Friday Letter China's inner ring road

International private equity real estate firms operating in China are today seeing better deals as liquidity tightens in the country, but they need capital if they’re to take advantage. 

 If there was one outstanding anecdote to takeaway from PERE’s Asia roundtable last week that best illustrates the standing of international private equity real estate firms in China, then it came from CBRE Global Investors.

Richard van den Berg, China head at the firm, recounted a recent experience in Chengdu, in the increasingly affluent Sichuan Province of the country.

A city with a population of about 7 million people (14 million if you count its immediate surrounding region), Chengdu is fast becoming a favourite for investment in western China. One report even said of the world’s 500 largest companies, 133 have already established branches or subsidiaries there. So it stands to reason it is also high on the investment lists of private equity real estate firms.

The problem for the likes of van den Berg and his peers was that, until now, the main sellers of land in the area, the local government, were not so interested in parting with anything inside the city’s three inner ring roads. As van den Berg stated: “The only pieces of land they wanted to sell were in the suburbs. Sometimes you had to drive as much as an hour to get there only to find the land had roads that still needed building. But that’s all that was available.”

Things are changing. Today he and his domestic partners are invited to conversations with state officials where the land on offer is indeed within the ring roads. Furthermore it’s coming to the table at 20 percent discounts to peak pricing or better. Why? Two words: liquidity issues. “They need to start selling their assets and now they are knocking on our door,” he said. Simplistically put, central government regulation is pushing Chinese lenders to restrict their activities meaning that conventional buyers of land are also restricted in what they can buy. With local governments in China depending on continual land sales, today’s curtailed buying force needs bolstering.

Perhaps it would be too strong to suggest this event is typical across China. Any country with 1.3 billion people is going to have multiple markets moving at different paces. But, there were six participating firms at last week’s roundtable – CBRE Global Investors, LaSalle Investment Management, Morgan Stanley Real Estate Investing, Invesco Real Estate, Aberdeen Asset Management and Henderson Global Investors – and each recalled similar experiences. Private equity real estate is now exposed to better quality assets in China and, at times, interesting discounts too. Furthermore, it is not just local authorities that are accepting pricing levels attractive to opportunistic capital, small to medium size developers are also engaging in talk of discounts.

Let’s be clear, we are not talking about domestic distress, the likes of which is understood in Europe and the US. This is not about rescue financing. But with many Chinese operators keen to sustain the China growth story, they need expansion capital and today it is less forthcoming, hence more conversations with international fund managers. However the money is badged up – Chinese developers cannot use debt for land purchases and only 50 percent gearing for property transactions so preferred equity is one type of capital deployed by private equity real estate firms – it is better able to make it to the negotiating table in the one country in Asia that practically every international firm wants a presence.

That is great news then for those with capital to deploy. Of course, therein lies the snag. Private equity real estate firms need to raise equity before they deploy it and fundraising totals in Asia have been disappointing in 2011 to put it mildly – one roundtable participant remarked that only a tenth of the capital sought for Asian opportunity funds launched this year had been raised and we’re already in November. Nevertheless, never underestimate the ‘snowball effect’ a number of successful forays by those already with dry powder can have. Each of the six participants predicted next year’s roundtable would be focused on more deals and, as such, more fundraising.

With firm’s like CBRE Global Investors now invited to negotiate on prospects within China’s inner ring roads rather than an hour away from them, that does not seem a far fetched notion at all.

To read more about what was said at PERE’s Asia roundtable, make sure you pick up a copy of next month’s PERE.