China is on the REIT path

Feature on Savills Prospect on 30 June 2019

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The Chinese have deliberated REITs for over a decade now, having experimented with a number of real estate securitisation products. Although most REIT-like assets in China are private funds, its incubation of REITs is reminiscent of property trusts that existed in Thailand before the realisation of its own REIT market there.

Thailand’s property funds, or PFPO (Property Fund for Public Offering) existed for a decade before the country’s first REIT, Impact Growth REIT, started trading on the nation’s stock exchange in 2014.

With each REIT alternative launched and paraded as being the nations “first” REIT, it is easy to lose sight that these products fall short of the accepted definition of a true REIT. Most of these products are hybrids and the debt components are sizable, in contrast to the direct ownership of properties under equity REITs.

In fact, China has already seen a number of these ‘firsts’. The country’s first quasi-REIT – the Auchan Tianjin No.1 Store Capital Trust Scheme – was launched way back in 2003. Penghua Qianhai Vanke REIT, the only publicly traded quasi-REIT debuted in 2015, which came on the back of the nation’s first pre-REIT – Citic Qihang Specific Asset Management Plan – these prototypes are the closest you can come to REITs in China.

While expectations have been building up for the eventual launch of Chinese REITs (C-REITs) in the wake of the government’s announcements to pilot the asset class, it remains to be seen how closely these will resemble the REIT standards in established markets. To date, the current framework remains inadequate in creating full fledge REIT structures in the Chinese market.

Hindered by existing regulations that prohibit publicly traded funds from holding commercial properties, the absence of a REIT code is glaring, which necessitates that most current alternatives be structured as private funds. However, Chinese regulators have of late sped up the drafting of the REIT framework.

However, the current tax regime in China, which results in multiple levels of taxation, is a major hurdle that will take a longer time to resolve. Having a pass-through tax structure remains a critical incentive as REITs distribute the majority of income to investors. Critically, tax waivers related to asset transfers, necessary in setting up REITs, are complicated by the fact that these are levied at the provincial level, which means grappling with local interests. While this can be avoided with offshore REIT platforms, onshore alternatives are structured to avoid some taxes. Here, direct asset transfers which incur land and deed tax are avoided by implementing property holding vehicle companies. Still, structuring additional layers might not be tenable as investors are generally averse to complex structures.

Given the current framework, any REIT launched prior to these issues being resolved could be seen as an anti-climax, as it might not recall the familiar structure seen in other markets. However, we believe that these problems remain surmountable.

A key part of the solution lies in the government’s plans to pilot the programs in its first tier cities, where we foresee the possibility of tax waivers being granted. Further candidates also exist in its free trade zones: Shanghai as well as a further three which were approved in 2014 – Nansha in Guangzhou, Qianhai/Shekou in Shenzhen and Hengqin in Zhuhai.

Still, make no mistake. Full-fledged onshore C-REITs remain a work in progress however experimental REIT-like vehicles will in time forge the future of China’s REIT landscape. The advent of C-REITs is set to be the biggest opportunity to emerge from China.

Region
China