China has approved a long-awaited pilot scheme for real-estate investment trusts, dubbed C-REITs, in a first step towards the creation of an asset class that analysts expect to exceed US$3trn.
After studying the introduction of REITs for over a decade, regulators last week endorsed the concept as an alternative funding tool for infrastructure and a source of stable returns for investors.
The move comes as China is accelerating reforms to its domestic capital markets in the wake of the coronavirus outbreak, making it easier and faster for companies and local governments to access capital.
Goldman Sachs analysts wrote in a report that China could become the world's largest REIT market with a potential size of over US$3trn, including US$1.5trn of infrastructure REITs on public-private-partnership projects.
Unlike REITs in overseas markets, which typically comprise commercial property assets such as office buildings and hotels, China's framework only covers infrastructure assets at this stage. These include warehouses, toll roads, urban utilities, sewage and garbage treatment facilities, information networks and high-tech industrial parks.
To qualify for the pilot scheme, assets must be located in one of six designated economic regions, including the Yangtze River Economic Belt and Guangdong-Hong Kong-Macao Greater Bay Area.
In a joint statement on April 30, the securities regulator and economic planning agency announced the pilot scheme, which at this stage allows mutual funds – but not private sponsors – to issue infra-REITs in the public markets and list them on stock exchanges.
“REITs can help corporates increase direct financing and lower leverage. This is also an instrument which offers a middle level of risk and stable yields, expanding investment channels for investors,” said the National Development and Reform Commission and the China Securities Regulatory Commission in the statement.
“Infra-REITs are also helpful in raising project capital and reducing debt burden for local governments.”
DEBT BURDEN
China’s local governments had Rmb54trn (US$7.61trn) of debt at the end of 2018, equivalent to about 50% of GDP, according to the Goldman Sachs analysts.
“With the backdrop of limited debt headroom and the need for China to build more infrastructure and public welfare projects in the future, we believe C-REITs, by injecting equity to these projects, could help to solve the dilemma,” they wrote.
China is setting its infra-REIT code mostly in line with international standards in terms of dividend ratio, leverage ratio and corporate governance structures. The REITs are required to distribute at least 90% of their audited annual net income after tax to unit-holders. According to the code, the aggregate borrowings of a REIT should never exceed 20% of its total gross asset value, which is lower than the threshold in other markets. Hong Kong, for example, stipulates 45%.
Infra-REITs will be issued by mutual funds and gain their exposure to underlying infrastructure assets by acquiring asset-backed securities.
The guidelines also require the REIT sponsor to participate in the strategic tranche of the REIT IPO, which cannot be less than 20% of the deal, and be subject to a five-year lock-up. Excluding the strategic tranche, at least 80% of the IPO must be sold to institutional investors and the rest can be sold to retail investors.
RIGHT TIMING
REITs have been under consideration in China since at least 2008, but regulatory and tax hurdles have so far hindered progress. Only quasi-REITs, which are more akin to a debt product, have been sold in the private markets so far.
Guangzhou Investment’s GZI REIT became China's first listed REIT when it raised US$230m from a Hong Kong IPO in 2005. Other Chinese REITs have since listed in Hong Kong and Singapore, and overseas bankers agree that the time is right to introduce REITs in the domestic market.
“REITs can redirect household savings to property and infrastructure industries which are in need of funds as a result of the pandemic, reducing their reliance on the banking system at this difficult time,” said a banker.
“Global markets have been volatile lately and REITs work well for risk-averse investors,” said another.
Domestic bankers, however, are more sceptical about the scheme.
“The impact on the country's infrastructure investment in the short term may be limited as many of the high-quality infrastructure projects already sold special-purpose bonds to raise funds, while it won’t be easy for projects with poor cashflow to do a REIT,” said a Beijing-based analyst.
A Guangzhou-based analyst said the complexity of the structure remained a hurdle, as China lacked asset managers with experience in REIT management or operations.
"The REITs will involve the set-up of mutual funds and ABS or even special purpose vehicles. This is complicated for many project owners and they may prefer to do an IPO or to sell bonds,” he said.
According to data from GF Securities, there were 68 quasi-REITs in China with outstanding issuance of Rmb127bn as of April 30. Just three were infrastructure REITs of toll-road and bridge construction with an outstanding amount of Rmb11bn, accounting for 8.6% of the total.
Zhao Xijun, deputy director of the Institute of Finance and Securities at Renmin University of China, reckons the pilot programme has limitations but that it will help China to develop its capital markets in the long run.
"The pilot scheme is used to test the maturity of the market, laws and regulations, and investors’ acceptance,” he said. “It may not be successful but it will facilitate China to accumulate experience for future improvement of the new fundraising tool.”