Funlive: Finding the ‘right model’ for China Multifamily

This article is sponsored by Funlive

Multifamily residential has been one of the most popular asset classes for global investors in recent years, and China offers enormous potential due to its size, government support and the demand for quality rental assets from migrant workers and those who cannot afford to buy. Keith Chan, chief executive of Funlive, a vertically integrated multifamily operator and investment manager, says the right business model is crucial in capitalizing on the opportunity and bringing increasing institutional investment to a rapidly growing and developing sector.

What is driving the multifamily residential market in China?

The dynamics of the multifamily sector in China are straightforward, and the fundamentals for the tier one cities and the top tier two cities are driven by three major factors.

Firstly, China’s urbanization rate has been consistently rising and converging to the world average’s 80 percent. As a result, the urban population of these cities is huge and can be treated as metropolises by world standards – 25 million for Shanghai and close to 10 million for Nanjing, for example.

Secondly, following the development of these urban metropolises, there has been an explosion in the migrant work population, which has expanded 2.5x nationally relative to 20 years ago. This translates into a need for these cities to consistently provide quality housing – a key urban infrastructure to keep high value-adding talent to drive the development of these metropolises.

Thirdly, the capital value of residential properties in these cities is high and has been outpacing rental. This has led to an overall lower affordability for home purchases and pushed young professionals and families into renting. We are of the view that if these three trends stack up for a city, then the fundamentals are robust.

Adding to this, the government has been supporting the residential sector since 2014-15, and promoting the idea that residential units are not for speculation, but accommodation, which supports a professionally managed multifamily sector. In fact, it has been pushing state owned enterprises (SOEs) into the rental and affordable housing sector; however, progress has been slow.

The government also introduced tax breaks for multifamily in 2021: VAT has gone down from 9 percent to 1.5 percent, while real estate tax has decreased from 12 percent to 4 percent. While this does not make a huge difference on the bottom line, it does boost yield given the buy-to-hold, operating nature of this asset class.

Multifamily is a preferred asset class within real estate, following overall government support. In China, multifamily has been classified differently compared to for-sale lending for major banks as an “encouraged sector” with favorable terms.

For example, we secured bank lending for one of our platforms and the bank has since been proactive in looking to work with us more in the multifamily projects, even in the second half of 2021, standing in contrast to the attitude towards single-family residential for-sale projects amongst the capital markets. We are confident that this is not only because of the sound fundamentals of the multifamily sector, but also an echo following positive government support, where banks see it as a safe investment with a smaller overhang.

Finally, the multifamily sector is in a process of institutionalization, with a clear best model emerging and strong interest from sources of long-term institutional capital both internationally and here in China.

How is the multifamily residential investment and operating model developing?

A couple of years ago, the multifamily sector in China was fairly distinct from that of the US or Japan. Initially, all the operators tried to adopt the master lease model, where they would take long-term leases over properties and then rent short term to tenants. So, back in 2018-19, a number of players tried to get into the industry by adopting this model because it would allow them to scale up very quickly.

However, to scale up, they took on too many projects at low margins or even making a loss, and a lot of these platforms went bankrupt, even those that had received private equity backing. Now, operators looking to go down an asset-light model need to either choose to be more like a hotel operator, managing the assets and generating fees, or turning to revenue-sharing with the owners rather than having a fixed cost through the master leases.

The alternative to this is a more asset-heavy business, where you build to rent. You can buy land and develop, or buy existing assets and convert to multifamily. Of course, this requires development skills and is capital intensive.

Chinese developers tend not to be keen on this as most do not want to be long-term owners of the assets, even where a section of a development has been reserved for rental housing. To meet the challenges of this model, you need to be a fund manager in order to build the capital for these projects.

This is what we do at Funlive: we are the developer and operator of the assets and also a fund manager for vehicles that will own them in the long term.

I believe this operating and asset management model is the best way to go in this sector – like GLP and ESR in the logistics sector, that is where we want to be in the multifamily space. We have a first mover advantage in this space given we launched in 2018 and the competitive landscape in multifamily funds management in China is not so crowded, yet investors have been supportive because this model has been proven in other markets and asset classes globally.

Is investor interest in the sector still growing?

Yes, we continue to see more and more investors coming into the space. Traditionally, the multifamily sector all over the world has been popular due to its resilience and stable cashflows, and we note that this is increasingly the case post-covid. Since 2018, we have been able to establish investment ventures with Proprium Capital, Gaw Capital Partners and various sovereign funds. We also are managing a conversion project for Blackstone Group – their first China multifamily investment.

Last year, we teamed up with KKR, which invested in a 3,000-unit multifamily development that we will operate in Beijing. So, that interest from global investors in the sector and in this fund manager/operator model remains strong.

Furthermore, we are seeing more interest from Chinese institutional investors. Going back a year or 18 months, insurers were still in the process of working out the policy angle to multifamily given its residential nature. However, that attitude has changed a lot in favor of multifamily since then.

Through active conversations, we have noticed that major insurance companies have enlisted multifamily as one of their strategic focuses if they have a real estate allocation. Given the stable and resilient nature of multifamily, this should fit well into the long-term investment profiles of insurance capital, and to this end we are hopeful that we can add Chinese insurance companies as our investors.

One more thing that is supporting investor interest and the institutionalization of the sector is industry consolidation. In the past, there were many failed operators due to missteps in business models. Now there is a smaller number of better and more stable players in the market, which is good because the whole sector will be more healthy and more appealing to both investors and renters.

How has the ongoing pandemic affected the multifamily residential market in China?

When covid first emerged in Q1 2020, site visits to projects by potential renters were largely limited by the government. This has coincided with the Lunar New Year, where most residents have returned to their home cities and, as a result, new leasing activities were challenging.

Once we got to late April 2020, however, things recovered quickly, our occupancy rebounded from low 80s to an average of 92 percent and has stayed at a high level since then. For 2022, the omicron outbreak is having a similar impact on occupancy and leasing, yet key metrics including rental collection rates have been strong and we are positive multifamily will remain one of the less affected asset classes and business sector.

We also note that residents are increasingly appreciative of the fact that a professionally managed multifamily building offers more support during lockdown, because there are staff there to help. Our staff have been working very hard during this period. This is something I experienced myself in a modern, professionally managed residential complex in Shanghai; organizing supplies and other things is much easier than for people in older buildings without proactive management.

Has your view on the best cities for investment changed at all?

There are eight cities where we think we will focus for the time being. The first five would be the priority: these are the tier-one cities of Beijing, Shanghai, Guangzhou, Shenzhen and also Hangzhou, which is an important tech and manufacturing center. However, we would also look at three other cities which have very good potential: Wuhan, Chengdu and Nanjing.