BLUEPRINT: Sustaining opportunity

The first thing you notice upon entering CITIC Capital’s headquarters at CITIC Tower in Hong Kong’s central business district is just how Chinese the office interior looks. From the ornaments to the upholstery, a sense of the Orient is practically everywhere.

On a purely physical level, that initial impression immediately sets this alternative investment firm apart from many of its China-focused peers, even those PERE has visited here in Hong Kong. Perhaps surprisingly, CITIC does not manage just Chinese money. In fact, a significant proportion of its equity has been committed by international institutions – American, Middle Eastern, Japanese and European. Nevertheless, this firm is conscious of impressing a Chinese environment onto its visitors, many of which come from overseas.

Examining its ownership structure, it is not difficult to gather a sense of national prowess here either. The alternative investment management and advisory company, founded in 2002, is owned 55 percent by parts of the CITIC Group, China’s largest conglomerate, and 40 percent by China’s sovereign wealth fund, China Investment Corporation. The remaining 5 percent is owned by its management, led by chairman Zhenming Chang and chief executive officer Yichen Zhang.

CITIC Capital has approximately $3.5 billion of capital under management across four core business lines, namely private equity, structured investment and finance, asset management and real estate, the latter of which accounts for roughly $600 million today. Overseeing that portion is senior managing director Stanley Ching, who is responsible for leading all of the firm’s real estate efforts.

A critical year

A diminutive man, Ching nonetheless has a resoundingly deep, purpose-filled voice that projects well across CITIC Capital’s large, polished boardroom table. He has a tightly packed day, so he can spare just one hour to relay the direction of his platform before he must rush off for his next appointment. It’s not surprising then that a minute’s banter about the significance of this year’s Year of the Golden Rabbit, which occurs only once every 60 years – “Anything associated with gold must be good, right?” he quips – is quickly replaced by talk of the firm’s “critical year” ahead.

“It’s a critical year for us in terms of working out what opportunities exist and how we can leverage these opportunities,” Ching says. CITIC Capital started investing in real estate in 2005 and has to-date been very much focused on residential properties. However, with rapid policy changes by China’s government attempting to stem housing bubbles while concurrently steering its economy towards greater domestic consumption, Ching and his team are rapidly evolving as well – towards retail real estate.

Indeed, CITIC is evolving so rapidly that 2011 will be the year the firm introduces its first China retail fund, the CITIC Capital China Retail Investment Fund (working title), which was being readied for launch at the time of this interview in mid-February. The firm aims to attract up to $600 million in capital commitments for the seven-year, closed-ended opportunity fund, from which it expects to generate 18 percent IRRs and a multiple of 2x equity. “It is challenging, but I think the beauty of this country right now is that it is very big and most of its cities are at different stages of development,” Ching says, adding that he thinks the fund could acquire six or seven retail assets outright.
CITIC’s new retail strategy would be a significant departure from the firm’s residential-heavy past. Its second fund – CITIC Capital Vanke China Property Development Fund, which is jointly managed with residential developer Vanke Group – closed on $150 million in equity in 2006 and invested in 10 residential projects in eight Chinese cities, including Tianjin, Dalian and Suzhou.

“We’re still hearing people talk about second tier city residential, but we’re out of there already,” Ching says. “Now that the government is shifting from export-orientated growth to domestic consumption, we’ll be in the right sector. These demographic changes will help retail.”

Indeed, retail real estate is expected to receive favourable treatment from the government in terms of land prices, tax breaks and operations. Of course, Ching isn’t the first PERE interviewee to expressly recommend swimming with China’s policy changes to get ahead in this game. Goodwin Gaw, founder of CITIC rival Gaw Capital Partners, made similar comments at the tail-end of last year.

Still, Ching, like Gaw, believes his firm is ahead of the pack when it comes to chasing opportunistic returns in China. “The trick is you have to be ready, have your own team ready,” he says. “Otherwise, you’ll see the opportunity but won’t be able to take it.”

Sustain and deliver

Despite its rapid strategic shift to reflect state policy changes, CITIC historically has been somewhat reliant on identifying its deal pipeline quickly. For example, CITIC Capital China Real Estate Investment Fund III, which closed on $400 million shortly after the global financial crisis hit at the end of 2008, had identified its pipeline of deals within months.

Today, the vehicle is more than two-thirds invested, meaning CITIC has passed the necessary hurdle to begin fundraising on its fourth fund. “2009 was quite a difficult time until about May, when the market suddenly turned around,” Ching recalls, noting that Fund III should be fully invested by the summer.

Although there has been a somewhat frantic push by international private equity real estate firms into China over the past few years, Ching believes many of the country’s investment markets have matured and, as such, a steadier, more sustainable approach is warranted, particularly as those much-coveted IRRs of 20 percent or more are becoming increasingly less probable. “A lot of people are seeing the same opportunities now,” he says. “[International investors] need to get used to a more reasonable return from China. A few years ago, most deals were driven by IRRs, but now we are looking more at investment multiples. Why? Because we are looking at opportunities that also will be there eight to 10 years down the road.”

Again, Ching shares a similar analysis to his peers. Rong Ren, chief executive officer at Harvest Capital Partners – another Hong Kong-based real estate investment management firm to have switched to retail acquisitions lately – says: “I agree with Stanley that the so-called opportunistic returns approach will need to be adjusted to be more realistic.” Pointing to China’s increasing domestic liquidity levels as another reason, he adds: “This mass liquidity will create pressure on return requirements, as it cannot be channeled out of the country so easily.”
While Ching does not see IRRs of 12 percent or 13 percent as acceptable for investors right now, he does believe that they might be in three or four years time. But what does that do for a business model originally built on opportunistic returns? He says it means more execution and operational efficiency is needed.

CITIC Capital’s real estate team is 26 professionals strong at the fund management level, although it is substantially larger at the project level. This is about the right number to service a $600 million fund on top of its legacy portfolio, Ching says, adding that retail investments are particularly labour intensive. In fact, one shopping centre recently acquired by the firm has more than 40 staff focused on the asset and it has not even opened yet. “It’s not about how much we can raise, but what is the right size,” he contends. “Retail investments depend on the right operational team.”

Relieving the pressure

As China transitions itself into a market where its maturity begins to chip away at historically high returns, Ching highlights the need to remove needless pressures, and one area where that can be achieved is through the fee structure. Without divulging exact numbers, he says CITIC’s fee structure is significantly below the typical two and 20 asked for by managers elsewhere. “Of course, lower fees can hurt the manager,” he admits. “On the other hand, it might release some investment pressure. If we get two and 20 and don’t do anything for three years, we could end up rushing because the investment period is coming to an end. You’ve already charged 6 percent and then you make a risky investment.”

While lower fees have been a consistent feature of CITIC’s investment vehicles, co-investments by LPs have been somewhat absent. Ching thinks that will change with its fourth fund. “We’re in a different environment now, an environment where investors are getting more sophisticated,” he says, adding that he recalls only being asked for co-investment rights by an LP once before. “Our LPs know the market better now, so I think we could end up with some LP co-investments this time.”

In addition, Ching noted that some of the longer-term investors are looking at a China as a country where they want a presence for the next 20 years or more. “A fund is step one,” he says. “Co-investment is step two, and the third step is doing something themselves.”

So, is Ching worried then that this could mean fewer investors in future? “That’s not a concern for us,” he says. “As long as the market is still growing, more institutional investors will come and that improves its liquidity.”

Looking ahead

Meanwhile, some firms, in response to the more challenging investment prospects for international capital in China, have begun looking to other markets in the region. That includes CITIC Capital Partners, the firm’s private equity arm, which last month closed on $220 million for its second Japan buyout fund, CITIC Capital Japan Partners II. So does that mean Ching also would consider investing internationally, like the firm’s other business lines are doing?

“It’ll be China for the next few years,” Ching replies. “Of course, we will keep our eyes open to what is happening in Japan or Southeast Asia. Things can change and we have to be prepared, but right now we are not seeking foreign investment opportunities.”

Indeed, Ching’s team is trying to position itself as having a sustainable strategy while maintaining the capability to respond to market shifts quickly – a challenge to be sure. But with less pressure to invest stemming from lower fee structures and modest fund sizes, CITIC‘s real estate head seems unperturbed. Such stoicism, you could argue, is very Chinese; then again, so is the firm.

For now, CITIC Capital’s real estate endeavours remain as Sino-centric as its décor. And with its fourth fund poised for marketing, don’t expect that position to change any time soon.

Ching on funds:

CITIC Capital’s real estate head outlines the firm’s four funds and adds his thoughts on them

1. CITIC Capital China Retail Investment Fund (working title)
Year: TBD

Fundraising target: $600 million

Strategy: Retail. CITIC aims to acquire six or seven retail centres across China, taking full ownership positions in each. However, it is possible at this stage that the firm could work with China Vanke again, in which case ownership would be shared.

Ching says: “We have an aggressive schedule [for this fund].”

2. CITIC Capital China Real Estate Investment Fund III
Year: 2008

Amount closed: $400 million

Strategy: Residential/commercial. This fund was the first to be managed solely by CITIC Capital and had a pipeline of 12 acquisitions ranging from development to completed properties to entity-level investments.

Ching says: “Today, the fund is 70 percent invested and should be fully invested by the summer.”

3. CITIC Capital Vanke Property Development Fund
Year: 2006

Amount closed: $150 million

Strategy: Residential. CITIC teamed up with China’s largest residential developer, China Vanke, raising $150 million from a set of international institutional investors, including some from the US and Japan. Fully invested in 10 schemes across eight Chinese cities, the fund today has exited four of the projects and returned all of its investors’ capital.

Ching says: “At the time of raising the fund, our IRR target was 15 percent, but we should outperform that projection by a big margin, probably in the ballpark of 20 percent.”

4. CITIC Capital China Property Fund
Year: 2005

Amount closed: $86 million

Strategy: Residential/commercial. CITIC located a distressed situation in Shanghai, where a company with debts to the government needed to liquidate a 30,000-square-metre mixed-use property to help it meet its obligations. CITIC raised $86 million in equity from a small pool of investors and, with leverage, acquired the asset. It exited the asset within two years, returning IRRs of 30 percent and 1.48x equity.

Ching says: “The building itself was in perfect shape and was almost fully leased. I suppose this fund was more of a club deal.”
CITIC Capital
Hong Kong
Other offices:
Shanghai, Beijing, Tokyo, New York
170 (26 in real estate)
Assets under management:
$3.5 billion ($600 million in real estate)
Other business lines:
private equity, structured investments and finance
and asset management