Many mezzanine debt providers for real estate in China have decided that now is a time for caution rather than aggressive investment, delegates heard at the PERE Forum China in Shanghai.
Unlike previous downturns in China, such as those in 2007 and 2011, this particular credit and lending crunch is not driven by harsh government policies, according to Ping An Real Estate Fund Management managing director and general manager Wei Wang. This time, the fundamental supply/demand dynamics for real estate in the country are “out of whack,” and thus the banks themselves are choosing to not lend to the smaller developers or give out many mortgages.
Normally this would present many compelling opportunities for more expensive lenders like private equity funds. However, Thomas Liu, managing director and head of greater China for Standard Chartered Bank’s Principal Finance Real Estate, added that the supply/demand imbalance exists not only in the capital available to developers but also in the physical property stock. “It will take time for the market to come back,” he said. “There will be good opportunities, but we have to be patient.”
Whereas 2012 was a good recovery year after the recession of 2011, none of the panelists predicted that 2015 would see a recovery of the same level. In anticipation of a slower recovery, Forum Partners investment director Andy Wu told delegates that his firm had changed the way it underwrites mezzanine deals.
“We need to at least make money back with some returns even if the market goes down,” Wu said. “That means we have to be much more careful about the supply/demand in the market.” Liu agreed that Standard Chartered will no longer project a 5 percent to 10 percent growth, but a 10 percent drop in price. Only if the deal can be profitable after the price drop would the bank invest, he said.
Indeed, Wang said Ping An just recently decided to slow down its pace of investment in mezzanine property deals, because “there will be plenty of time to pick what opportunities we want.” And not all opportunities are appropriate for mezzanine investors, Liu also pointed out. Some small local developers that have overbuilt cannot be fixed with a simple capital injection, and even the country’s largest developers shy away from taking over those projects.
What these mezzanine lenders look for in investments, according to Wu, is a sponsor that has something at stake, whether their reputation, their business, or the properties themselves. “Especially if things do go wrong, we need to give the developer enough incentive to meet their obligations,” he said.
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