International property funds have seemed to launch their first wave of investments in China, particularly in Shanghai, in recent weeks. 

According to Stanley Chan, president of Shanghai-headquartered property investment bank Stanley & Co, a US-based property fund invested US$50 million to purchase a serviced apartment in Shanghai last month.  

In the same month, an Australian institutional property investor poured US$100 million to buy a 30,000 square-meter office building.

He refused to reveal names of the property investors, saying their deals had not yet been finalized.

With previous investments foreign property funds have purchased real estate worth US$300 million in Shanghai.

The investments include those made by Chan, whose company helps operate China businesses of three European and US property funds, including that of Lehman Brothers.

"Investments from foreign property funds will reach US$2 billion in the coming two or three years," said Chan during an exclusive interview with China Business Weekly.

Internationally, there are various forms of property investment funds, including real estate investment trusts (REITs), pension funds and insurance funds.

David Watt, director of corporate investment at Hong Kong-based property consultant DTZ Debenham Tie Leung, told China Business Weekly that in 2005, more opportunity property funds -- which are even more ready to make high-risk investments than average institutional funds -- are expected to pour their money in Beijing or Shanghai.

A global survey on property fund managers released on DTZ recently indicated that many respondents of the survey identify China as a desirable destination over the medium- and long-term.

In Beijing, Singapore-based CapitaLand last week announced its purchase of two shopping centers with an investment of nearly 1.7 billion yuan (US$205.31 million) after it poured US$120 million in Shenzhen to buy local retail properties.

The retail properties in Beijing and Shenzhen will be combined to a retail property fund planned by CapitaLand, which vows to become China's No 1 retail property fund operator.

Liu Shichun, president of Beijing-based Financial Street Holding Co Ltd, said his company is in final negotiations with a US fund company to sell a development.

Financial Street Holding is the sole developer of Beijing's downtown business hub Financial Street.

Capital thirst

The escalating interests of foreign property funds in the Chinese market come as China's real estate market is looking for new capital sources.

The People's Bank of China, the nation's central bank, released tighter mortgage regulations in June 2003. Purchasers of unfinished homes cannot qualify for a mortgage. Commercial banks were permitted to lend money only to real estate developers with good credit, and only when they provided at least 30 percent of the capital needed for the projects.

The lending policy was strengthened again and again with the macroeconomic adjustment policies launched last April.

In September 1, 2004, a strict land policy increased developers' capital pressure. The policy required that all land for commercial use must be transferred through auction or public tender, and all land transference fees must be paid within 60 days. Previously, the money could be paid by developers in installments.

Chinese developers have long relied on bank loans as 70 percent of their development capital. But now developers find they have to have 40 percent or even 50 percent of the total money needed for a development if they want to launch it.

With dwindling sources of capital, domestic real estate developers have closely eyed Hong Kong and foreign funds.

On the other hand, international fund managers are shifting their eyes from European and the North American markets where property prices have been too high with low interest policies of US dollars in the past years.

They are investing more in mature Asian markets, particularly in Japan, South Korea and Singapore, but China's attraction is growing due to its fast economic growth, Watt said.

Chan said another attraction of the Chinese property market is the prospect of the renminbi's appreciation.

Investing in China's property at the current value of the renminbi means property funds can buy cheaper properties. They can obtain both rental revenues and future returns of selling the properties at higher prices, Chan said.

Challenge remains

Despite domestic developers' capital thirst and international property funds' growing interests in the Chinese market, most property funds remain highly cautious in pouring their money into China.

According to Chan, the scale of already invested projects by European and US funds are small with individual investment often less than US$20 million.

The sum has been quite small compared with tens of billions of US dollar assets of international leading property funds.

Watt said most fund managers surveyed by DTZ worry about the high risks of investing in the Chinese market.

"China's land-use right is 70 years, so people just ask what will happen after 60 or 70 years," Watt said.

The transparency problem also puzzles international property fund managers. Richard Johnson, head of corporate financing and investment Asia, Jones Lang LaSalle, said much of land and property transaction information is still inaccessible to property investors, even in big municipalities like Shanghai.

China's laws are impeding foreign property funds to come, said Chan.

The strict foreign currency regulation in China increases the difficulty to float the money freely across borders. The situation makes property fund managers worry about the safety and liquidity of their capital, Chan said.

Also, China lacks industrial fund laws, which make international property funds unable to register themselves as financial institutions. They can only operate as real estate development companies and cannot raise money locally, Chan said.

Ray Huang, director of the investment department at CB Richard Ellis' Beijing office, said China's tax system is discouraging property funds to buy developments for rental incomes.

If they buy and rent properties, property funds have to pay property transaction tax, retail tax, income tax and property leasing tax while property owners need to only pay the property transaction tax. The system encourages people to sell properties instead of buying them for rental income, Huang said.

Most international property funds do not develop buildings themselves. They mainly buy finished properties from developers to enjoy long-term rental revenue.

But Chinese real estate developers mainly need money to support the initial stage of their developments. In this period, they are the most thirsty for money, Liu said.

For some funds who would infuse their money into ongoing projects launched by capital-thirst developers, they often find their charge of return unacceptable by domestic developers.

"They charge more than 20 percent of returns. It seems that China's real estate developers still make huge profits but the reality is the sector can only enjoy a little more than an average profit," Liu said.

Solutions ahead?

In the current situation, the rational choice for international property funds are tentative moves in trial bases, Watt said.

He recommends property funds diversify their global investment portfolio by gradually increasing their investments in the Chinese mainland.

Watt suggests US and European fund managers follow their Asian counterparts who have adopted more flexible policies.

Johnson thinks the present development of property funds in China is quite normal.

"It took more than 20 years for REITs to become mature in the US market. Another 10 years had been spent for REITs to play adeptly in Japan and Australia. So a long period is also needed in China," Johnson said.

For Chinese developers, trying to develop high-quality buildings and hiring professional property management teams are their best strategies to attract property funds, he added.

While it is very difficult to revise China's laws and tax policies in the short term to smooth the entry of international property funds, Huang of CB Richard Ellis suggested foreign fund managers snatch a bigger Chinese pie by buying non-performing assets -- many of which are nearly finished developments -- from China's asset management firms.

To speed up the processing of non-performing assets of China's State-owned commercial banks, the Chinese Government has released a series of beneficial policies.

These policies can help international property funds enter the Chinese market with low costs, Huang said.

(Business Weekly January 11, 2005)