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ASIA NEWS: Different route to the same place

With two exits imminent, private real estate and infrastructure firm InfraRed Capital Partners expects to have returned all of the $710 million of equity it raised in 2007 for its first China-focused fund, InfraRed NF China Real Estate Fund I. That fund focused predominantly on equity investments in development projects.

For its $500 million follow-up effort, however, InfraRed is considering how to tackle a much-changed Chinese real estate market, where cracks in the national economy are showing and financing conditions for developers are tougher. As a result, real estate head Stuart Jackson believes that up to half of the capital raised for its latest vehicle would be deployed into financing projects. Indeed, the firm is understood to have teed up a trio of mezzanine loan deals representing approximately $150 million in equity.

Chinese policy should support InfraRed’s strategy. According to property services firm Jones Lang LaSalle (JLL), bank lending in the Chinese economy, including the real estate sector, fell by RMB 1.3 trillion (€157 billion; $214 billion) last year. News service Bloomberg, meanwhile, reported that about $16.6 billion in debt issued to developers throughout the country is scheduled to mature next year, further piling on the pressure to locate alternative – and perhaps more costly – sources of funding.

Jackson noted how foreign firms have only seen the door for mezzanine financing opportunities open in the past two years. Following the global financial crisis, Chinese government stimulus had allowed developers to borrow at historically low interest rates, giving them little reason to tap foreign alternatives. That changed in subsequent years, as Beijing’s concerns about nonperforming loans translated into tighter policy. That, in turn, forced China’s banking and ‘shadow’ banking systems to become increasingly selective about which developers they financed.

Today, only the most solvent and often only the country’s largest developers still are able to borrow heavily from China’s banks. The country’s smaller developers, meanwhile, are forced to look wider afield for funding. That is where internationally capitalized private equity real estate firms have plotted the opportunity of the moment.

“The big names now get the majority of the banks’ lending quota,” one Chinese developer currently borrowing private equity capital told PERE. “For mid- to small-size developers, it’s less easy.”

Unsurprisingly, InfraRed is not alone in its ambition to operate in this financing black hole. Harvest Real Estate Investments (HREI), the Hong Kong-based private equity real estate joint venture between London property company Grosvenor and Beijing-based asset manager Harvest Fund Management, also has set the focus for its incoming opportunity fund on making investments with developers based at least partly on financing. For the firm, typical equity investments will come with debt-like downside protection measures, including loan like payments from the developer if a tenant is not secured upon development completion. Both HREI and InfraRed executives expect the opportunistic returns they previously enjoyed via equity heavy-strategies to be possible with these side-door approaches to funding developers.

HREI executive director George Agethen argued that the funding from his firm would be more suitable for developers, as it can be offered on a considerably longer-term basis than the typical two-year financing historically available from domestic banks or trusts. Indeed, ever since the global financial crisis, developers continually borrowed such debt just to have to refinance their existing loans shortly thereafter. Meanwhile, the
interest on this repeatedly rolled-over debt has ‘snowballed’.

The Chinese developer agreed. “A lot want to extend loans because rates are fluctuating,” he said. “Long-term capital is preferred, but domestic banks don’t provide that.”

In keeping with the strategies of InfraRed and HREI, JLL’s China director Greg Hyland predicted that financing would come in various forms, including different types of preferred equity and mezzanine financing. At times, the financing might even come stapled to other ‘control mechanisms’, he added.

In one example of the emergence of such financing, HREI’s first investment, the RMB1.7 billion acquisition of a Shanghai shopping center, was funded with RMB1 billion of equity and RMB700 million via a mezzanine-style loan. InfraRed’s strategy, meanwhile, sees the firm sharing in development profits, in addition to seeing the loan and accompanying interest repaid. PERE also has learned of another firm which, in return for buying a development, has secured a guarantee from the developer that it will pay rent for a period of time after completion if the building is not fully leased up.

“We can do things like this today because developers need capital to fix their balance sheets,” Agethen said. “When we first started in this industry in 2001, it was rare to have debt-like protections in equity investments.” One global financial crisis and some reactive policy from Beijing later, the avenues for private equity real estate firms like HREI to opportunistically access Chinese development seemingly are multiplying.