From Caijing Magazine

Financing specialists with restored faith in the viability of Real Estate Investment Trusts (REITs) in China hope never to cry wolf again.

Those declaring the demise of property investment instruments were discouraged during their early years, when the absence of a legal framework and a smattering of swindlers led to a loss of  faith.

Now, attitudes have improved and the wolf-criers are being kept at bay. REITs, securities for direct real estate investing that sell like stocks, are getting ready for China. 

A major reason is that REITs recently got support from the top when the State Council, China’s cabinet, mentioned the instruments for the first time as a worthy financial innovation.

The State Council’s support was included in a wide-scale directive called Financial 30, which among other things called for launching pilot REITs as part of a general initiative to broaden financial channels for real estate companies.

REITs are getting a green light despite the current economic downturn and the negative feelings toward real estate innovations following the recent subprime mortgage crisis in the United States.

A central bank source told Caijing these new instruments eventually would take the shape of trusts allowing REITs issuers to freely choose between the interbank market and stock exchange. Moreover, fund managers would not be limited to trust companies, and that the door would be open for participation by fund managers as well as securities firms.

Although some details of the REITs pilot have yet to be worked out, Caijing learned, its framework emphasizes strong supervision, with securities and banking regulators joining forces.

Several candidates for pilot projects have been floated as well. These include Tianjin TEDA International Holding and CITIC Securities. Property developers in the Tianjin Binhai District and Shanghai Pudong District are seeking to list REITs on the Shenzhen and Shanghai exchanges as well.

Plans drafted by CITIC Securities and Lianhua Trust are the main candidates for pilot projects backed by the central bank.

REITs can apply to properties or mortgages, often for shopping malls, office buildings, apartments, warehouses and hotels. Individual investors can be invited to play by buying REITs shares directly on a stock exchange or by investing in a mutual fund that specializes in real estate. An additional investor benefit is that many REITs are tied to dividend reinvestment plans.

Until now, and through the years of China’s modern real estate boom, REITs investments were not allowed on the mainland. But mainland developers raised money through REITs issued offshore and in Hong Kong.

In 2005, for example, Guangzhou Yuexiu REITs were listed on the Hong Kong exchange. The stock’s performance fell short of investor expectations.

That same year, Dalian Wanda Group and the Australian investment bank Macquarie Bank tried to issue HK$ 10 billion worth of REITs on the Hong Kong exchange. But rent levels did not meet the requirements of regulators with the Hong Kong Stock Exchanges and Clearing, which say REITs must allocate at least 90 percent of net profits to investors every year, and the project failed.

Nevertheless, Macquarie introduced Dalian Wanda to another instrument called cross-border Commercial Mortgage Backed Securities, which allowed the developer to raise US$ 145 million in September 2006.

REITs got another black eye in October 2007, when a scandal broke out involving a plaza developer in Beijing. The developer managed to qualify for REITs and attract Hong Kong investors by allegedly exaggerating rent receipts.

Looking forward, Lenovo Raycom Investment Management CEO Li Rurong said a solid cash flow is crucial for the success of any REITs project -- a point underscored by the subprime crisis. Otherwise, another expert said, REITs can be as dangerous as subprime instruments.

The new support for REITs is being closely watched by real estate companies in Beijing, Tianjin and Shanghai. They’re looking at REITs for the asset securitization of commercial properties.

For example, developer COFCO plans to repackage its properties including two in Beijing -- the Xidan shopping mall and Chaoyang’s Seattle project -- as well as the Tianjin World Trade Center. These projects are worth more than 10 billion yuan combined.

In recent years, several development firms tried but failed to win permission from the China Securities Regulatory Commission (CSRC) for listing asset-back securities. Plans hit a dead end for Shanghai’s Jinmao Plaza, which wanted to package five years’ worth of property rents to raise funds, as well as Poly Real Estate, North Star Industrial, Lianhua Trust, CITIC Securities and Lenovo’s Raycom.

Regulators have been cautious about REITs because they require several levels of legal transactions involving investors, issuers, trustees, custodians, property managers and property assessors. The process also involves complicated tax and mortgage details.

Proper legislation is considered essential for REITs to succeed. Wang Jun, a chief financial expert for the East Asia and Pacific region at the World Bank, said without the proper legislative foundation any REITs project could stumble with "more haste and less speed."

Ultimately, the government’s macroeconomic policies will determine the instruments’ future.

The central bank started studying related policies and possible pilot projects in January 2007 while searching for ways to protect financial stability amid a real estate boom. The central bank looked at REITs to play a benchmark role in real estate pricing, curb soaring prices and disperse market risks, Cheng Jiansheng, director of the central bank’s Real Estate Finance Department told Caijing.

CSRC set up a working team in April 2007 to study launching REITs. The next step came in March 2008, when the China Banking Regulatory Commission (CBRC) called on five trust companies to draft REITs proposals for investing in mature real estate projects that generate stable rental income.

The effort cooled after the subprime crisis and subsequent global financial crisis forced Chinese decision-makers to adopt a more cautious outlook toward real estate-linked financial products.  CBRC’s plan fizzled, and REITs policies were shelved.

The State Council’s financial directive brought REITs back to life. And the central bank, which says China’s legal framework favors REITs, is backing the initiative again.

Industry experts have warned about possible pitfalls. For example, some question whether REITs should be allowed to offer high yields. Others wonder whether China’s commercial property market is mature enough.

But apparently there’s no turning back. According to the central bank’s plan, the pilot project will be launched initially on the interbank market, allowing for legislators and supervisors to gain experience. After risk controls are in place, REITs would be offered to retail investors on the stock exchange.

1 yuan = 14 U.S. cents