Vlinker: Meeting China’s demand for rental housing

Demographic and economic drivers, government support and evolving capital markets support investment in multifamily residential properties, says Vlinker’s Craig To.

This article is sponsored by Vlinker.

Every year, China’s large cities see an influx of new workers from smaller cities and towns all across the nation. Many of these people are new graduates looking to forge a career in one of China’s megacities, such as Shanghai, with 27 million people.

With the cost of housing so high, these people create huge demand for rental housing, particularly at the more affordable level. Craig To, head of capital raising at rental housing investment manager Vlinker, explains the factors underpinning the rental housing market and what makes assets and operators successful.

What is driving demand for rental residential in China?

Craig To

We have very strong macroeconomic and demographic pillars for sustainable growth. China has a very healthy growing urbanization rate; it has grown from around 46 percent in 2000 to around 60 percent today and is predicted to hit 70 percent by 2030. That means one billion people living in cities.

Much of that urbanization will come in large Tier One cities – Shanghai, Beijing, Shenzhen and Guangzhou – because that is where the best job opportunities are. These cities also have a high ‘floating population’ of people who have moved from other areas of China to seek those opportunities.

We estimate that one million new graduates arrive in Shanghai looking for work each year. While China’s overall GDP growth is slowing, Tier One cities will show stronger growth, which supports rents. 

One of the main reasons for such strong demand for rental housing is that sale prices for residential are so high. Prices are 70 times rents, compared with 30-40 times in New York or London. And because Chinese people are marrying later and are more focused on consumption than saving, they are more inclined to rent. These factors together mean substantial and long-term demand for rental housing in Tier One cities.

For the time being we are focused on Shanghai as it has such continued potential for rental housing due to the long-term demand. However, we will also consider Tier One cities where the rental housing markets sees similar drivers. 

There are various models for owning and operating rental residential in China. Which do you favor and why?

When Vlinker launched in 2011, we were one of the first rental housing operators in China, and we used the master lease model, which became very popular. Operators would take a master lease on an asset, convert it to residential use and then rent out individual units.

Operators preferred to be ‘asset light’ because of the cost of buying land zoned for residential and because the asset-light model allowed them to scale up rapidly. However, there were lots of new entrants to the market from 2015 onwards and they were all looking to scale up, which meant very low margins and a need for economies of scale.

Not all these operators were successful, and indeed, some went under. We were the biggest asset-light rental housing operator in Shanghai, with more than 40 projects. 

However, there were a number of changes to regulations and factors such as the emergence of China real estate investment trusts (C-REITs), which made it more attractive to operate an ‘asset heavy’ model and to own and operate the real estate. So, in 2020, we sold our master lease business and began to acquire and develop our own assets. We formed a $650 million joint venture with a leading international investor and now own and operate seven assets in Shanghai. 

Despite that change of direction, we still get a lot of requests from asset owners to convert their office buildings or retail malls into residential and to operate them for the owners. However, our primary focus is to be investors in the assets as well as operators.

What support has the government offered to the rental housing sector and to encourage this change to an ‘asset-heavy’ model?

The government has made it clear that it supports the provision of more affordable rental housing and has provided support for the sector. The big challenge for asset heavy investment in multifamily residential used to be the cost of land, however Shanghai now has a specific zoning type for rental housing, which is intended to enable the construction of affordable rental housing.

Plots cost only one-third to one-sixth of the residential equivalent for sale land price. Additionally, once a project qualifies as affordable rental housing, you can actually get very low financing costs – as low 3.5 percent per annum – for your construction, and there are also tax breaks on VAT.

Then in 2021, it was announced that rental housing could be the basis of a C-REIT, which gives a new exit avenue and also an opportunity for domestic investors to allocate capital to the sector. So, this is a boost to liquidity.

More recently, there has been an easing of the minimum distribution of C-REITs to 3.8 percent from 4.2 percent, which means better pricing for anyone listing a new C-REIT. We are engaging in very close discussions with the regulator on C-REITs and will continue to investigate further. 

What is more attractive: greenfield development or conversion opportunities?

We have a mix of greenfield and conversion projects. There are advantages for each and distinct challenges, too. There are factors in common, as well: renters are looking for places which are close to the city center or which are further out but close to public transport.

The main challenge of new development is that it takes time to acquire the land, gain planning permission and to go through construction. It could take as much as four years.

Conversions vary in difficulty. A hotel is the easiest to convert as it has the best fire safety infrastructure and the mix of private rooms and amenity space is there already. It is a bit more difficult for offices and far more for retail malls. However, we did undertake mall conversions for the asset-light business, so it can be done. 

Our latest asset was a brownfield site, the repurposing of a former factory dormitory for a Taiwanese industrial company which was relocating its operations. It had six separate buildings, enabling us to create one of the largest rental housing developments in Shanghai.  

What is your target market and what do they look for?

We are focused on providing affordable housing for young professionals, mainly in their early 20s, because we have witnessed there is a huge headspace for this segment because the current stock of supply simply could not catch up.

The young customers want a good value proposition, but they also want their own space, not just to share a flat and not have their own kitchen and bathroom space, which accounts for the most of current supply. 

As well as these private facilities, tenants like to have shared amenities because so many of them have come from all over China to Shanghai and want to be able to have social interaction. Having large buildings means you can add a lot more amenities.

We build gyms, basketball courts, badminton courts, coffee shops, libraries and coworking spaces. There are all sorts of amenities there for you, but you can still stay in your own space if you prefer.

In order to maximize value, you need to be very smart how you design these spaces in order to maximize space, storage and efficiency, as well as making them places people want to stay. That boosts value for money for both customers and investors. 

Do operators need to offer additional services to tenants?

We organize activities which help tenants to socialize with each other. In general, we are trying to promote a sense of belonging, because a lot of them are out of towners looking for a sense of community.

Looking after those needs is an important part of our success. It is a very granular business; the day-to-day operations of leasing and management are very important to get right. 

Our experience in the master lease business contributes to the success of that ongoing management. In the longer term it is about far more than just acquiring land and building assets, but about maintaining sustainable communities. 

Vlinker Pujiang Center Community
Vlinker Pujiang Center Community: Shanghai’s largest affordable rental community, the result of converting former factory dormitories

How did the Chinese rental residential sector perform during the pandemic?

There was something of a divergence in performance between high-end rental residential and the more affordable end of the market where we operate. After the Shanghai lockdown, which was lifted in June 2022, there was a considerable outflow of expats and high-net-worth individuals, which sent occupancy rates in high-end developments down to 50-70 percent.

However, in our part of the market we saw occupancy drop only a few percentage points to around 86 or 87 percent. Even throughout the pandemic we still saw people moving to Shanghai, because in difficult times people recognize you are more likely to find work in a bigger city and so that is where they head.

Nonetheless, since the end of the pandemic, we have seen leasing accelerate. Our latest asset in Shanghai, which has 3,116 rooms, only really started marketing after the lockdown, in June and July last year. By March this year we hit 92 percent occupancy and in February alone we rented out 800 rooms.