In the capital-intensive real estate industry, developers that need liquidity have relied heavily on funding backed by their properties. When their liquidity demand cannot be met with this conventional financing approach, domestic developers and investors set eyes on secondary financing backed by existing properties, especially commercial properties, believing this new approach would prove a blue ocean for funding. Starting with the history and substantial features of real estate financing, we look into the prospect of real estate securitization in China, with real estate investment trusts (REITs) as an example.
In view of the heavy tax burden in connection with transfers of real estate to and from developers, few developers that seek real estate financing would choose to transfer title to their real estate. Instead, many of them prefer equity financing, which involves indirect transfer of ownership, or usufruct, of real estate through assignment of the equity in subsidiaries (companies set up for running projects), while authentic assignment of equity is seldom seen because developers and investors usually reach consensus on repurchase. In practice, both the financing approach that combines “claim plus mortgage” and the approach that focuses on usufruct in real estate are implemented in non-open markets, and transactions resulting from both approaches give rise to a debtor-creditor relationship.
As access to bank facilities is restricted, trusts have taken their place as the major source of funding for the real estate industry. This trend entails an increasingly complex structure of trusts that enter into financing transactions, which evolve from the conventional “trust loan plus equity investment trust” model at the beginning, to usufruct investment fund trust at a later stage, and to usufruct property trusts launched most recently.
The current practice of transferring usufruct, represented by usufruct in trusts, marks the highest level of quasi-securitization permitted for asset managers. However, the authors believe that achieving true real estate securitization is the right direction in which China’s property financing should develop. In the section below, we look into the prospect of real estate securitization in China with domestic quasi-REITs as examples.
QUASI-REITS IN CHINA
REITs are investment funds that focus on investing in the real estate industry. Their funds, raised by issuing beneficiary certificates of shares or units in open markets, are put into the hands of professional investment managers who invest them in real estate or related projects to achieve capital appreciation and earn investment income that is distributed to investors as dividends.
No PRC law on REITs has to date been enacted, nor can any explicit provisions on REITs be found in the Company Law, Trust Law, Securities Law, Securities Investment Fund Law or any taxation laws or regulations in effect. Owing to this lack of pertinent legislation, and changing controls over real estate financing, quasi-REITs in China are created under various legal frameworks. Below is an overview of major REIT models.
(1) Trust plans. The trust plan was initially introduced for capitalizing the first department store opened by Groupe Auchan in Tianjin. It was the first quasi-REIT used for operating property in China. In 2003, Beijing International Trust & Investment (known as Beijing International Trust) and Groupe Auchan jointly launched the Capital Trust Plan for Tianjin No.1 Store of Groupe Auchan.
Capital pooled under the trust plan was used to acquire title to the Tianjin No.1 Store. In addition to long-term steady high returns from leasing the property, investors could expect potential income from property appreciation. However, this trust plan is not considered a true REIT, because instead of allowing trading on exchanges, as foreign REITs do, it limited transfer to chosen investors, although holders may seek mortgage loans from banks as an alternative way of getting liquidity.
(2) Specific asset management plans of securities companies. This model was adopted by the CITIC Qihang Specific Asset Management Plan, the first Chinese REIT. The plan was launched by CITIC Securities in May 2014, under which a non-public equity fund was created to hold equity in a project company that controlled two properties, known as Tianjin Jingzheng and Tianjin Shenzheng, and the specific asset management plan was used in turn to subscribe to shares in the non-public equity fund, which was under management of CITIC Goldstone Fund Management. However, since it was offered through private placement, the CITIC Qihang Specific Asset Management Plan was still different from foreign REITs, despite their similarities in deal structure.
(3) Public securities investment funds. The model was used by Penghua Qianhai Vanke REIT’s Closed-End Hybrid Securities Investment Fund, the first public REIT in mainland China. The fund, created by Penghua Fund Management in June 2015, acquired a 50% stake of its target by taking the opportunity presented by capital increase of the target and thus is entitled to 100% operating income and property management fees generated and received by the Qianhai Business Mansion project from 1 January 2015 to 24 July 2023. Penghua Qianhai Vanke REIT is not an equity-based REIT in the traditional sense, nor does it invest the absolute majority of its resources in the real estate sector. Despite this, it sets an example for future equity-based REITs by breaking the upper investment limits.
Since Penghua Qianhai Vanke’s REIT was issued, no innovative breakthrough has been made by quasi-REITs in the PRC under the existing legal framework, and no REITs in the true sense have been introduced to the Chinese market, given its existing tax system. But the authors believe the Chinese market will see true REITs very soon due to ongoing financial innovations.
Lu Guofei is a partner and Zhang Yingying is an associate at Boss & Young
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