SPECIAL REPORT: Greetings from Wuqing

A few years ago, there was little reason to visit nondescript Wuqing, a satellite district north of the city of Tianjin one hour’s drive from Beijing. However, things can change quickly in China.

In August 2008, the Beijing-Tianjin Intercity Railway was completed, connecting Wuqing to the Chinese administrative capital. Since then, the district’s attractiveness to investors has soared, as the multiple cranes dotted along its skyline can attest.

Like other parts of China that have received sudden infrastructure stimulus, real estate developers have piled into Wuqing, bent on capitalising on the spoils that come with the district’s anticipated urbanisation. The population is expected to more than double from roughly 500,000 today to more than one million in 10 years’ time, and the city’s annual GDP growth has reached 20 percent. As a result, this place has now been shoved to the forefront of investors’ minds, from private property speculators to some of China’s best developers.

Once they’ve bought their luxury goods at Florentia Village, people can chill out at our place
Rachel Tan, TAN-EU Capital

Domestic buyers, naturally, account for the majority of activity in markets like this, but international institutional dollars are seeping in too, sometimes via private equity real estate firms. In two examples, Hong Kong-based Gaw Capital Partners and TAN-EU Capital, which both invest on behalf of foreign investors, already have made bets on the district’s retail potential. Buoyed by local developments such as Wuqing’s first exhibition and convention centre and an amusement park, both of which are close to completion, the two firms made their first investments this year.
Just across the road from the train station, the Florentia Village stands proudly as a new Italian-themed luxury outlet mall. Opened to the public in June 2011, the mall boasts designer brands from the likes of Bulgari, Fendi, Gucci and Versace, and its early performance encouraged Gaw Capital in May to participate in a $200 million investment club seeded by the mall. One month earlier, TAN-EU completed its first investment, snapping up a large plot of land immediately next door.

PERE accompanied TAN-EU and its co-general partner, Hong Kong-listed developer SOCAM Development, on a visit to both the Village and their development site for a more granular understanding of their plans. Doing so offered a rare opportunity to get under the skin of a particular transaction by one of China’s private equity real estate firms and shine a light on the sort of real estate to which international institutional investors can get exposure in the world’s most populous country today.

Right place, right time

Together, TAN-EU and SOCAM have acquired 1.1 million square feet of development land next to Florentia Village hoping to supplement the outlet mall’s “discretionary” shopping experience with “necessity spend” retail, food and beverage options and other entertainment.

“Once they’ve bought their luxury goods at Florentia Village, people can chill out at our place,” says Rachel Tan, chief executive officer of TAN-EU, as she highlights that there is just one “proper” restaurant among the 165-units of the Village. “We’re also going to meet their basic consumer needs, capturing that necessity spend as well.”

Families visit here to do photo shoots. I’ve even come here and seen brides and grooms taking their wedding photos
Hong Kit, SOCAM Development

The investment is the first for SOTAN China Real Estate I, a ‘special situations’ club fund raised by TAN-EU in February, comprising $200 million from European institutional investors and $200 million from SOCAM’s balance sheet. The vehicle is subject to stricter investment controls than many generalist Asia opportunity funds. Fortunately for TAN-EU and SOCAM, the Wuqing investment fits perfectly within their criteria. Nonetheless, there undoubtedly is an element of ‘right-time, right place’ in finding it.

Four years ago, SOCAM’s chief executive officer, Philip Wong, was contacted by lawyers representing Florentia’s Italian developer, RDM Fingen, to invest in a retail-led development over two neighbouring sites. Initially, he was unconvinced the scheme would work, but the two groups remained in touch while RDM developed the first site into Florentia Village on its own. Then, when it transpired that RDM had insufficient capital to develop the second site, the SOTAN fund was well positioned to snap it up for RMB260 million (€33.5 million; $40.07 million) in a deal requiring RMB234 million of equity from the SOTAN club.

“At that time, they were using phase one – the outlet mall – to raise a fund,” explains Wong, “but they were in a period where the fund was not yet closed and they wouldn’t be able to support the second phase.” By that stage, however, RDM had proven it was indeed able to attract high-calibre European retailers to Florentia Village, prompting SOCAM and TAN-EU to feel more confident about prising from them the second site. Given RDM’s financial situation, a price reflecting a discount of 20 percent on comparable land prices at the time was agreed, Wong says.

As fate would have it, RDM raised its money just months later via a club structure called Silk Road Holdings. Investors included Gaw Capital Partners and RDM Fingen’s owners, the Italian Fratini family, among others. By then, however, the second plot was safely in the custody of the SOTAN club. Proud of the purchase, Tan notes that a recent comparable sale in the area reflects a valuation uplift of approximately 100 percent.

An informal agreement

Today, the site is being cleared for its first phase of development. Following the successful removal of some Wuqing locals that had broken through one of the site’s temporary walls and started to grow crops, the diggers should break ground imminently. “We might have to buy their vegetables,” quips Hong Kit, one of SOCAM’s senior managers responsible for project management, while on the site visit. More important at this stage, however, is a soil investigation. Currently underway, a positive outcome would instigate the site’s development.

The first phase of the project comprises 322,000 square feet of serviced apartments. Following that is 376,700 square feet of street-front retail, 218,500 square feet of mall retail and a 322,900-square-foot anchor store unit – intended for a large supermarket or department store. Most of the necessary permits are in place for these, and the first of the apartments will be marketed for pre-sale – a common method among developers in China for generating early cash flow – come October. The construction of the residential portion should complete by mid-2014 and the other parts periodically thereafter, with the entire site due to reach practical completion in the middle of 2015.

Visitors to the scheme should see little to differentiate it stylistically from Florentia Village, thanks to an informal agreement between the SOTAN and Silk Road clubs to ensure its fusion of Italian architecture is continuous. A major draw for visitors in itself, the paved walkways and arched units that distinguish the mall are expected to figure prominently. Florentia Village’s Roman Coliseum centrepiece, complete with classic Roman SPQR mosaic and eye-catching multi-jet water feature, will not be recreated, but SOTAN’s scheme will see its Venice-inspired canal system extended and culminate in a lagoon – a focal point in itself.

I gave her pressure to raise the capital before we agreed to commit
Philip Wong, SOCAM Development

Kit explains how impactful the Italian décor of Florentia Village has been. “Families visit here to do photo shoots. I’ve even come here and seen brides and grooms taking their wedding photos,” he tells PERE as we amble along one of the mall’s several streets, replete with mock-Florentine housing frontage. Indeed, Kit says the plan is for visitors to feel like they are shopping on a film set, and SOTAN’s scheme will keep faith with a similar approach.

Not that the layout is solely for the benefit of visitors. The scheme’s abundant Italian motif is meant to preserve a stronger sense of identity than can be brought by any individual tenant, Kit says. The Village is now nearly fully occupied but, should any retailers depart, their absence is meant to be inconspicuous.

Tan adds that themed development is a particular forte of SOCAM’s big brother Shui On Land, the developer behind Shanghai’s iconic Shanghai Xintiandi redevelopment, which comprises street retail styled as traditional Chinese housing. SOCAM expects to borrow from Shui On Land’s experience as it links its scheme to the Village.

The investment thesis

Tan says there is a waiting list of tenants for space at Florentia Village, and part of SOTAN’s investment thesis is to capture the overflow. She declined to divulge the partnership’s underwriting assumptions, but she notes that the Village recently achieved a rent of approximately RMB10 per square metre per day (China’s renting metric) and the sort of retailer SOTAN wants would likely pay around half that amount. However, she adds: “The rents achieved by Florentia Village serve as a good benchmark on which to base our underwriting.”

TAN-EU and SOCAM expect to capture the food, beverage, entertainment and necessity spend of Florentia Village consumers, many of whom would likely treat the scheme as supplementary to their visit to the mall or even the local theme parks. Wuqing will provide visitors, although Tan believes the majority will come via the Beijing-Tianjin Intercity Railway, with the majority of those from Tianjin.

The partners are forecasting a total cost for the scheme of approximately RMB670 million, including debt, the latter of which can be injected now that the development is starting. In China, land sales are done entirely with equity, while debt can be used for development – if you can get it. Tan notes that SOCAM’s banking relationships are long-standing and that should help the partnership to obtain financing. In addition, the real estate ‘fundamentals’ supporting its investment, coupled with the rental levels achieved at Florentia Village, should convince lenders to engage, she argues.

Unnatural bedfellows

Whenever international investment managers talk about doing business in China, the discussion invariably levitates towards the importance of a strong local partner. Indeed, TAN-EU chief executive Rachel Tan labours the importance of her firm’s partnership with SOCAM Development in the SOTAN China Real Estate I club vehicle, of which the two firms are joint general partners.

To Tan, SOTAN’s set-up is a competitive advantage, as the structure forces an alignment of interest unnatural to the typical nexus between fund manager and development partner. “Other GPs will rely on a local developer, but here the GP also is the developer,” she says.

Not that TAN-EU and SOCAM were natural bedfellows in the beginning. An accord on areas including fundraising, investment profiling, underwriting and exiting investments needed thrashing out, and both Tan and SOCAM chief executive Philip Wong admit there were some hairy moments.

In one example, SOCAM originally gave TAN-EU just three months to produce its half of the capital. “I gave her pressure to raise the capital before we agreed to commit,” says Wong, admitting now he was not familiar with the trials of institutional capital-raising. “The first deadline was three months, but thankfully they kept moving it,” injects Tan.

Three years ago, the chairman did suggest TAN-EU follow the Shui On Land and Winnington structure. Rachel insisted a structure like that can’t work, and she put forward the structure we are working with now
Philip Wong, SOCAM Development

Another area in need of ironing out was the structure of the vehicle. Wong tells how Vincent Lo, renowned Hong Kong entrepreneur and chairman of parent company Shui On Group, originally had advised him to replicate a similar model to the Trophy Property Development Fund, a China real estate development fund managed by Hong Kong fund manager Winnington Capital but seeded with assets from Shui On Land.

“Three years ago, the chairman did suggest TAN-EU follow the Shui On Land and Winnington structure,” Wong says. “At that time, I was just a real estate executive and didn’t have any experience in fund structuring. However, Rachel insisted a structure like that can’t work, and she put forward the structure we are working with now.”

Wong admits the experience of becoming a GP has been educational. SOCAM has built up assets under management of HK$22.2 billion (€2.32 billion; $2.86 billion) since listing on the Hong Kong Stock Exchange in 1997 and has enjoyed a flexible approach to investing along the way. However, for the SOTAN club, the firm needs to stick to the fund’s strict mandate, and Wong admits to having been frustrated by not being able to offer certain opportunities to the club that he regarded as attractive but that sat outside of the remit.

Still, Wong is pretty happy with the investment SOTAN has made so far. He jokes again, offering to buy TAN-EU’s stake in the Wuqing site from the club because he likes the deal so much. “I’d offer to buy out the fund today at the IRR they require,” he quips. Tan replies with a modicum of consternation: “Yes, but we want to make sure we optimise the return for the fund, don’t we?”

Continuing the thought, Tan muses: “Perhaps we could offer it to SOCAM at the end of the fund. Of course, we would need to have it valued given that SOCAM is a related party.”


Building a track record

While Tan describes the Wuqing investment as typical of what SOTAN does and expects the club to be populated with similar deals, Kenneth Gaw, co-founder of Gaw Capital Partners, believes the circumstances surrounding Florentia Village won’t be easy to replicate.

Gaw, however, does regard the investment as an ideal basis from which to build a track record, and he empathises with TAN-EU’s current business model as Gaw Capital itself operated with less discretion in its early day. “When we started, we didn’t operate blind-pool, discretionary funds either,” he says. “We started investing project by project or on a club basis. That’s how you build track record.” Today, Gaw Capital is widely respected as one of China’s preeminent private equity real estate firms and already is raising capital for its fourth fund after collecting more than $1.4 billion from institutional investors since its inception in 2005.

Gaw Capital committed to the Silk Road club almost one year after Florentia Village opened its doors to the public so, on a standalone basis, its ownership in the mall is somewhat stabilised already. However, like the SOTAN club, Gaw is convinced RDM has proven its mettle in the China market now and its investment in Silk Road is expected to lead to the development of similar malls across China. “We’re not just investing in this centre, but in the platform,” he points out.

Gaw, however, strikes a cautionary note when asked to talk about investing prospects for the city of Tianjin. “We don’t have any investments in Tianjin itself because we feel there’s been overdevelopment,” he says. “This project is on the outskirts and it’s different to a lot of Tianjin’s development. Here, we’re talking about destination shopping.”

“Frankly, just a few years ago, this place was considered to be in the middle of nowhere. Go there now, and you see excellent infrastructure. The Wuqing government has done a very good job developing this city from basically nothing to something that registers with people and about which a publication like PERE is writing, which is pretty amazing.”

The key for private equity real estate firms engaging with China’s fast-moving real estate markets is to strike investments in sectors resilient to its equally fast-moving government policy. Slower moving seems to be China’s evolution from an export-driven to a consumer-driven economy, which makes well-executed retail offerings an obvious destination for private equity real estate firms and their institutional dollars.

With that in mind, it is little wonder that TAN-EU’s SOTAN club invested in Wuqing. The challenge for Tan’s nascent firm, of course, is in populating the club with similar deals. Nonetheless, as TAN-EU’s next-door neighbour Gaw Capital says, track records need to start from somewhere.