Last month, CBRE Global Investors held an equity closing of $470 million for its second China-focused opportunity fund. Uncharacteristically, however, the Los Angeles-based firm had yet to invest a single dollar from the vehicle.
As explained by Richard van den Berg, the firm’s China head, and Shane Taylor, head of research and strategy for Asia -Pacific, CBRE Global is waiting for land prices to drop before calling down capital. “We are of the view that land prices in China are heading in one direction,” said Taylor. “[Land sale] volumes have come down, and what typically happens at this point in the cycle is that prices follow.”
According to research by CBRE and the China Index Research Institute, while the three-month moving average accommodation price per square meter for development land in urban China has risen to beyond RMB3,000 (€356; $482) this year, land sale volumes have plummeted by more than 57 percent between January and May. “In the next several quarters, we think that average land prices will continue to come down,” said Taylor. “And that likely marks a good entry for us.”
The fund, CBRE China Opportunity Fund II, is expected to provide its investors with access to developments across select Tier II cities in China and satellite cities near Tier I cities, with an emphasis on the more affluent eastern coast. In inland China, the onus is expected to be on the Sichuan province.
Developments, anchored by residential but allowing for significant convenience retail, are expressly designed to cater to the country’s growing middle class, which van den Berg expected to continue to expand despite the current deceleration of economic growth. “We believe in the underlying fundamentals of the middle class here,” he said, “and the mixed-use component is a reflection of the maturity of some of these markets.”
According to market sources, the fund could grow to as much as $900 million at final closing, after co-investment capital is taken into account. At up to $100 million of equity per investment, that could see CBRE Global amass a portfolio of nine investments, from which investors are expecting opportunistic returns.
To successfully attain such results, van den Berg said a number of variables are being considered beyond property market data like current yields and rents. Construction costs have remained steady over recent years – material costs such as steel have come down and offset labor costs, which have risen slightly ahead of inflation – and that is why the land price is so important.
“The land price typically is the most volatile of all the variables when it comes to development,” said Taylor. “It is very cyclical, and we must play that cyclicality.” van den Berg added: “
We don’t expect price wars, but we see an entry point coming that puts us in a more competitive position than those developers that acquired land at higher prices over the last two years and that gives us head room in case the market correction for end unit pricing continues.”
So what sort of discount can investors expect? Between nothing and 20 percent, with the better plots discounted less, according to van den Berg. “When you consider that for Tier II cities the land component makes up between 30 percent and 40 percent of the total development cost, a reduction of 20 percent on the land has a considerable positive effect,” he said. van den Berg is confident of achieving such discounts, adding that the location of sites tendered should improve as well. Local authorities, traditionally big sellers of land, currently are under tighter credit controls, meaning they are more willing to listen to offers for sites benefitting from infrastructure and proven demand. “Given that banks have imposed lending restrictions, they need to supplement their capital streams,” he said.
CBRE Global’s first China Opportunity Fund generated a gross return of 15.3 percent IRR from its nine developments. For a 2006 vintage fund, that was top quartile. For the successor fund, van den Berg noted that CBRE Global has a pipeline of up to $300 million of the equity just raised. If Fund II also is to be top quartile, much will depend on when it buys its land. Based on its research, it appears that time is imminent