Interest in Chinese real estate is considerable but accessing this immature market can be problematic. A solution is presented by Cohen & Steer's Scott Crowe and Derek Cheung
China is hot. The world's fourth-largest economy has emerged as a global economic force and adopted - in its own way - the tenets of capitalism. It is a member of the World Trade Organisation; it has (in part) cleaned up its banking system; and it has permitted its currency to float within a narrow band. Foreign banks have opened branches in China and, according to Bloomberg, there are now 106 billionaires (as measured in US dollars), up from 15 last year.
China's gradual move toward free market principles has been accompanied by large-scale industrialisation and urbanisation, with hundreds of millions of its citizens moving to the cities in search of greater opportunity. Over the past 50 years, the country's urban population has increased more than seven-fold, from 72m in 1952 to 540m in 2004. World Watch Institute reports that, if urbanisation continues at the rate of 1% annually, an estimated 900m Chinese will live in cities by 2020.
The massive urban influx into China's cities is spurring an extraordinary demand for housing. This, in turn, has attracted foreign investors who recognise that real estate is a pure investment play on China's economy, and that the residential sector will be the first major investment opportunity. But however great the demand and attractive the rewards, direct investment in Chinese real estate is not easy. Despite recent advances, China's markets are still developing and lack transparency.
Enter Hong Kong. China is increasingly using Hong Kong as its portal to global financial markets. Although dwarfed by the mainland - 2006 GDP was US$189bn (€133bn) compared with US$2.7trn for China(1) - Hong Kong is one of the most sophisticated of the world's great financial centres, along with New York and London. It has transparent financial systems and a legal, accounting and regulatory infrastructure modelled on the UK that has not changed since Hong Kong was returned to China 10 years ago.
Foreign institutional investors that want to take advantage of the diversification opportunities represented by Chinese real estate may find an acceptable level of comfort in the mainland China and Hong-Kong-based property companies that trade on the Hong Kong stock exchange. Real estate companies listed on Hong Kong's Hang Seng Property Index are subject to similar standards of disclosure, reporting, supervision and transparency as those listed on other major stock markets.
IPOs by mainland developers have received a warm welcome this year in Hong Kong. The largest so far was Country Garden Holdings Co, which raised HK$12.9bn (€1.2bn) in April; international institutions bought 80% of the offering, and as of 15 October, it had risen more than 70%. State-controlled Sino Ocean Land Holdings' September IPO raised HK$11.9bn and was 206 times oversubscribed. KWG Property Holding Ltd, which raised HK$4.5bn in June, reserved about HK$1.2bn of its IPO for corporate investors, which could include pension funds. There are now more than 30 mainland property companies trading in Hong Kong.
This flurry of IPOs by mainland developers was spurred by austerity measures designed to discourage speculative real estate investment. To that end, the central bank raised interest rates five times in 2007, and economists expect two more increases before the year-end. The government tightened controls on land use, imposed additional property taxes and promised strict enforcement of the land appreciation tax. This followed the austerity measures introduced in 2006 to suppress rising property prices by imposing a business tax on the proceeds of properties sold within five years. These moves have not, to date, had a discernible impact on China's heated economy.
Institutional investors may also find opportunities with Hong Kong-based publicly traded real estate companies that have extended their development activity onto the mainland. A short list would include Cheung Kong Holdings, Kerry Properties Ltd, Henderson Investment Ltd, and Chinese Estates Group. Several have tapped the Hong Kong stock market to fund residential development projects on the mainland, and institutional investors are paying attention; the California Public Employees Retirement System committed $500m to a real estate fund sponsored by a Hong Kong-based developer that will, in part, develop housing on the mainland.
Hong Kong-listed real estate investment trusts (REITs) are another property investment channel. By and large, REITs have not invested widely in mainland property, as government regulations prohibit them from engaging in development. But these passive property holders are expected to serve as the exit vehicles when mainland property developers complete and sell their holdings. Core property investors that prefer more stable, less risky real estate returns than those provided by development projects may find REITs to be an attractive alternative.
Investing in China through Hong Kong brings a certain amount of disclosure that is reassuring to foreign investors, and indeed, institutional investors have invested in Hong Kong-listed mainland companies without incident for years. These companies enjoy the prestige of being listed overseas, and China's government understands the benefits that Hong Kong confers.
But China country risks remain. China is an opaque, centrally controlled society, and the government may exercise its influence in unexpected ways. It will, and has, issued regulations, imposed taxes and modified laws to help control the booming real estate market. Investors are well advised to factor these uncertainties into their valuations.
Scott Crowe is the global research strategist for Cohen & Steers' global and international portfolios and Derek Cheung is head of Cohen & Steers' Asia-Pacific real estate securities research.
(1)The World Factbook
International investing will get easier for mainland Chinese
Earlier this year, the Chinese government announced that it would expand its Qualified Domestic Institutional Investor Program to allow mainland individual investors to invest overseas for the first time, albeit through Hong Kong. It is believed that the region's increasing significance was the reason why China Construction Bank, the country's second-largest bank, paid HK$3.6bn (€322m) for the Hong Kong Ritz Carlton; CCB is expected to use part of the building for its headquarters.