China Property - Shanghai Could Become a Testing Point for REITs

§ Shanghai as a testing point for China REITs - As reported by 21st Century Economic Report, following the recently announced government target to establish Shanghai as an international financial center and international transportation center, Shanghai could likely become a testing point for REITs in China.

§ A batch of commercial properties selected - According to the report, a batch of property assets, which come mainly from a state-owned property company in Pudong, has been selected for the pilot testing. The batch includes commercial properties, high-tech incubation facilities, and some industrial properties, all with occupancies of over 80%. The process is now pending the approval from the regulatory authorities, and after that a proposal for consultation will be made.

§ Two potential formats - As reported, there will likely be two proposed types of format for REITs in China: 1) a debt-like instrument, which basically involves the securitization of rental income of the corresponding properties, and the ownership of those properties would remain in the hands of the property company; and 2) an equity-like instrument, where the ownership title will be transferred out of the vending property company.

§ State-owned assets first - According to the report, the first REIT vehicle for pilot testing will likely only contain assets that carry higher rental yields and that belong to state-owned property companies in Pudong. The successful establishment of a REIT market would also offer long-term benefits to the local government, as REITs could allow them to develop and retain rental properties in prime-areas, then enjoy the longer-term rental returns and capital appreciations of land in the prime-areas, rather than just selling those for development purposes.

Implications -
In our view, if a REIT market is successfully set up in Shanghai (and then for the country afterwards), it would offer the following benefits to the sector:
1) Potential increase in transactions in the commercial property market would offer more valuations benchmarks (e.g. cap rates and rentals);

2) Increased opportunities for NAV realizations for developers, though at the beginning, this might apply more to state-owned companies; and

3) The establishment of a REIT market in Shanghai would support the government's goal to turn Shanghai into an international financial center, which will be positive for the Shanghai economy and property market. In terms of potential beneficiaries, companies with meaningful investment properties, and/or exposure to Shanghai would likely benefit, including CR Land, Franshion, Hang Lung Props, Kerry, Shimao, SOHO and Yanlord.