COMMENT: The right indicator

Anyone looking for the final word on core real estate in China would have done well to attend the third annual PERE Forum: China 2014, this year held at the Andaz Xintiandi hotel in Shanghai.

In the opening panel session, core real estate was included as one of five pressing topics relevant to the private property investment market in China today. It figured intermittently through the subsequent eight panels. Finishing with a session on lending habits, the existence and complexion of institutionally acceptable property able to provide secure, long-term returns was never far from the conversation.

The upshot from the day? That core real estate is yet to meaningfully materialise in China, even though international capital has been raised and is waiting for the stuff. It, arguably, isn’t far away. But as the 160-strong event heard, there are certain essential ingredients still missing from the marketplace.

Firstly, the definition of core real estate. During the opening panel, Baring Private Equity Asia’s China head Charles Lam defined what we should be talking about, the “international core standard”. His reading was approved by speakers and delegates alike, who adopted his take on property able to sustain up to 70 percent of an asset’s return from income, the rest from capital appreciation. But it was widely acknowledged that in China today, the reality is typically the reverse.

Let us not talk about the super prime offices in CBD Beijing, Shanghai or Shenzhen – those properties are not being traded by their Chinese owners. There is plenty of other property in Tier I China able to demonstrate long-term cash flow, PERE heard. But here’s the rub: an alarming percentage of that real estate is not fully occupied. Furthermore, in certain cases, the chances of increasing tenancy is low owing to the poor construction quality of the buildings in question. That is where the ‘sustain’ part of Lam’s international core standard comes into focus.

As Xu Xialiang, president of China’s own Fosun Group (and a forthcoming PERE Blueprint subject – look out for the September issue of the magazine) said, income generating does not always mean core. Look at many offices built in prime locations in the 90s, he suggested.

As Xu reckoned, the depreciation of Chinese property, and its adverse impact on the capital income/appreciation ratio is not sustainable if the country wants to offer to core cash flow hunters what they need. Property obsolescence means redevelopment, which means is risk-return dynamic is of the opportunistic variety. Dare we say it: the Chinese obsession with occupying new property needs to evolve too if core charisma in the country’s markets is to shine through widely.

So property building standards must improve and a litmus test will be two to three-term occupancies before serious refurbishment is needed. We shouldn’t even be talking about redevelopment. Some panellists felt these improvements were incoming. However, nobody would table a timetable for delivery. 

But one panellist however hit the nail on the head when he forecast an era in which Chinese institutions will be buying international-standard core real estate in China expressly to satisfy their perennial liabilities: this more than anything will be confirmation that the market had finally got there. Chinese REITs would be another. With only one REIT actually operational, that may be some way off, though.

Meanwhile, as PERE’s today breaking news of Ping An’s new Alternative Investment Division demonstrates, China’s institutions, particularly its insurers, are still in the early throes of formulating their teams and strategies. China’s $8 trillion insurance sector, for example, was only granted permission by the Chinese government to invest stakeholder capital into real estate in 2012, and raised the limit from an initial 10 percent to 30 percent earlier this year. Up to 15 percent of that can be invested overseas. And it would be a reasonable bet to assume Chinese capital will hunt yield abroad first. But when that trend reverses, we’ll know core real estate – to the international definition –has arrived in China.