Property experts from Baker Mckenzie’s Hong Kong office have proposed a new “G-REIT” investment tool to accompany mainland China’s ambitious Greater Bay Area (GBA) development initiative announced in February.

The top-tier law firm, which has participated in 10 major REIT IPOs in Hong Kong including Link, Champion and Yuexiu, has floated the investment tool as an additional means for GBA developers to attract and recycle capital, facilitate property supply, and provide an internationally recognized investment product for potential GBA retail investors.

From left: Milton Cheng, Jeremy Ong and Rico Chan

Milton Cheng, managing partner of the firm’s Hong Kong office, said the city’s capital markets experience and familiarity with REITS could be leveraged to help with the introduction of a G-REIT. “It is still in development stage in China itself, but we feel that the experience we have through the Hong Kong capital markets could be useful,” said Cheng.

“One of Hong Kong’s key roles within the GBA overall strategy is to be an international financial centre for orderly two-way, cross-boundary capital flow within the GBA,” he explained. “And we think that G-REITs are one meaningful and innovative way in which Hong Kong can fulfil that purpose.”

Rico Chan, head of Baker McKenzie‘s real estate group in Hong Kong, mainland China and Asia, told China Business Law Journal that step one in developing a G-REIT regime was about how to enliven the Hong Kong REIT market by different means, such as further opening up the Stock Connect, a collaboration between the Hong Kong, Shanghai and Shenzhen Stock Exchanges.

“There’s every reason to allow [Chinese investors] on the stock connect to be able to invest in the Hong Kong REIT,” said Chan. “So there’ll be more liquidity to support the Hong Kong REIT, [and this] will also give the residents in China, and in GBA in particular, a chance to know and understand this product.”

Step two, said Chan, who also leads the firm’s GBA initiative, is to create a REIT market in Shenzhen, and then the rest of China. He added that northbound (Hong Kong) investment into Chinese markets should be considered later on as well. “By doing this we are really building synergistically connectivity between the two markets.”

Jeremy Ong, a registered foreign lawyer in the firm’s Hong Kong office, pointed out that GBA-based developers who sold completed properties to G-REITs could continue to hold a certain degree (perhaps 20%-30%) of equity stake in G-REITs, and maintain operational control and branding over them. At the same time, G-REITs could also provide stable income for individual and institutional investors.

But Ong warned there would be challenges for G-REITs, especially when setting up a Hong Kong REIT with Chinese properties. Currently the assets injected into a REIT listed in Hong Kong must be offshored, while a large number of properties in China are onshore. Converting those properties to a foreign structure involves various approvals, taxes and other costs.

“One way to potentially reduce the friction cost is to explore the possibility of having a REIT with an onshore structure, so that offshoring the properties is not needed,” said Ong.

Another challenge is that selling property into a REIT would impose taxes on developers. Ong compared Hong Kong with Singapore, where tax breaks for S-REITs were introduced in 2015 to ensure a critical mass of S-REITs could stand on their own two feet.