China real estate trust to help streamline segment

Dismissing China's real estate market as a bubble or heroin, pushing the country on a "treadmill to hell" is nothing short of alarmist. Beijing may bristle at criticism of any kind, but it always has its finger on the pulse of problems. So too is it with the property sector which it tries to control with a mix of incentives and raps.

In a significant step, the State Cabinet last week inched closer to launching Real Estate Investment Trust or REITs that will not only streamline the real estate segment but open China's young markets a bit more and give investors more sophisticated tools.

According to media reports, REITs will be launched in the second half of this year. Initially, the government will restrict participation only to institutional investors and allow the instruments to be traded at inter-bank markets. Only at a later stage, will it come out with listed REITs for individual investors.

For starters, Shanghai would be the first city to roll out an unlisted REIT, supported by government-backed companies owning commercial properties and warehouses in free trade zones. It will be followed by unlisted trusts in Beijing and Tianjin.

A REIT is a similar instrument for investing in real estate as mutual funds is for stock investment. It has some of the characteristics of debt — like a regular income stream — and equity, where investors are exposed to the risks and rewards.

Trading houses and insurers are enthusiastic about the development and wants the government to rush with listings. Institutional investors such as insurers and banks consider REITs an attractive investment tool to diversify their portfolios, as they are comparatively safe and offer stable returns compared with equities. Chinese insurers, which cannot directly invest in real estate, are especially keen to see this come through.

Analysts say China's REIT market, when fully operational, will give developers a new source of financing for their projects and another ready market for completed properties. It will also provide an opportunity for small investors to invest in expensive real estate assets that would otherwise be inaccessible to them.

Problems Plenty

Despite market enthusiasm, a lot of issues need to be thrashed out before the government allows the funds to be listed. Taxation remains a major problem as China has a rather complex taxation regime for real estate. Experts say that if investors have to pay too much tax on REITs, returns would be smaller and it would no longer make sense.

Other issues pertain to valuation. Proper valuation of real estate is difficult in China due to the lack of market transparency. Also, availability of suitable properties is dicey. REITs aim to invest in good quality, established properties which yield stable income. Although Chinese real estate market has grown phenomenally in recent years, the supply of higher quality, economically viable buildings is limited.

Rein on prices

Despite the problems, the launch of pilot REITs can only be welcome news, especially with the government trying its best to control runaway prices. In April, the State Council introduced tough rules to cool the white-hot real estate market after home prices rose by a record 11.7 per cent in March in 70 major Chinese cities. REITs is expected to cool a market where prices have risen at the fastest pace in five years.

Among the many measures, the government has made it tougher to buy second homes, banks have been warned against extending loans for property speculation and local governments have been ordered to control land sharks. The introduction of a trial property tax programme in cities like Shanghai, Beijing, Chongqing and Shenzhen has also convinced speculators that they carry a significant cost of holding investment properties.

Jun Ma, chief economist at Deutsche Bank, Hong Kong, in his May report says the State Council measures in mid-April are amongst the most severe steps in history and demonstrate the strongest determination of the central government to stabilise property prices.

According to Deustche Bank estimates, weekly property transaction volumes will likely fall by a sharper-than-expected 60-70 per cent from the recent peak in mid-April in the near future. For the moment, this certainly doesn't bode well for property stocks.

The writer is a journalist based in China