China faces “three tough battles” if it is to achieve growth, believes Xi Jinping. The Chinese president, speaking at a meeting of the government’s finance and economic affairs committee in April, was referring to his ambition to reduce poverty, tackle pollution and prevent financial risks, according to the state-run Xinhua News Agency.
His call to arms seems to be working. The past 12 months in China have been a period of relative macro stability, a welcome respite for global capital markets. At PERE’s annual China roundtable in Hong Kong last month, real estate executives expressed their optimism about this stability and endorsed Xi’s landmark governance move.
“It is not unexpected, even though it created a lot of headlines,” says Ellen Ng, managing director, real estate, at New York-headquartered private equity firm Warburg Pincus. “He has built himself up as a very capable and well-recognized leader. Having that news formally announced removed overhang in the market.”
Until a year ago, Ivan Ho, chief executive for Hong Kong at China-focused investment manager KaiLong, says he would have to spend an entire meeting with institutional investors talking about currency issues, political risk and economic instability in China.
Nicholas Wong, principal at the Aon-owned alternative investment advisor Townsend Group, says that he too would constantly get calls from investors reacting to the negative headlines.
No longer. Ho, currently raising institutional capital for KaiLong’s second Greater China-focused real estate fund, for which his firm is targeting over $500 million, says he can now generally get straight to discussing his firm’s China strategy and investment opportunities.
In fact, beyond stability, this roundtable believes Xi’s battle against financial risks is likely to provide investment possibilities for opportunistic managers. With real estate developers facing the brunt of China’s intensifying deleveraging efforts to diffuse financial risks stemming from ballooning debt levels, a window for distressed investments has opened, they say.
“While we have successfully partnered with many developers in the past, we haven’t done too much residential development in China in the past five years. However, as some of the developers get squeezed, we do see some opportunities for partnerships or investment that wouldn’t otherwise be available. The developers are now more open to doing more joint ventures with other capital providers,” says Ng.
Khoon Ng, chief executive of Paladin Asset Management, an investment affiliate of one of China’s biggest developers, Guangdong-based Country Garden, says until about 18 months ago, many Chinese developers were able to issue RMB bonds or ‘Panda bonds’ – some with “unprecedented deal sizes and rates” – and had access to bank lending and peer-to-peer lending. Any “innovative lending model” related to real estate markets has now been stopped, he notes.
“The credit market has been very tight. But at the same time, the residential market grew by 5-10 percent in the first five months of this year. While the top 50 developers grew by almost 30 percent, effectively three times more than the market average, the smaller developers were not able to sell as much or get any funding. So the only logical outcome is that there will be a lot of distressed property assets,” he says.
Claire Tang, head of acquisitions for Greater China at LaSalle Investment Management, adds: “If you look at the offshore bond markets for small to mid-size developers, or ones that are highly levered, in some cases bond yield spreads have increased by 300 basis points in the last six to nine months.”
While Tang agrees there is now a moderate level of distress being seen in the capital structure for some developers, she does not believe it has permeated to the asset level yet – at least not in terms of the asset pricing and particularly not in Tier 1 cities.
Paladin’s Ng echoes Tang’s view. He says it will take some time for financial institutions or developers holding these distressed assets portfolios to accept the pricing being offered by buyers, since many of them are still living in the mood prevalent 12-18 months ago.
However, that is expected to change by the fourth quarter of 2018. Paladin Asset Management has already launched an investment program to seize the opportunity. In May, it set up a $1 billion special situations fund with Hong Kong-based private equity real estate firm Gaw Capital Partners, targeting distressed real estate assets across China.
“If you are an officer and you expose a bad loan right now, you will lose your job,” Paladin’s Ng says. “So you would wait until the end of the year. The way to negotiate a deal is different when you are in May versus when you are in December.”
Three of a (different) kind
Deals picked by our roundtable participants reflect last year’s themes, such as the institutional attraction for the hotel and logistics sectors and the changing face of the market’s credit environment
What: Logistics firm GLP’s privatization by a consortium, led by its chief executive Ming Mei and including private equity firms Hopu Investment Management, Hillhouse Capital and Chinese developer Vanke, among others.
When: July 2017
Her view: “It solidifies logistics as a core rather than an alternative asset class. Now the largest logistics operator in China is owned by domestic capital rather than foreign.”
What: Beijing-based Chinese conglomerate Wanda Group’s sale of 77 hotels for around $2.9 billion to Guangzhou-headquartered developer R&F Properties and 91 percent stake sale in 13 tourism properties to Sunac China.
When: July 2017
Her view: “The deal was telling of the political environment, of of the liquidity needs of even big developers and telling of the broader consolidation trend in the industry. After trading, a few months later, TenCent come in to digitize the malls. So, if certain people perceived the Wanda trade as a negative, it eventually seemed to have
executed a meaningful repositioning. It is also telling of the resilience of some of these developers.”
What: CK Asset Holdings’ sale of 75 percent stake in Hong Kong’s The Centre to a consortium that includes
Beijing-based China Energy Reserve and Chemicals Group among others, for HK$40.2 billion ($5.1 billion; €4.4 billion).
When: October 2017
His view: “Initially, it was being seen as a group of investors locking in the opportunity and then flipping floor-by-floor to potential buyers. However, shortly afterwards, the government began to have more control on the deal
and look at who the lender was. Also, the deal involved not just traditional lending but also bonds and mezzanine financing.”
Accessing distress deals
This is not the first time the market has been hopeful of a distressed investment opportunity arising in China. Asked whether this time would be different from past periods when similar hopes did not translate into concrete opportunities, Wong says:
Chief executive, Hong Kong, KaiLong
Ho has more than 15 years’ experience
in China real estate investment and
development. Ho mainly focuses on fundraising, fund
management, acquisitions and business development for
Managing director, real estate, Warburg Pincus
Based in Hong Kong, Ng is responsible for
the firm’s entity-level, programmatic joint venture and
project-level investments across residential, commercial
Principal, Townsend Group
Wong leads the firm’s Asia-Pacific team
based in Hong Kong. His team manages
Townsend’s existing Asia-Pacific portfolio and sources and
underwrites investments in the region.real estate sectors in China.
Head of acquisitions for Greater China, LaSalle Investment Management
Tang is based in Shanghai. She joined LaSalle
in 2007, and has over 10 years of experience in real estate
and investment management, specializing in the Greater
Chief executive, Paladin Asset Management
Ng has over 15 years’ experience in the field
of property-related corporate finance in China. He has
been working with Paladin Asset Management for the past
“The leadership in China is really strong. If the government wants to achieve higher quality growth it needs to deleverage. This time, a lot of these assets are of much higher quality than 20 years ago. A lot of the buildings are high quality and more desirable. Meanwhile, the property market has also gone up, and so, as a result, some developers will get hurt. But it won’t be like people losing their equity.”
At the same time, however, there are still several constraints for foreign managers hoping to operate a distressed investment strategy in China. Warburg Pincus’s Ng says since China is a big market, playing the distress or NPL market takes a unique set of specialized skills.
“The ability to monetize is also a challenge,” she adds. “After sourcing a deal, what do you do with it? Should you convert it, add value and then sell it? Or are there other channels to monetize and realize the gain? Anecdotally speaking, some of our portfolio companies have been buying from court auctions recently. There are now more diversified ways to acquire these kinds of assets.”
Ho agrees: “It might not be easy for a foreign fund manager to participate in the NPL market to compete with domestic capital. But for us, we usually use a more proactive way. For example, some domestic wealth management company raises a fund with a short fund term, and once that expires we can purchase the assets. Or, if there is a potential developer that owns some assets, we can buy the good quality assets instead of buying the whole portfolio.”
The deleveraging efforts stand to benefit foreign fund managers in other ways. Ever since Chinese regulators have imposed stringent curbs on capital flows, much of the domestic capital, trapped onshore, has turned to domestic real estate purchases. Local fund managers have since become formidable competitors to international capital in the auction rooms.
Tang believes that might change in the short term. “Without a significant track record, smaller investment managers are currently having a difficult time raising more capital, and the required return on that capital is getting much higher because of the deleveraging taking place. As their cost of capital gets higher, foreign capital will likely become more competitive toward the latter part of this year.”
Beyond the potential for distress, China is also seeing a growing institutional market for its underdeveloped alternative assets, such as co-living and co-working hubs, as yields on commercial properties continue to remain low.
In May, Singaporean state fund GIC announced a partnership with NOVA, a Shanghai-headquartered operator and investment manager co-founded by Warburg Pincus, to establish a 4.3 billion yuan ($670 million; €570 million) rental apartment platform in China. As part of the deal, GIC also agreed to acquire a minority stake in NOVA.
Ng says Warburg Pincus is bullish on the for-rental apartment sector in China. She says the firm is underwriting each asset in the lease-and-hold model at 16-18 percent IRRs.
“So, despite views on for-rental apartments not being profitable, we have kept our bar high,” she says.
But others, like Tang and Paladin’s Ng, still need some convincing about the viability of co-living investments. Ng says he spent six months looking at the sector and found less than 4 percent yields, when the interest cost on debt to buy them was 7-8 percent.
More than a quarter of LaSalle Investment Management’s latest $1.15 billion pan-Asia opportunistic fund – LaSalle Asia Opportunity Fund V – is to be invested in China, a higher proportion than its predecessor fund. So far, the fund has not been invested in niche asset types.
“Co-living is an easy asset class to get into. But it is also a difficult asset class to scale and underwrite,” remarks Tang. “Yields on these residential or commercial assets converted into co-living projects are very low, especially in Tier 1 cities – our target markets. Despite favourable development on the creation of REIT vehicles to provide an exit on such assets, there is not a significant spread to be made.”
Meanwhile, there are also reservations about how much ought to be invested in shared offices, another property subasset type that has picked up tractions globally. In April, the New York-based co-working leader WeWork reportedly acquired Chinese co-working startup Naked Hub, which was backed by Gaw Capital Partners, for around $400 million.
Ho says Kailong is thinking about how it could allocate a portion of its office space to allow for a co-working environment. However, he says he would prefer to allocate only around 15-20 percent of an office’s space for co-working.
Turning words into action
This year’s China roundtablers talk with a sense of optimism stemming from their 1,000-foot view perspective of the country’s economic prospects. But how this optimism translates into tangible activity for their respective businesses remains less clear. The distress they point to is largely theoretical and niche asset classes like co-living and co-working property are as-yet unproven.
As they relay, institutional money is moving on from old Sino-centric concerns. But that is not the same thing as fully endorsing private real estate strategies for the country to the extent it once did.
Indeed, according to PERE data, $1.8 billion has been raised for China-focused, closed-ended real estate funds to date this year, while only $450 million was raised in 2017. In contrast, a record $5.61 billion was raised for China-focused funds in 2013, the most in a year since the global financial crisis. Chinese vehicles’ performance have also varied. According to industry body ANREV’s China Funds Index, 10 funds recorded a total return of 4.17 percent in the fourth quarter of last year, lower than the five-year average of 5.8 percent.
Investors will need to see the macro-induced optimism, as is present around the table, translate into a more solid performance if they are to step back into the market in such significant numbers.
Lessons from Anbang
PERE asked participants if the regulatory blow to Chinese investors’ pace and style of overseas acquisitions has made international investors rethink how they partner with such capital
They were once among real estate’s biggest dealmakers with the biggest wallets. But stuck in the regulatory crosshairs, the likes of HNA, Anbang Insurance and Dalian Wanda have been forced to limit – and in some cases halt – their overseas investing programs over the past two years. And, as Chinese regulators continue to impose stringent controls on capital outflows, the impact on Chinese overseas investments has been monumental.
Chinese investment into the UK’s commercial real estate market for instance, has drastically fallen this year, according to Cushman & Wakefield. Mainland Chinese investors invested $325 million in the first quarter of 2018, which is 70 percent lower than the quarterly average of the past five years of $1.1 billion. Paladin’s Ng says the saga has tarnished the image of Chinese investors. “It has places like London and Sydney,” he laments. “They [sellers] just do not think you can close the transaction even though you put in a lot of money and effort to show them you can.”
But has this regulatory scrutiny also provoked widespread reassessments on how to transact with Chinese investors, and which among them is a credible buyer or not?
“It is art more than science,” Wong says. “Remember, Lehman Brothers was a triple A tenant just before the GFC. So, we need to look at what is on the table and have a stringent KYC [know your customer] policy.” According to Warburg Pincus’s Ng, sellers also now need to provide more buffers for surprises and to ensure they can get the capital offshore. “Even with the most genuine of motivations, they could be stuck, so we need to have alternatives and be mindful of the risks inherent in these groups of people,” she says.
At the same time, the participants agreed Chinese investors cannot be painted with a single brush. As Ng says: “Some are cowboys and others are genuine buyers.” She adds Warburg Pincus has successfully achieved exits on some of its school portfolios to Chinese buyers and the firm is taking a keen interest in such assets that Chinese people want to own. “The main question is about sustainability – what is the long-term trend of this capital? Is it hit and run?” remarks Wong. “Chinese people buying apartments in Australia is along-term trend but Chinese developers with no expertise in Australia building their own projects without a local partner, and then selling to Chinese investors is not sustainable in my opinion. We need to differentiate what we are getting into.”