ASIA VIEW: Before it’s too late

Fears of a hard landing for China’s property sector have been growing for some years now. Over the last 12 months, however, those concerns have become amplified amid stagnant residential sales, falling housing prices and the near-collapse of a mid-sized Chinese real estate developer.

But far from running away, there is a body of argument to suggest that precisely now is the time for global private equity real estate firms to be looking at the country. There exist opportunities not only in distressed assets for opportunistic buyers but for credit firms who can provide financing to cash-strapped developers – but only while the window remains open.

A slew of measures are being implemented by the Chinese government to arrest the decline in property prices and reduce the onshore funding pressure on developers. Recently released property data suggests that some of these policies are gradually beginning to yield results, and unless the pace of reforms is intentionally halted, the opportunities available to global debt funds and distressed buyers will soon dwindle.

Forum Partners, the global property investment firm, is among foreign firms taking notice that time may run out. In an interview with Bloomberg in April, Gregory Wells, the Hong Kong-based managing director of the firm, said that the firm was planning to invest in structured debt deals in China via a new pan-Asia debt fund. He thought now was a great time and that the market had bottomed out. I would agree with his further point that what remains of 2015 would be a good time to invest, but that in 2016 there would be less of a requirement for foreign credit capital such as Forum’s.

The dynamics are such that traditional sources of funding in China, including bank lending, continue to be available only to select, large-scale developers. That is forcing some mid-sized groups to turn to offshore borrowers that are lending at higher borrowing rates. In comparison to the 6 percent to 7 percent bank lending rate, private equity firms can charge around 16 percent to 20 percent for mezzanine financing in China, according to estimates by CBRE.

The ongoing debacle stemming from Kaisa Group, the Shenzhen-based mid-sized developer that in April became the first Chinese developer to default on its offshore debt has at the same time widened the possibility of other distressed buys, thus presenting a duel dynamic. Private real estate firms can play in the debt-laden developer recap space. Indeed, a few months after the government froze some Kaisa’s development projects following missed interest payments on its dollar bonds, rumors surfaced that a takeover from a private equity firm could be on the cards.

Standard & Poor’s has also indicated in a recent note that defaults by other firms cannot be ruled out, given that profit margins of many property companies in China are declining.

However, given the number of deals having actually materialized in the country in the last one year, these opportunities haven’t spurred much interest. Distressed debt investment firms such as Lone Star Funds and Oaktree Capital Management appear to be silent spectators at the moment.

The inactivity of investment banks as lenders could be a result of many shutting down their commercial real estate debt divisions in the region following the global financial crisis. Other private equity firms are understandably unnerved, given the degree of partner risk and the risk of a potential default, especially following the Kaisa-default.

But if the opportunity is not seized now, there may not be any left after some time.
In early May, the central bank cut interest rates to 5.1 percent, the third rate cut since November last year. And, if reports in the Chinese media are to be believed, the China Securities Regulatory Commission is also reviewing the possibility of launching the first publicly traded onshore REIT in China. The domestic real estate investment trust called Penghua Qianhai Vanke REIT will be issued by China Vanke, one of the largest property developers in the country. If such a platform is eventually approved, it could soak up the existing appetite for offshore borrowing.

There are glimpses of recovery in the housing market too – a sector which is a major indicator of the country’s economic climate. At the time this issue went to press, some cities such as Shanghai and Beijing had reported a slight revision in housing prices.
It is true that for every report signaling a turnaround, there are others that continue to predict doomsday. Either way, private equity real estate firms need to wade through the negative headlines coming out of the country, recognize the opportunity and act now.