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China Reits Property Landlords to Shine 19 SECTOR BRIEFING number DBS Asian Insights DBS Group59 Research • May 2018 China REITs Property Landlords to Shine 19 DBS Asian Insights SECTOR BRIEFING 59 02 China REITs Property Landlords to Shine Ken HE Equity Analyst DBS (Hong Kong) [email protected] Carol WU Head of Greater China Research DBS (Hong Kong) [email protected] Danielle WANG CFA Equity Analyst DBS (Hong Kong) [email protected] Derek TAN Equity Analyst DBS Group Research [email protected] Jason LAM Equity Analyst DBS (Hong Kong) [email protected] Produced by: Asian Insights Office • DBS Group Research go.dbs.com/research @dbsinsights [email protected] Goh Chien Yen Editor-in-Chief Jean Chua Managing Editor Martin Tacchi Art Director 19 DBS Asian Insights SECTOR BRIEFING 59 03 04 Executive Summary 08 China REITs Are Lagging Edging Towards Onshore REITs Major Obstacles in Fostering 18 an Onshore REIT Regime CMBS/CMBNs Are Growing Faster C-REITs Are Imminent Which Asset Type Will Benefit 28 More? Modern Logistics Properties The Rise of Active Property Asset Management Which Developer Will Benefit From the Establishment of C-REITs? 49 Appendix DBS Asian Insights SECTOR BRIEFING 59 04 Executive Summary No REIT regime yet he real estate investment trust (REIT) has become an important investment vehicle as evidenced by its separation from the financial sector in the Global Industry Classification Standard as a sector on its own. Major Asian countries/regions have joined western countries to kickstart local versions of REITs, leaving China the last Tbig economy that has yet to have such an investment vehicle. Two major technical In our view, removing legislative obstacles (publicly traded funds are not allowed to obstacles hold commercial properties) is the first step that the government needs to take towards establishing a modern REIT regime. Near-term relaxation could be allowing mutual funds to invest in onshore pre-REITs. Currently, the government is fine-tuning regulations whereby a single mutual fund is not allowed to invest over 10% of its total net asset value (NAV) in one single security and a single fund management company is not allowed to invest over 10% stake in one single security. Taxation is a more complicated obstacle as there are central/local tax (國稅地稅) systems in place. We think a waiver of taxes related to asset transfers is required to develop a REIT regime, as this is one of the biggest concerns for – and a huge burden on – landlords to build a REIT platform. So far, under the current taxation scheme and regulations, onshore pre-REITs have complicated structures to save on/avoid some taxation. Having said that, taxation, in our view, is a factor determining the market size of China REITs (C-REITs), rather than an obstacle preventing the establishment of C-REITs, as offshore C-REITs also need to pay various taxes in China. Other areas that China needs to fine-tune to foster an ecosystem for C-REITs include a unified product structure, a standardised valuation methodology, a transparent credit rating system, and supervision of special-purpose vehicles (SPVs). Onshore pre-REITs The origin of C-REITs can be traced back to 2005, when the first red-chip REIT – Yuexiu REIT – was launched on the Hong Kong Stock Exchange (HKEx). However, the development of the sector has largely stagnated until the emergence of onshore REIT-like securities in 2014. Currently, there are 28 quasi-/pre-REITs (類/類REIT) which are primarily debt-like vehicles and barely resemble an equity-REIT in other countries, as the government aims to manage the risks of such products at the initial stages and believes that a debt structure is more secure than an equity one. But the fact is those pilot debt-like products have a less favourable risk/return profile compared to offshore C-REITs as (i) their leverage is high, ranging 50-70% versus 20-40% DBS Asian Insights SECTOR BRIEFING 59 05 of their offshore peers’; (ii) the coupon rate has been low at 4-7%, versus an average yield of 6-9% of offshore peers’ (total returns could be higher, including capital gains); and (iii) those pre-REITs are all held by private funds with fewer than 200 investors, pointing to limited liquidity. Other problems existing in some products include low interest coverage, having a single underlying asset or single end-customer, the parent company’s credit enhancement, and a vague credit system. In our view, relaxation of policy and taxation is needed to foster a better ecosystem for growing equity-REITs. CMBS are growing The big difference is, compared to REITs, that commercial mortgage-backed securities faster (CMBS) do not involve asset transfers, avoiding the two key obstacles faced by onshore REITs. Compared to traditional bank loans, CMBS enjoy lower funding costs and better liquidity. CMBS kicked off in August 2016 and have witnessed faster growth since then. A recent spate of policies has led us to believe that the long-awaited C-REIT is imminent, even if the initial structure of the REIT may not be similar to that of offshore REITs. (i) Continuous deleveraging efforts: Top governors have reiterated the need to put more effort into ensuring financial security and healthy economic growth. This can be tracked from the deceleration in the growth in banks’ assets. According to Standard & Poor’s, growth in banks’ assets was 5.5% in 8M17, much lower than an average of 15.2% during the past five years, and also the first time this figure has dipped below the corresponding GDP growth. The government has been pushing other sectors to swap debt for equity to help them deleverage. But unfortunately, the property sector is one of the few sectors that have been gearing up despite strong property sales. We believe the government may switch its focus to deleveraging in the sector after successful destocking, and C-REIT could be an effective way. (ii) Weaken residential properties’ attractiveness as investments: Local governments have implemented a series of policies (including purchase/sell/mortgage limitations) with the intention of managing residents’ expectations on housing prices. Meanwhile, the central government has attached more importance to long-lease rental apartments, proposing to give more incentives (including land supply and tax incentives) to this segment. Three million units of rental housing are targeted to be supplied in trial cities, which is huge compared to the average annual sales of 1.7mn units during 2013-2016 in those cities. And we believe China needs the REIT platform to hold these rental-housing assets over the long term. In addition, the first pre-REIT for long-lease rental apartments was launched on the Shenzhen Stock Exchange on 3 November 2017, prompting some industry experts to expect the breakthrough in onshore REITs to come from long-lease rental apartments. (iii) Develop commercial properties’ function as investments: The regulators have been speeding up the drafting of the REIT code recently. In addition, the issuance of onshore pre-REITs has also accelerated. Apart from this, a new policy which aims to encourage the conversion DBS Asian Insights SECTOR BRIEFING 59 06 of commercial land/properties to long-lease rental apartments was introduced. As mentioned above, the upcoming C-REITs could be public funds with investment targets in onshore pre- REITs, which do not look exactly like REITs envisioned by overseas investors. Yet, this vehicle should greatly improve the liquidity of commercial properties and unlock book value. Commercial properties We expect the investment focus to gradually switch from residential properties to commercial to outperform? properties. Based on our study, the capital value of commercial properties in Japan and Hong Kong has outperformed residential housing prices after the introduction of local REITs. In addition, we are seeing big potential in C-REITs. REITs’ market cap as a percentage of local GDP average 6.0% in major Asia-Pacific countries. Even if we conservatively assume a 1% figure for China, C-REITs’ market cap could potentially be US$115bn. In our view, the required yield return of C-REITs will likely fall in the 5.5-6.0% range, compared with the current China 10Y government bond yield of 3.9%, the latest weighted-average rate of 4.5% for wealth management products (WMP), and the current offshore C-REITs’ yield of between 6% and 9%. The yield spread (above China 10Y government bond yield) is likely to be 2%, compared to c.3% for HK REITs and Singapore REITs (S-REITs), which could be justified by higher asset appreciation potential in China. Which asset type to We expect hotel and retail mall assets to benefit more from liquidity improvement. In benefit more? addition, in anticipation of C-REITs, active property asset management / redevelopment and conversion of hotel or retail malls to offices are rising, especially in Beijing and Shanghai. Modern logistics Both assets generate relatively stable cashflow and require less operating capability. properties and Grade-A Therefore, both assets have been chased by financial investors and insurance companies offices during the past two years. As the renminbi (RMB) has reversed its downward trend, foreign capital has also been flowing into these two assets. This, coupled with stricter capital outflow, should continue to drive up the capital value of both assets. We are positive on the logistics property sector and we expect state-owned enterprises (SOEs) and market consolidators that have better access to industrial land to benefit more from the potential establishment of C-REITs. Shenzhen Chiwan used to be the second-largest warehouse play in China, but its development over the last two years has been dragged by its B-share status. The company is expected to leverage the potential establishment of C-REITs to quicken its asset turnover and grow its portfolio.
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