Long Odds: China's bet on REITs draws skeptics

SHANGHAI/BEIJING — China’s plans to introduce real estate investment trusts (REITs) mark a crucial step to get private money to fund infrastructure such as toll roads and sewage systems, but authorities have their work cut out in creating a fully-fledged market.

In many countries REITs are used as a means for investors to own property via the stock market, enjoying the income from projects such as tenanted office blocks, while allowing developers to free up their balance sheets for new ventures.

The test, say experts, is whether Beijing is able to develop a more market-based means of financing future growth, which evolve only slowly but has the advantage of enlarging the pool of available capital and weaning off inefficient state players.

Half a dozen infrastructure experts, fund managers and lawyers told Reuters that setting up a REITs market in China could prove tricky, pointing to difficulties such as lack of sufficient returns, stakeholder reluctance as well as legal and tax issues.

Leo Zhang, an infrastructure expert in China and Chairman of Jumbo Consulting, an infrastructure-focused consultancy, expects it will take several years to develop the market.

“In the foreseeable future, for example, in the next 5 years or so, I don’t think the scale will be too large. Just a dozen products nationwide initially,” Zhang said.

Under the pilot unveiled last month by the National Development and Reform Commission (NDRC), the state planning agency, assets eligible for issuing REITs include data centers, toll highways and sewage systems among others. They must be operational for at least three years.

Though property is currently excluded for fear of stoking an asset bubble, the REITs could unlock funds for the next wave of job-creating infrastructure projects as China strives to revive economic growth amid its worst downturn in three decades.

$3 TRILLION MARKET?

A broader China REITs market that eventually covers property could reach over $3 trillion, Goldman Sachs estimates – surpassing the United States as the world’s largest.

Yet, experts say developing a market even a tenth of that size would first need authorities to address some fundamental issues.

The biggest snag is finding projects for China’s REITs that offer attractive returns since few, funded by cheap state loans, were designed with market-level returns in mind.

“Return in infrastructure is particularly low in China compared to in other markets,” Jumbo Consulting’s Zhang said.

Infrastructure funded through public-private partnerships (PPP), which have to date led China’s efforts to attract private investors, usually yield at best between 5% and 6%, compared to between 12 and 15% for those in Western economies, according to Zhang.

The low-returns problem has stung Beijing before, when it stumbled in its 2016 push for PPP Asset-Backed Securities (ABS) as some seemingly promising projects suffered losses for consecutive years.

NDRC and the China Securities Regulatory Commission (CSRC), who jointly issued the circular in April, did not respond to requests for comment.

TAX, LEGAL UNCERTAINTIES

Even for higher yielding projects, questions remain over whether the current shareholders – local authorities and others – would have enough incentive to sell into REITs given they are now enjoying the returns on their initial investments.

Taxation is another issue.

The risk is that under current rules the asset owners – still likely to be the government vehicles, with REIT-holders owning the right to the income stream – are liable for high income tax and various value-added taxes.

There have been calls for tax breaks to help kickstart the new market, but these can be complex to set up on a project before the REIT containing it is successfully listed.

“In my view some tax policies can be given at the operational level of REITs. But how to give them on the project offloading level, it may not be that easy,” said Deloitte partner Yu Na in Beijing.

Legal issues also loom large given China’s lack of a well-established legal framework.

“If the purpose is only to explore new funding sources to relieve local government investment vehicles’ debt burden temporarily, without optimizing the legal, execution and information disclosures on the fundamental assets, it could be too flawed to attract long-term investors,” said Kenny Wu, head of China Credit Research at Hong Kong-based asset manager BFAM Partners. (Reporting by Samuel Shen in Shanghai, Yawen Chen in Beijing and Clare Jim in Hong Kong; Editing by Jennifer Hughes & Shri Navaratam)