NAREIT - Special Issue

Despite rent growth and capital value in China, is there considerable investor risk?

For years, China did not register on international investors’ radar. However, in recent years, there’s been a quantum shift in the level of interest in the country as many investors have been won over by the massive, unprecedented opportunity represented by this country with the world’s fastest growing gross domestic product. The momentum increased as China’s government has loosened its hold on the country’s economy. However, even though China offers great promise of growth, there are obstacles looming ahead.

“Just six to 12 months ago, many U.S. investors were skeptical about investing here. Now, U.S. REITs are developing an appetite for China,” says Peter Mitchell, CEO of Asian Public Real Estate Association (APREA).

In addition to the temptation of massive economic growth opportunities, investors are now more confident about the stability of the Chinese government. However, these factors are tempered by the challenges of investing there, according to Trevor Cooke, executive director of capital markets for the Property Council of Australia, which is working with APREA and the Chinese government to develop a REIT structure.

“Aside from a few companies, U.S. REITs have not been investing in China,” Cooke says. “The challenge is to discover what foreign investors can bring to the table. China has plenty of capital, so your company needs to bring an incentive. For example, industrial REIT ProLogis, Inc. (NYSE: PLD) brings plenty of expertise in building infrastructure for an established client base.”

Guy Jaquier, president for Europe and Asia for industrial REIT AMB Property Corporation (NYSE: AMB), says REITs began investing outside the United States approximately five years ago, following their customer base beyond American borders. “Our customers, such as Fed Ex and DHL, are global by definition,” says Jaquier. “However, when you follow the supply chain, it takes you to China.”

Jaquier says AMB is also attracted to China because of the country’s manufacturing growth. The existing infrastructure in China is underdeveloped, particularly in the case of modern Class A warehouses. “There is approximately 10 years of pent-up customer demand in China from a variety of different sources,” he says. “The central government is trying to promote growth.”

Morgan Parker, president of Taubman Asia for shopping mall REIT Taubman Centers (NYSE: TCO), says the growing local economy has sparked his company’s interest in China. “The growth in China’s retail sales has been 14 percent to 16 percent annually for the last five years and is expected to accelerate. The growth in rents and capital values are the biggest reasons to invest in China,” he says.

Potential for Chinese REITs

APREA and the Property Council of Australia (PCA) are working with the Chinese government to develop a REIT structure.

Trevor Cooke of PCA says that REIT legislation is in the draft stage, with a timeframe of approximately two years or longer before REIT legislation will be introduced. “The Chinese government is looking into the possibility of REITs in China, but this requires the development of a property act to provide a system for private ownership of land and the securitization to allow for profitability,” he says.

According to Peter Mitchell of APREA, some Chinese officials believe that REITs are not required for the property investment market to develop. However, Mitchell believes a change in attitude is on the way.

Jaquier says that some of the obstacles faced by real estate companies investing in China are similar to those faced in any country. For example, new players entering a market have less information than residents, which fosters a need to build local connections.

“China is a very difficult market that demands investors find an experienced local partner to work with,” Mitchell says. “The laws are very complex, and understanding them can be difficult without local help.”

Local partners can also smooth the way when cultural differences come into play. “One of the biggest challenges faced by investors is recognizing the importance of cultural differences,” Cooke says. “The British, Australians and Americans must have local partners because of language and cultural barriers, but it can take years to develop a relationship with a Chinese partner.”

Additionally, land rights can be a major obstacle to entering China. “Most land is privately owned, without a readily recognizable title,” Cooke says.

Jaquier says that land in China changes hands by public policy changes rather than through the market. At various times, the different levels of government dictate the public policy about land.

Despite the challenges that lie ahead, several REITs are moving forward with Chinese developments. For example, AMB’s capital allocation target for Asia in 2010 is 22 percent, up from 6 percent in 2006. AMB expects China to represent a large portion of the company’s capital deployment in the continent, perhaps rising to 10 percent of its global portfolio by 2010. “In terms of development projects, about 20 percent to 25 percent of these projects are in the China pipeline,” Jaquier says.

Additionally, ProLogis currently has a small percentage of their allocation in China, approximately $400 million in investments out of a $31 billion global portfolio.

“We expect to invest more in China in the coming years,” says Jeff Schwartz, CEO of ProLogis. “The challenges of building an infrastructure and building a global platform have required a big commitment of resources, but this will reap massive dividends down the road. China represents a massive, unprecedented
opportunity.”