A highlight of New York-based asset manager BlackRock’s mid-year Asia investment outlook published last week was its comment on how the pace of China’s deleveraging campaign has “run ahead of the firm’s expectations.”
Concerns that Beijing’s desire to deleverage could cause a slowdown may have already been priced into markets, but Andrew Swan, head of BlackRock’s Asian and global emerging market equities, fears there could be a lag effect felt in the second half of the year.
Opportunistic real estate investors in China are also waiting to see what the rest of 2018 has in store. But this is more out of hope for distress investment opportunities arising from the country’s debt reduction policy.
Participants at PERE’s annual China roundtable this month expected meaningful numbers of distressed portfolios to come to the market by the fourth quarter. As the executive at one Chinese asset management firm remarked, an officer who exposes a bank loan right now risks losing his job, so his instinct would be to wait.
Property consultancy JLL also predicts 2018 will be a record year for en bloc transactions in China, as small to mid-sized developers are forced to trade assets to meet debt obligations.
Why might this happen? The real estate sector in China takes up a high percentage of the total financing in the economy. It was around 42 percent in 2016, when the deleveraging efforts first started, according to UBS Asset Management.
Tighter lending has hit the country’s developers hardest as they struggle to raise funding for projects and repay debts. In June alone, five listed developers were reportedly forced to suspend bond issuances totaling 38.1 billion yuan ($5.9 billion; €5 billion). Meanwhile, financing costs are also rising. The average cost of overseas debt issuance has risen 100 basis points to 6.98 percent from 2017, JLL estimates.
Private real estate managers are preparing to seize deals when the white flags start waving. Paladin Asset Management, an affiliate of the Guangdong-based developer Country Garden, is one investment manager to have set up a $1 billion special situations fund to take advantage. It joined forces with Hong Kong-based private equity real estate firm Gaw Capital Partners. PERE has been told of another global private equity fund hopeful of making more entity-level investments in debt-burdened Chinese developers.
Despite the opportunities, international money managers still have barriers to entry when it comes to doing business in China, access to deals being the obvious one. With domestic equity looking for opportunities at home amid expatriation capital controls, and more local asset management companies being set up, some of these portfolios could end up transacting Chinese organization to Chinese organization. Local managers might also be more willing to have looser underwriting and diligence norms, adding to their competitive advantage, some industry observers believe.
And if international investors do end up sourcing good portfolios at favorable prices, the exiting process remains cumbersome, especially until capital controls end. Opportunistic or value-add managers hoping to flip the assets quickly could face delays in repatriating proceeds to overseas investors.
Windows of distressed investing in China have opened in the past, international managers remind us. This time, however, President Xi Jinping’s resolve to prevent a debt debacle mean more opportunities could be waiting to be tapped.