funding.


“During the first half of 2011, there was a surge in the issuance of trust products invested in real estate developments. However, during the second half of 2011, the Chinese government started placing restrictions on real estate trusts as well, thereby further reducing the funding channels for smaller property developers,” comments Peng. “This is a good opportunity for real estate private equity funds.”


Real estate private equity funds, a relatively new phenomenon in China, are not yet highly restricted by the government and there are only a small number of them, according to Peng. The fund has completed 50% of the fund target of 3 billion renminbi, mostly from wealthy individuals, some of them influential real estate developers and, potentially, a financial institution.


Putting money to work

With a targeted internal rate of return of 25% to 30%, ATAbax is expected to complete five investment transactions soon after the lunar New Year in 2012. It will invest in seven to eight more projects in the second half of 2012. “Since our investment horizon is fairly short – about two to three years, we must invest in property projects with liquidity – that can generate sales proceeds shortly after close;” explains Peng. “Two to three years is the time frame within which we expect a comeback in China’s property.”


“We saw a dramatic drop in land purchases in the second half of 2011. But projects will continue to be launched for the land purchased around 2009 and 2010. Therefore, a land supply shortage seems likely in the spring of 2013.”


The fund is looking to invest in quality locations in projects that have obtained all necessary approvals and are ready to commence construction (or are being constructed) – a consideration given in by the fact that the time required to secure all approvals and licences is hard to control.


For ATAbax, the greatest post-investment risk is control. “We have to ensure that the management of our portfolio companies spend money properly, especially when sales proceeds start to come in.


In many cases, Chinese developers like to use the money available in one project to buy land, and/or start the preparation for another. We have zero tolerance for that and therefore must have solid controls over the financial operations of the project company.”


Short-term negative

CBRE Global Investors, manager of US$94.8 billion of real estate assets globally, is in talks to team up with Chinese partners and local governments and expects to invest in residential developments by the second quarter of next year as price corrections are expected to bottom out amid signs of credit easing and early signs of warming. The fund is expected to invest more than US$500 million into equity over the coming three years.


“Both on micro and macro levels, the credit tightening and measures and sales restrictions are having an effect, with inflation tapering off, declining from over 5% in the beginning of 2011 to just over 4% in the final quarter and house pricing are coming down,” notes Richard van den Berg.


“Combining this with a global economy which is expected to slow, the period of credit tightening by the government might start to be reversed gradually,” says the country head of Greater China and portfolio manager of CBRE Global Investors China Opportunity Fund.


Van den Berg views the cut of 50bp in reserve requirement ratio (RRR) by the People’s Bank of China effective on December 5 as the first step of the government’s easing. More interest rate cut and RRR cut are expected in 2012. “I don’t believe that there will be an immediate property market relaxation, but we notice a change in trend,” he adds.


The government’s vigorous property cooling measures have been effective. Van den Berg believes that prices are likely to continue to fall during the first half of 2012 and stabilize thereafter. “However, China is not one market and cities – and even districts in cities – will correct at a different pace and a different magnitude.


First tier cities have seen the highest price escalations over the past years and may correct more steeply than second and third tier cities, where the affordability is still strong. We have already seen land prices drop generally between 10% to 20% in many cities and can expect another 10% to 15% on top of that, making new land acquisitions from the middle of the year attractive.


“The current market downturn is very much instigated by the government as it is looking to stabilize the real estate market, making it affordable to the lower to mid-end customers. We are not looking in China as a crash scenario. With the first step of easing, we expect property buyers will come back in the coming months. In fact, we feel the risk is on the upside with a potential for pricing to increase sharply again when the sentiment and confidence returns as the fundamentals and affordability, in general are strong.”


Given an investment horizon of three years, CBRE is eager to invest in residential and mixed-used residential projects across China but with a main focus on second and third-tier cities, where fundamentals regarding supply and demand as well as pricing are favourable.


There are several factors affecting the long-term demand for housing. “Between 1950 to 1990, all housing was built and provided by state-owned companies. The quality was lacking and maintenance poor or non-existent. Many people still live in poor quality housing, which will drive the demand for new quality housing,” he says.


“Second, China’s urbanization rate is in the mid-40%, below the world average’s of the low 50%. Third, several generations of one family used to live in a single apartment. This has begun to change to one family per apartment and only one or two generations. People are moving out earlier.”


Targeting land acquisitions

Although CRBE has experience in developing projects on its own, it prefers to team up with strong local partners with market knowledge, track record, infrastructure and a sales network. Its portfolio consists of a mix of residential, office, retail and logistics but residential property projects remains to be a large proportion.


While short-term outlook remains cautious, van den Berg expects that distressed opportunities are going to be extremely limited. “Yes, some small and medium property developers are and will start to face liquidity issues and be forced to sell assets or their business at heavy discounts. We will be looking with our partners at those opportunities but it is not going to be a main focus.”


“Prices are going down, but a distressed scenario is unlikely as general fundamentals, growth rate, high liquidity and low debt levels will underpin the market – making the current corrections orchestrated by the government an attractive moment to get back into the market”.



13 Jan 2012


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