ASIA NEWS: The price of certainty

Harvest Real Estate Investments (HREI), the collaboration between China’s second-largest asset manager Harvest Fund Management and the fund arm of UK property company Grosvenor, is taking a slightly different tack in its first attempt to lure international institutional investors into the Chinese real estate market.

Last month, HREI, led by private equity real estate veteran Rong Ren, began fundraising for its maiden opportunistic real estate fund, for which it is seeking $500 million in equity. In a departure from traditional China-focused property funds, the six-year vehicle’s return profile does not exactly match the spoils offered by rival firms. Nonetheless, HREI thinks its redefined approach will be attractive.

The HREI China Total Return Fund is projecting an IRR of between 16 percent and 18 percent, prior to carried interest being paid. On a net basis, investors in the fund should expect an IRR of between 14 percent and 15 percent – a cosmetically lower pitch than the returns China property funds historically have offered to investors. Driven by China’s rapid economic expansion and ground-up development, 20 percent IRRs and higher generally have been the norm.

“China has changed,” said Ren, declining to discuss HREI’s capital-raising plans. “The risks and challenges are new, and I’m surprised so many GPs are still targeting aggressive underwriting assumptions.”

For Ren, China’s risks remain very real. He believes many developers are stuck because they want to benefit from general economic stimulus but feel curtailed by real estate-specific measures devised to prevent market bubbles. “So developers have a problem,” he said. “People are queuing for houses but, on the other hand, it is harder than ever for them to access capital.” 

Ren sees no property crash on China’s horizon, but he believes deleveraging will take place given the vast amount of poorly assigned debt from the country’s banks and trusts. Research firm Business Monitor International estimated that total social financing – a measure of aggregate liquidity that the financial system provides to the real economy – has expanded by almost 250 percent since China announced its 2008 stimulus package. Frivolous lending to real estate has played a major part in this financing explosion.

As a result, like many other China-focused real estate investment management platforms, HREI sees a funding gap for its private capital to bridge. However, in a departure from assuming only equity positions through joint ventures – the traditional way – the firm is seeking to take partial or full fixed-income positions in its deals to ensure it receives capital back. One transaction the firm presently is evaluating involves it injecting a put option into its commitment at an agreed price. In another, HREI has proposed making an equity commitment alongside a larger short-term loan.

HREI also has adopted a strategy focused on Tier I as well as the fashionably entitled ‘Tier I.5’ markets rather than the arguably more popular (among private equity firms) Tier II and Tier III markets. Ren is confident these markets offer better exiting certainty. Questioning the viability of investing outside of China’s top cities, he asked: “How many funds have monetized and delivered 20 percent to investors? Very few.”

For Ren, it is this certainty that institutional investors outside of China value most above other considerations. For that, however, those investors might need to sacrifice some of the heady returns the country once was expected to produce.