Foreign Participation Surges in China’s Property Development

March 29, 2011 Posted by China Briefing Reading Time: 4 minutes

Mar. 29 – China’s restrictive policies on its real estate market have made it difficult for property developers to borrow enough loans from banks and for property buyers to hoard houses for investment purposes, but more and more capital – including a large amount of foreign capital – is flowing into real estate development enterprises in the form of privately raised property funds.

Tightening policies lead to foreign PE funds for property development
China’s property development sector has been witnessing an influx of foreign investment since the second half of last year. During the first quarter last year, the actual foreign capital used for property development saw a sharp year-on-year decrease of 33.7 percent, while during the second and third quarters foreign investment in the area surged by 2.8 percent and 26 percent respectively, from a year earlier. A March 9 report on China Securities Journal estimated that the total amount of foreign capital in China’s real estate industry in 2010 exceeded RMB150 billion.

Foreign investors’ increasing interest in property development is a result of increasing demand for funds from domestic developers. Following the China Banking Regulatory Commission’s “Interim Measures on Fixed Asset Loan Management (2009 No.2)” that took effect in October 2009, developers who ask for a loan of over RMB5 million or for over 5 percent of the total amount of the project will need to find a trustee for loan management. However, the trustee system has hampered many developers’ investment plans and led to a shortage in their cash flow, since it only approves the loan to be used for the purpose developers claimed in their original loan application.

In reality, many developers will normally have several ongoing projects and shuffle the revenue from one mature project to pay for the mortgage of the projects in development. As a result, developers need to find new avenues for fund-raising, and foreign capital has become a major one of them. According to statistics released by the National Beaureu of Statistics, among the total RMB724.9 trillion-funds property developers raised last year, the use of foreign capital increased by 66 percent from a year earlier, while domestic loan issuance to the sector only grew by 10.3 percent.

China’s restrictions on house purchases also motivated speculators to seek new projects in China’s real estate market since they still see a large demand for houses from the county’s massive population. As speculators find it increasingly difficult to access the real estate market directly, they turned to invest in the equities of property development companies that are running short of cash. According to data provided by Wind Information, a Chinese financial database and information provider, between January and October of 2010, the number of privately-raised funds for property investment has increased from 2009’s two to ten, raising a total of US$1.9 billion – 3.4 times more than 2009’s amount.

Partnership with overseas funds
China’s property market has attracted extensive interest from sovereign wealth funds (SWFs), especially those in southeastern Asian countries including Singapore, the Philippines and Malaysia. China Securities Journal estimated in a recent report that there have been at least 10 domestic property developers that have cooperate with overseas SWFs. The Government of Singapore Investment Corporation (GSIC)’s equity subscription in several of China’s major property developers is a good example of such partnership. Yang Ning, vice president of Yangguang Co. Ltd., told China Securities Journal that playing the role of limited partners, the overseas SWFs do not only gain profit proportionate to their equity shares, but also share commercial management revenues with their Chinese partners, who function as general partners.

In addition to SWFs, other types of private equity funds are also ambitious about entering the Chinese property market. In 2010 alone, overseas PE funds including the U.S.-based Blackstone, Netherlands-based GTC Real Estate, and some foreign capital-based PE funds of the HSBC Bank have established partnerships with domestic property developers. Most of their interest is focused in the area of commercial real estate development.

As a major channel for foreign funds to enter the Chinese property market, foreign direct investment into the field in 2010 saw an impressive 40 percent year-on-year increase, reaching US$24 billion and contributing 22.7 percent to the total actual foreign capital that went to non-financial areas.

Foreign investors confident in the Chinese market, but government calls for caution
The high return on investment in the property market, coupled with strong expectations that the yuan will continue its appreciation, gives foreign investors every reason to be optimistic about market prospects and to consider establishing RMB-based property funds to be able to enter the Chinese market without having an actual project.

A report by DTZ, the leading global real estate adviser, recently predicted that over 80 percent of foreign funds will set up RMB-based funds in the future and most of the capital will flow into the property market.

The Chinese government, while happy that foreign capital can lead to long-term property development, is still concerned over the inflow of “hot money” through illegal avenues for short-term speculative investment. China’s Ministry of Commerce has called for a stricter review on foreign-invested property projects and strengthened supervision on real estate projects after mergers and acquisitions as well as equity subscriptions by foreign capitals.

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