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Published by greg.r, 2020-03-27 12:03:11

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China Special 2020
April 2020 • perenews.com
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Contents
How to contact us
Senior Editor, Real Estate
Jonathan Brasse
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Editor
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Special Projects Editors
Helen Lewer
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I2nsight
Key trends From nancial reforms to mega-city clusters, the issues shaping Chinese real estate
A year in the market Major fundraises turned heads, while wider challenges left their mark on Chinese real estate 4
EDITOR’S LETTER Property investing is now a long game 6
Analysis
8
Moving into multifamily Chinese renters need professionally managed residential, says Funlive’s CEO, Keith Chan
Analyzing China outbound
Greenberg Traurig’s Joel Rothstein discusses changing patterns in outbound property investment 11
Seeking value in size and complexity GoHigh Capital’s Josh Zhou on why large and complicated repositioning and refurbishment projects offer strong return prospects 16
Opportunities in maturing China
The growth of the consumption economy is positive for real estate, says Canada Pension Plan Investment Board’s Jimmy Phua 19
Louise Fordham
[email protected], +44 20 7566 5440
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Kyle Campbell
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Mark Cooper, Jesse Koppi, Daniel Humphrey Rodriguez
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Chinese outbound investments continue to slide Real Capital Analytics’ David Green-Morgan examines the latest real estate investment data 20
Urban attraction Infrastructure development and hukou system changes are among the factors maintaining momentum in China’s cities 22
China’s digital future Yardi’s Bernie Devine on how technology will impact Chinese real estate 25
Choppy waters Hong Kong currently faces a number of issues, but in the longer term what matters is how it nds its place in China 26
Data room Closed-ended fundraising falls in 2019, while core-plus strategies dominate 28
China Special 2020
ISSN 1558–7177 • APRIL 2020
Cover story
12
Accelerating change
The forces assailing China’s real estate market aren’t undermining its long-term potential, but they are hastening structural changes
April 2020 •
China 1


Key trends From nancial reforms to mega-city clusters, Mark Cooper covers the issues shaping Chinese real estate
Enduring fundamentals Regardless of current events, the fundamental reasons for investing
in China real estate have not changed over the past decade. The nation’s great surge
of urbanization will continue for a decade and more, creating huge demand for new real estate.
Quickening trends
The upheaval created by the coronavirus outbreak, the US-China trade war and ongoing nancial reform is not creating new trends in China. However, it is accelerating burgeoning trends. The rise of logistics, the adoption of exible working, sustainability and wellness, increased opportunities for overseas investors and the importance of technology are all supported by current market circumstances. Megan Walters, global head of research at Allianz Real Estate, says: “For global real estate investors looking to diversify and capture global growth prospects from technology, it is essential to be invested in real estate on the China side of the tech divide.”
2
PERE • April 2020


City clusters
China has invested and continues to invest billions of dollars in infrastructure. Much of this is aimed at creating clusters of cities linked by high-speed rail and which bene t from each other’s comparative advantages. Three mega- city clusters, the Greater Bay Area, the Yangtze River Delta and Jing Jin Ji, will be a major focus for real estate investment. Smaller cities in these clusters may offer the best opportunities.
Financial reforms
For several years, China’s regulators have been attempting to make the economy more stable
by restricting non-bank nance and high-risk investments. This has hit some overleveraged rms, including real estate developers, and acted as a brake on overseas investment. However, the travails of domestic property owners have allowed more space for overseas capital. Further government reforms are opening up China’s nancial markets.
Trade war
The trade war between China and the US has hit exports and GDP growth and has accelerated manufacturing moving from China to South-East Asia. For real estate investors, the change frees up former industrial space which can be converted to higher and better use. However, David Kim, head of private funds at ARA Asset Management, says: “China is almost 20 percent of world GDP and far more integrated with the world economy than in 2003. It can’t simply be sidelined and all the manufacturing moved to Vietnam.”
Hong Kong hardship
The world’s most expensive real estate market is under re: the covid-19 outbreak followed six months of political unrest, and neither development has been good for real estate. Of ce rents have begun to slide, while retail is losing the gains made when Hong Kong became the rst choice for Chinese shoppers. The territory may have to embrace its Chinese future as part of the Greater Bay Area to maintain its status.
Containing the coronavirus
China is paying a heavy economic price in order to contain the covid-19 coronavirus outbreak, which emerged in Wuhan in late 2019. Real estate owners have introduced new hygiene practices, offered rental relief to tenants and in some cases closed malls as shoppers and workers have stayed at home. Stuart Crow, CEO, Asia- Paci c capital markets at broker JLL, said that during February the commercial market had come to “almost a complete halt.”
The real estate industry is pinning its hopes on these measures working, warmer weather killing off the virus and a sharp second-half recovery.
April 2020 • China 3


Insight
4
PERE • April 2020
Brook eld makes its biggest real estate purchase in China
Brook eld Asset Management bought a 13.9 billion yuan ($2.1 billion; €1.8 billion) mixed-use complex in Shanghai from Chinese developer Greenland, the rm’s biggest real estate investment in China. The investment manager bought three of ce towers and a lifestyle retail mall at Greenland Huangpu Centre (GHC), with a total area of 166.3 million square feet. Located in the South Bund in Shanghai, the property’s price was 10.6 billion yuan but came with additional construction costs of 3.3 billion yuan. PERE understands that the capital for the investment came from the Brook eld Strategic Real Estate Partners III, which raised $15 billion in early 2019.
CITIC announced plans for a $200m China senior housing fund
CITIC Capital, the China-focused private equity rm, announced plans to launch its rst senior housing fund. Stanley Ching, senior managing director and head of
real estate at CITIC Capital, told PERE the rm was targeting a $200 million equity raise for the fund, with commitments from a handful of investors. The fund will be invested in developed assets in rst and second tier Chinese cities. CITIC Capital declined to comment on target returns. However, according to one source familiar with the capital raise, the fund is targeting a 13-15 percent internal rate of return.
A year in the market Major fundraises turn heads,
but the coronavirus outbreak and ongoing trade war are leaving their mark on China’s real estate sector
CapitaLand pivots to discretionary fundraising with $750m debt fund
CapitaLand announced it had raised $556 million for the rst close of its debut real estate- focused debt fund. The rm set a $750 million target for CREDO I China. The blind-pool commingled fund also marked CapitaLand’s move into discretionary fundraising. It will undertake mezzanine lending to “high- quality borrowers for high-quality properties,” CapitaLand told PERE.
FEB 2019 MAR APR
Foreign investors cashed in on China’s limited real estate buying window
Real Capital Analytics reported a boom in overseas investors buying Chinese real estate in the rst quarter of 2019, with more than
$4 billion of cross-border deals, following a strong nal quarter in the previous year. This rapid surge in foreign investor interest in Chinese real estate was largely in response to the increasing buying opportunities arising from the country’s ongoing deleveraging program.
MAY JUN JUL AUG


Trade war damages China’s real estate market
China and Hong Kong were materially impacted by the US-China trade war, a report from real estate services rm Colliers International said. Trade tensions, coupled with other factors, have led to what Colliers described as a material slowdown in of ce leasing demand in Shanghai and Beijing in H1 2019. For 2019, Colliers expected net absorption in the Shanghai of ce market to drop 37 percent, average Grade A of ce rents to drop 4.7 percent and vacancy rates to rise
by over 8 percentage points to 22.1 percent, as multinational companies look to curtail expansion plans amid the escalations. A similar outlook was forecast for other key Chinese cities and more so for Hong Kong.
SEP OCT
CBRE GI, LOGOS form $800m Chinese logistics vehicle
In September PERE con rmed that Los Angeles-headquartered CBRE Global Investors partnered with the Sydney-based logistics developer LOGOS Property group to raise onshore yuan to invest in Chinese logistics. The renminbi- denominated vehicle raised $800 million in total commitments from three to four Chinese insurance companies and two offshore institutional investors in July. The partnership will invest in existing logistics assets in rst and second tier Chinese cities, and pursue logistics development projects, targeting a develop-to-hold, long- term investment strategy.
KaiLong Group raises $575m for second China fund
KaiLong Group held a nal close of KaiLong Greater China Real Estate Fund II on $575 million, surpassing its initial target of $500 million. The value-added vehicle is dedicated to industrial, of ce and retail real estate assets primarily in Hong Kong and mainland China. Allianz Real Estate anchored the fund and has committed more than 30 percent of the total capital. PERE understands from a source involved in the fundraising that there are 16 LPs in the fund.
Coronavirus hits China’s retail and hotels sectors rst
The rapid spread of the virus spawned worldwide travel restrictions in and out of the country. The outbreak had an immediate negative impact on the Chinese real estate market, with retail initially hit hardest due to the travel restrictions and temporary store closures. Performance in the hotel sector was also “signi cantly worsened by the outbreak of novel coronavirus,” according to a report by data provider STR. The report noted hotel occupancy in Mainland China declined 75 percent between January 14 and 26.
Insight
NOV DEC
JAN 2020 FEB
ADIA makes $750m follow-on bet in China logistics mandate
Abu Dhabi Investment Authority, through its subsidiary HIP China Logistics Investments, committed an additional $750 million to Prologis to invest in logistics in China. ADIA has committed a total of $3 billion in the logistics development mandate with Prologis in China, according to market sources. Per its annual report, ADIA’s real estate exposure in China has increased
by one-third in the past two years, based on the sovereign wealth fund’s conviction in structural growth drivers such as urbanization, a growing middle class and rising consumption levels in the market.
April 2020 • China 5


Insight
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Editor’s letter
Property investing is now a long game
Louise Fordham
[email protected]
In the light of the covid-19 outbreak, it seems almost cliché to call these uncertain times. The situation is fast moving. At the time of writing, the epicenter of the pandemic had shifted from China to Europe and many
countries had imposed travel restrictions, including border closures. As of March 17, World Health Organization gures put the global number of con rmed cases at 179,111. Although China accounted for 81,116 of these, it was the location of just 39 of the 11,525 newly con rmed cases.
It will be some time before we can gauge the full impact of the virus on China and its real estate market. However,
containment measures have impacted
footfall in shopping areas, lowered
occupancy rates in hotels and led to a
rise in homeworking. On a practical
level, travel restrictions triggered by the
virus have reportedly impeded deals. As
one commentator in the report says of
the commercial market: “Buyers can’t
make site visits so they can’t carry out due diligence and numerous sellers have put their sales on hold. There are a few sales going through, but a fraction of the usual volume.”
To compound matters, China was not on its strongest footing when covid-19 arrived, having already faced wider economic and political challenges, such as the Hong Kong protests and the trade dispute with the US.
Yet the long-term potential of Chinese real estate should not be overlooked. Investment in traditional and digital infrastructure, development of mega-city clusters, e orts to open up the region to foreign investment, and demand for last-mile logistics following a spike in online retail are just some of the reasons why investor appetite is likely to pick up again once market conditions improve.
Louise Fordham
“ It will be some time before we can gauge the full impact of the virus ”
6
PERE • April 2020


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Analysis
KEYNOTE INTERVIEW
Moving into multifamily
Chinese renters need professionally managed residential, says Funlive’s CEO, Keith Chan
China’s burgeoning multifamily resi- dential market has enormous potential, with strong government support and demand from millions of workers who have moved to the nation’s largest cit- ies. But there is no easy money to be made – the sector has already seen its rst major bankruptcy. In 2018, Hong Kong-listed China residential devel- oper China SCE launched Funlive, a new residential platform, in order to take a long-term approach to provid- ing homes for Chinese renters. Fun- live chief executive Keith Chan talks to PERE’s Mark Cooper about the scope for multifamily in China and the best strategies to exploit the opportunity.
QWhy is the rental residential market in China attractive?
Firstly, multifamily is an established asset class and sector globally, with proven resilient returns – it was the
SPONSOR
FUNLIVE
best-performing US real estate sec- tor during the global nancial crisis. It is large and mature in the US and Ja- pan, while developing elsewhere in the world.
Secondly, the demand drivers in China are very strong. China’s rst-tier and major second-tier cities have a mi- grant population of around 40 million who are looking for decent accommo- dation, but might not be able to a ord to buy. On the other hand, this demand of looking for quality apartments has not been met, with a general lack of institutionally managed rental apart- ments in the market.
Thirdly, the rental residential sector in China has not matured as much as the US and Japan markets, and is very frag- mented with no large dominant player.
Finally, there is strong demand from institutional investors, because they see the sector developing across the world and in many cases have already pro ted from their US multifamily investments.
Also, the sector is well supported by the Chinese government, which for the past few years has been emphasizing that homes are for living in rather than speculating on.
In many ways, multifamily resi- dential today is similar to the growing trend of logistics ve to 10 years ago – you could see global fundamental demand coming from the growth of e-commerce, while the market was un- dersupplied with modern, institution- ally managed logistics properties. At the same time, there were no incum- bent players that dominated the mar- ket, leaving a lot of growing space for quality operators to thrive.
For our parent company, Chi- na SCE, investing into multifamily
8
PERE • April 2020


Analysis
Apartment living: the urban migration trend is stoking investor interest in multifamily
City thinking
Funlive’s Keith Chan on the Chinese cities that offer the best opportunities for multifamily residential investors
Today, the bulk of the opportunities are in the top-tier cities, primarily Beijing and Shanghai, because of the number of migrants they attract from all over China. We are also looking at top second-tier cities like Hangzhou, because it is the home of Alibaba and therefore attracts a host of tech companies and migrant workers.
However, migration is not limited to the top-tier cities. Other cities
are attracting migrants. For some migrants and companies, Beijing and Shanghai are too expensive, so they look for alternatives. For example, a young graduate from a smaller city in the eastern Chinese province of Anhui might choose to move to the regional capital Hefei, rather than Shanghai. Often these smaller cities o er a good quality of living, which is attractive, and are often associated with particular business lines, like automotive or electronic appliances. So we expect to see at least four to six second-tier cities emerge as strong markets for multifamily. Nonetheless, as the sector is so new in China, investors are keen to focus on the rst-tier cities initially.
Just as an example, we manage the rental apartment portion of a China SCE mixed-use project in Quanzhou, a third-tier city in Fujian Province. Rents are relatively low compared with rst-tier cities, of course, but
we have 90 percent-plus occupancy and it works very well. It is right in the center of the city and is very popular with tenants. There is a lot of potential for rental apartments in second-tier cities but it will take time, especially for investors to get comfortable with the idea.
residential space is a long-term strate- gic move. It has been active in residen- tial-for-sale development since 1996, and the business has been extremely pro table due to the weight of urban- ization during that period. However, margins have also compressed over time and we expect urbanization to slow in the future after reaching around 70 per- cent, which means the for-sale residen- tial strategy may not have the growth in the future that it has had in the past. Building Funlive as a long-term plat- form for multifamily apartments, which we expect to become a key property market sector, is an important part of the evolution of the company.
QHow are the different models for rental residential investment in China
developing?
In China, when people notice there is an opportunity in a particular space, especially in the tech sector, they tend to move and speed up the development of their business very quickly. It is axi- omatic that a China business needs to build scale quickly, so it can dominate the sector and force out competitors. It is believed to be OK to make losses in the expansion phase because pro ts will come once you are dominant, but the winning players normally need to have long-term nancing capability with trustworthy management.
Most players in the China rental apartment sector have had a similar mentality, but have been generally con- strained by time and capital, as acquir- ing, developing and operating an asset takes time and requires an enormous amount of capital. To get around this, most of the rst movers in the China multifamily residential market expand- ed their businesses using a master lease model, where they secure a long lease, say 10-15 years, from a building owner and convert it to rental apartments for end-users.
Initially, this model was very prof- itable and scalable, but asset owners have seen the market develop and so
April 2020 •
China 9


Analysis
the cost of master-leasing properties has increased signi cantly since 2017. At the same time, operators have found the capex required to convert a build- ing to residential use to be substantial, so many focused on cutting cost and operating low-end products with less investment. With more competition coming into the market, margins for these operators have contracted signif- icantly – some have rented out apart- ments at a loss in order to keep build- ing scale, but this is not sustainable.
On the other hand, the usual as- set-heavy model, where investors and operators develop, operate and hold rental apartment assets, or acquire ex- isting assets for conversion, is much less adopted by the existing players due to the huge capital requirements and the need to build up reliable asset manage- ment capability. Funlive is a vertically integrated platform which manages as- sets for ventures invested by China SCE and institutional investors. We also do master-lease projects if pro table.
So far, we have a total portfolio of 20,000 units, but a lot of those are still in the development stage and around 3,200 are operational. Leasing has slowed a bit temporarily since Chinese New Year because of restrictions on taking on new customers due to the coronavirus outbreak, but leasing is ex- pected to resume to a normal or higher level afterwards. In addition, we expect to add 1,000 operational units in Q2 2020 and hit 10,000 within 12 months.
In terms of market segment, we con- sider the rental residential market in China as a pyramid, with a small slice at the top consisting of luxury serviced apartments, often targeting expats, and with the lowest slice being low-end co-living type apartments, often very small units, which cater to new gradu- ates. A lot of the master-lease operators target this latter type of space, because the conversion and t-out costs are lower and you can pack a lot of units in. There is nothing wrong with this, but the projects end up looking very simi- lar. We are targeting a higher grade: the
middle and mid-high space in the pyr- amid, for individuals and families seek- ing to rent – these are the existing or potential high spenders in the consumer space.
It is a di cult space to access because it is so new. There are e ectively no es- tablished multifamily assets in top-tier cities. Most of the existing assets avail- able are value-add, conversion opportu- nities from o ces, hotels or maybe re- tail which can be refurbished for rental apartment use. Prices have been high for this, although we expect the market to get softer and prices more realistic this year. We are now actively seeking these opportunities in key gateway cities.
“We are targeting returns upward
of 15 percent for rental apartment development investments”
The price of residential land is also often cited as a problem as pure resi- dential – for-sale land is competitive among developers. But we believe there are land parcels that can be acquired at good prices and from which investors can enjoy very good returns. We target land with commercial title, which can be used as multifamily rental opera- tions. Generally, we need the blessing of the government for this, but it is doable and – in Shanghai, for example – a commercial plot will be at discount to the price of a pure residential plot. China SCE also does quite a lot of inte- grated projects across China and some
of these will include a rental residential element alongside commercial and for- sale residential. So, the price allocated to the rental residential portion will not be the same as the other parts.
Human resources is a di cult area for operators because this sector is so new, and the residential market in Chi- na is so focused on developing for sale. Operators need to recruit very careful- ly and most of the time train personnel themselves in order to make sure they have the right skills in the business.
We are targeting returns upward of 15 percent for rental apartment develop- ment investments. The asset sizes can vary but tend to be a bit larger than is typical in the US, where you would see a sweet spot from 200 to 600 units. We would normally choose 400 to 1,000 unit projects, but would also go higher than this. For larger projects with more than 1,000 units, there is an economy of scale, but we also consider the over- all leasing schedule as it would take a longer time to become leased up and operationally stable, and to see its ef- fect on returns.
Our rst investment partnership has been with Gaw Capital Partners, with a total of $800 million of capital commit- ted when we signed the deal in 2018. We have also been in talks with large institutional investors that are interest- ed in the potential for this sector.
China SCE is in this business for the long term, and so happy to hold assets for the very long term. Having said that, as the multifamily residential business matures across China there could be opportunities to realize value, so we will look at options from time to time. We want to be able to demon- strate performance for investors, but we also see a huge amount of value that can be generated from creation of a portfolio of assets in major cities. ■
Q
What are the obstacles
facing a China multifamily investor?
Q
Can you talk through the
mechanics of multifamily investing – the investors, the typical lot sizes, hold period and target returns?
10 PERE • April 2020


Analysis
Analyzing China outbound
Guest comment by Joel Rothstein
The chair of Greenberg Traurig’s Asia-Paci c real estate practice on the changing patterns and volumes of Chinese outbound property investment
The buying spree of China out- bound real estate investors, led by insurance companies, real es- tate developers with global ambitions, asset management companies and state- owned enterprises with access to sub- stantial capital to deploy abroad, has come to a close. No one element caused the pullback from overseas investment. A series of factors came together to create an environment to discourage, prevent or limit China-based investors from pursuing cross-border investment.
In recent years, as part of an e ort to restrict capital out ows and keep debt risks under control, Chinese reg- ulators implemented measures designed to clamp down on speculative overseas real estate deals. Outbound investment activity also depends on the ability to raise capital to fund deals. Capital sources became scarcer as government policies limited access. For example, the government substantially limited the ability of certain companies to market wealth management and other nan- cial products in China, the proceeds of which were used to fund speculative real estate investments abroad. Government policy also made it di cult for Chinese companies to issue bonds or other debt in foreign currency for the purposes of pursuing new real estate ventures.
Some Chinese investors remain active overseas, notably those with ac- cess to o shore foreign currency to
deploy into deals. Among others, this includes family o ces and a liates of listed developers that have experience in cross-border real estate investment deals and are also able to put together club fund structures with other investors with access to foreign currency capital for transactions.
Another category of investor that continues to participate in the market is the deep-pocketed sovereign wealth fund. In the current phase, we are see- ing increasing interest in alternative real estate-related assets and business, rath- er than trophy buildings. This includes logistics facilities, student housing, sen- ior living and care facilities.
Ingredients for growth
China cross-border real estate invest- ment activity will remain subdued for theremainderof2020.Twofactorsneed to come together to create an environ- ment favorable to the return of Chinese capital to the global real estate markets: economics and government policies. During times of domestic market dislo- cation and turbulence, whether caused by health crises or trade wars, China tends to retrench and focus on home markets rather than look abroad. Once the Chinese economy stabilizes and is on a path to steady growth again, inves- tors start to aggressively look outward.
A favorable economic environment will also impact government policies.
Comfortable with the country’s level of foreign currency reserves and con dent that certain overextended companies that aggressively pursued cross-border real estate investment are no longer a systemic risk, China will loosen cap- ital out ow controls. It is di cult to predict when the necessary ingredients will be in place to spark and restart Chi- na’s outbound real estate ows – which might not be until well into 2022. But when the door is nally pushed more widely open, the next wave of Chinese cross-border real estate investors will be markedly di erent.
First, we will see Chinese institution- al investors, whether insurance compa- nies, asset management companies or other nancial institutions utilize in- vestment strategies that are more akin to other global cross-border institutional investors. This means greater focus on long-term, diversi ed (both geograph- ically and in asset type) institutional grade investments. A smaller group of China-based real estate developers will be more active overseas than previously. Those that localize and build teams in speci c countries targeted for expansion will most likely succeed. Finally, as Chi- na’s nancial services and private equity industry further grows and develops, the next phase of China outbound in- vestors will include fund sponsors and asset managers that pool Asia-sourced capital into deals. ■
April 2020 • China 11


Cover story
Accelerating change
The forces assailing China’s real estate market are not undermining its long-term potential, though they are hastening widespread structural changes, says Mark Cooper
In the past 24 months China real estate investors have been battling the e ects of nancial de-risking, which has restricted the availability of debt; the US-China trade war, which has lowered growth and hit
exports; and the coronavirus, which brought the economy almost to a halt in February.
Covid-19, which emerged in the city of Wuhan, has had the most dra- matic and immediate e ect on the real estate market. Transactions, already at a halt for the Chinese New Year holi- day at the end of January, have barely started up again. Shopping centers and hotels have been all but deserted by customers, while o ce workers all over
the country have been working from home. As of March 10, more than 80,000 people had been infected and over 3,000 people had died
from the virus.
There has been a range
of intensity in the coro- navirus e ects. Hubei, the province where it started, was locked down,
with people remaining in their homes and not traveling into or out of the re- gion. Elsewhere, restrictions on move- ment have varied according to the seri- ousness of the outbreak.
The impact on the Chinese econ- omy is forecast to be dramatic, but the extent of the damage is as yet un- known. Forecaster Oxford Economics has downgraded its prediction for Chi- na 2020 GDP growth to 4.8 percent, having predicted growth of 5.4 percent earlier this year. The 60 basis point downgrade is equivalent to around 600 billion yuan ($86 billion; €78 billion) of lost growth.
Tommy Wu, lead economist at Oxford Economics, says: “The return to economic normality in China has been very slow since the coronavirus outbreak. Economic activity came to a standstill in the rst half of Febru- ary due to the extended Chinese New Year holidays in most of the mainland’s provinces and cities, with transport re- strictions implemented at local levels. This was then followed by slow work resumption in subsequent weeks.”
However, Oxford Economics is still predicting a “robust” recovery in the second and third quarters as China gets back to work.
The retail and hospitality sectors have been hardest hit, with shopping center footfall down as much as 90 percent and centers in the worst-af- fected areas closed. Hotel occupancy has fallen to single gures: global chain
12 PERE •
April 2020


5 4 3 2 1
January
February
Cover story
Marriott temporarily closed a quarter of its Chinese hotels.
The logistics sector has been hit by the manufacturing slowdown, but ris- ing e-commerce – as people turn to on- line shopping and food delivery – has softened the blow. Anecdotal evidence suggests activity fell by 40-60 percent in most warehouses. Most o ce occu- piers have sta working from home, but most o ces have remained open outside of the quarantine zone.
David Kim, head of private funds at ARA Asset Management, which man- ages retail and o ce properties across China, says: “We have worked with tenants to give them rental respite for February and March and will continue to monitor the situation closely. The impacts will be felt for several months. Footfall is down 80-90 percent in malls but people are returning to work in o ces. The government has already warned that people should not take advantage of this situation and just as we are trying to soften the blow for our tenants, it makes sense for banks to be lenient wherever possible.”
Investment activity falters
The investment market has largely stalled, especially regarding new sales. A few major asset sales that were in the pipeline have been shelved for the time being, while some deals that were near completion have been sealed. For example, in February, Singaporean sov- ereign wealth fund GIC announced the acquisition of Beijing’s LG Twin Tow- ers from South Korean conglomerate LG Group for more than 8 billion yuan.
Stuart Crow, CEO, Asia-Paci c cap- ital markets at broker JLL, says: “The commercial market has come to almost a complete halt [during February]. Buyers can’t make site visits so they can’t carry out due diligence and numerous sellers have put their sales on hold. There are a few sales going through, but a fraction of the usual volume.”
China commercial real estate transactions plummeted more than 50% year on year ($bn)
The rst quarter of the year tends to be quiet in any case in China due to the Lunar New Year holiday, which took place this year from January 24- 30. Real Capital Analytics data show a year-on-year fall in transactions of 69 percent in January and 58 percent in February. Meanwhile, residential sales volumes have started to creep up but are still well behind the seasonal aver- age and many transactions are reported to be taking place online.
The lack of activity so far this year means there is little rental and pricing information available. However, rents were already coming under pressure in the o ce sector. For example, Cush- man & Wake eld reports Grade A o ces in Shanghai and Beijing having fallen 1 percent and 1.3 percent, re- spectively, over 2019 due to the slowing Chinese economy. Some o ce land- lords, especially state-owned enterpris- es, have o ered rental relief to tenants, but brokers expect the rental slowdown to continue, especially in markets with substantial supply and vacancy. For ex- ample, the second-tier o ce markets of Chongqing, Shenyang, Suzhou and Changsha all had vacancy rates above 30 percent at the end of 2019, accord- ing to Cushman & Wake eld data.
Opportunities on the horizon
While the US-China trade war has slowed the economy, the Chinese gov- ernment’s nancial de-risking program has been more important for real es- tate. In recent years regulators have cracked down on non-bank lending, which is deemed to present a risk to the economy. This has restricted nancing for both Chinese companies and prop- erty developers, which in turn led to substantial asset sales in 2019.
JLL’s Crow says: “There have been substantial sales from Chinese rms in any case and we assume these will ac- celerate once the market comes back. Whether there will be many forced sales depends on how long this lasts.
0 2019
2020 Note: 2020 totals re ect preliminary data
Source: Real Capital Analytics
“Fundraising for China has come to a standstill, but I believe it will come back”
DAVID KIM
ARA Asset Management
April 2020 • China 13


Cover story
At the moment it seems China will be back on track in a couple of months, but the longer the market is o ine, the more likely it is we’ll see distress.”
Real Capital Analytics data show overseas investment in China real es- tate rose 41 percent last year to $13.62 billion. Only one of the top 10 buyers of real estate in China last year was based in mainland China, while seven of the top 10 sellers were Chinese.
Henry Chin, head of Asia-Paci c and European research at CBRE, says: “Before the coronavirus there were a handful of Chinese developers with a more than 100 percent net-gearing-ra- tio with a signi cant amount of short- term 24-month loans. So, they were already exposed and are likely to face cash ow issues.”
The People’s Bank of China inject- ed 1.7 trillion yuan into the economy on February 3-4 and it has established a 300 billion yuan fund, which will be lent to selected companies at a dis- counted rate of no more than 3.15 per- cent.
A range of initiatives at both the na- tional and local level have been intro- duced to support business. However, funding will not get easier for devel- opers, says Chin. “The Chinese gov- ernment has reiterated that they will provide nancial support for SMEs but not for property companies.”
CBRE estimates Asian private real estate funds have $51 billion of dry powder and that around $10 billion of that is allocated to China. “The appe- tite is there, once the travel ban is re- laxed and people can get to and around China,” says Chin.
Kelvin Wong, principal and man- aging director at investment manager Pam eet, says: “There may be oppor- tunities to buy from domestic compa- nies and state-owned enterprises which put properties on the market in order to release cash.”
Additionally, Chinese authorities have announced a range of measures to
“A lot of shopping has moved to e-commerce, which is great news for logistics”
HENRY CHIN CBRE
open the nancial sector to foreign in- stitutions. Measures include permitting the formation of wholly owned subsid- iaries and expediting approvals.
The combination of these measures, ongoing attempts to reduce nancial instability, and domestic companies’ need to shore up their balance sheets suggests more opportunities for for- eign investment in China real estate in the future.
Logistics reaps the bene ts
Another current trend set to be boost- ed by the coronavirus outbreak is the growth of the logistics sector and its popularity with investors.
“Retail has taken a hit and a lot of shopping has moved to e-commerce, which is great news for logistics, espe- cially last-mile logistics,” says CBRE’s Chin. CBRE predicts that underuti- lized retail space could be used for last- mile logistics, either providing pick-up points for online shoppers or adapting space for smaller logistics facilities.
Most logistics investors in China are underwriting their investments with the expectation that consumption will drive the market, rather than ex- ports, so the attractiveness of the sector ought to be undiminished. In March, ARA Asset Management announced the completion of its acquisition of a majority stake in logistics real estate specialist LOGOS, which has a China portfolio of approximately 10 million square feet.
The halt to China manufacturing in February gave rise to more specula- tion that substantial amounts of man- ufacturing will be moved from China to South-East Asian locations, such as Vietnam, which has already bene ted from the US-China trade war.
Last year, exports from Vietnam to the US rose 35.6 percent as manufac- turers moved production to avoid US tari s. The trade war, however, did not start the trend. Chinese manufactur- ers were already moving lower-end
14 PERE • April 2020


Cover story
Developing trends
Opening up: China is liberalizing its nancial markets but not drowning real estate in cheap debt, which bodes well for foreign investors
Going the extra mile: There will be more demand for last-mile and city-fringe logistics as e-commerce continues to boom
Staying healthy: Wellness is set to be a key investment theme in China’s o ce sector
Moving up: Chinese manufacturing will continue to move overseas, opening up opportunities for a change to higher use
Better management: Property and asset management will become increasingly important for both landlords and tenants
Limbering up: Agile working will be more in demand
manufacturing to Vietnam in order to take advantage of low sta costs.
Chin says: “Most manufacturing in China will stay where it is, as 60 percent of it is to serve the domestic markets, but we will see some move to South-East Asia and also ‘re-shoring’ to South Korea and Taiwan, for manu- facturing where South-East Asia lacks the capabilities.”
ARA’s Kim adds: “China is almost 20 percent of world GDP and far more integrated with the world economy than in 2003. It can’t simply be side- lined and all the manufacturing moved to Vietnam.”
Workplace priorities shift
In the o ce sector, Chin predicts that “the coronavirus will boost a num- ber of long-term trends, such as agile working, decentralization and a land- lord focus on the wellness aspect of sustainability.”
With most of China being forced into agile working in February, occu- piers are expected to demand more exibility from their landlords, which could boost both domestic and inter- national co-working brands. The mar- ket for exible workspace in China has been highly competitive, with several failures.
“This large-scale trial may encour- age companies to be more willing to accelerate the adoption of exible and homeworking polices in future,” says Chin.
Kim notes that “having our prop- erty management team in-house has helped us react more quickly and ef- fectively” to the coronavirus outbreak. More investment managers may be encouraged to do the same, while the industry as a whole is expected to re- quire more professional property man- agement and a particular focus on hy- giene and more frequent and rigorous sanitization of the o ce environment.
The focus on hygiene dovetails with a growing interest in health and
wellness among occupiers and devel- opers. Previously, this had been fo- cused on air quality, which is a problem in many Chinese cities and is becom- ing a di erentiator in promoting new o ce buildings. Now the focus is set to become broader.
Real estate investment managers have not only had to support their ten- ants, but also their investors.
Pam eet’s Wong says his rm has been conducting stress tests on the portfolio, including parameters such as “a slowdown in leasing demand, down- ward rental pressure, extended down- time and vacancies and increases in construction cost and project delays” and communicating these to investors. Investment managers say concerns over the coronavirus – both its e ect
on China and the impact on the global economy – have led to a hiatus in fund- raising.
Kim says: “Fundraising for China has come to a standstill, but I believe it will come back.”
JLL’s Crow adds: “I don’t think there are any investors who have lost con dence in China as a result; the positive dynamics of the market re- main intact.”
With the rate of infection in China slowing down rapidly and the approach of warmer weather less conducive to viruses, most people in China real estate remain optimistic the market will bounce back. Now, the larger question seems to be what e ect covid-19 will have on the rest of the world. ■
April 2020 • China 15


Analysis
KEYNOTE INTERVIEW
Seeking value in size and complexity
Large and complicated repositioning and refurbishment projects in China’s major cities o er strong return prospects, says GoHigh Capital’s Josh Zhou
For most outside observers, China’s real estate market is all about new de- velopment – the skyscrapers, malls and warehouses that characterize the na- tion’s growing cities. But in larger and earlier-developed cities, there is a sig- ni cant amount of mature real estate, some of which is ripe for redevelopment or repurposing. Also, China’s real es- tate boom has led to some misaligned development – the wrong building in the right place. Taking advantage of these circumstances can be pro table, explains Josh Zhou, executive partner at Chinese investment manager GoHigh Capital. However, these complex trans- actions require careful structuring, asset management capabilities and nancing
SPONSOR
GoHigh Capital
– and strong government relationships.
Q
assets in other major markets, so you need to work harder for your returns. Also, as the China property market ma- tures, we will see more older buildings that are in need of work for any number of reasons, so more opportunities will emerge. Looking further ahead, we see more opportunities for distressed asset deals. This will partly be related to the slowing of the Chinese economy, which was already happening due to nancial de-risking and the e ects of the trade dispute with the US.
16 PERE • April 2020
Why should investors
consider value-add and repositioning projects?
When the market is pushing ahead, when everything is in high-growth mode, it is easy to achieve strong re- turns from straightforward invest- ments. However, because the market is more competitive with more foreign and local investors becoming active, we have to go further. Core real assets in China are now performing like core
Q
Which sectors and
building types offer the best opportunities in China for repositioning?


This business is very asset-speci c, so any sector or asset type might have po- tential. But the most straightforward way to engage in value-add projects is o ce renovation and repositioning. O ce is very popular and is still the rst choice for institutional and private investors. For example, our Shanghai Jing’an GoHigh Tower project saw us acquire the building, refurbish it and increase rents by more than 50 per- cent. There is also potential for retail to o ce conversion, such as our Beijing Xinjie GoHigh project. We acquired a retail asset in Beijing and converted part of it to o ce use. There are also opportunities in retail refurbishment, converting hotels to o ce space or per- haps converting serviced apartments to condominiums.
More recently, we have been focus- ing on deals that are relatively large and complicated, because here we can use our experience to add value. And of course, more complicated deals mean less competition. So our Beijing Daxing Joybreeze project, a retail refurbish- ment in Beijing, was a substantial lot size and required a great deal of capital expenditure. As well as upgrading the retail space, we restructured the debt and brought in a new operating partner.
QWhich city markets offer the best opportunities for these types of projects?
Most of our projects have been in Bei- jing and Shanghai, simply because these are the most liquid markets in China – 75 percent of commercial property transactions occur in these two markets. Guangzhou and Shenzhen have far few- er transactions, and second-tier cities are a long way behind. Liquidity is our rst priority and it is much lower in sec- ond-tier markets. Values can go down very quickly in secondary markets due to that lack of liquidity, which might be an opportunity but is also a risk. We do see some opportunities in retail in smaller cities, but you need a very strong oper- ating partner that has local teams in the markets you are targeting. For example,
we have partnered with Grandjoy under COFCO Group, one of the best shop- ping mall operators in China.
Q
a shopping center to an o ce, for ex- ample, you will need to remove all the tenants. This is hard to negotiate for foreign investors and actually di cult for local operators too. We have found that building experienced teams in this area is invaluable. Cost control is also extremely important – you need to buy at the right price and stick to your budget for the renovation.
Without proper planning and es- timation, budget overruns can be a disaster.
Buying at the right price does not mean squeezing the last cent out of the seller. We try to behave as both a buyer and advisor. The structuring of these deals is often very complex and by
What are the major
obstacles you are likely to come across in repositioning an asset or gaining change of use? How can you deal with these?
If you are looking to change the use of a property or redevelop, you need to secure permission from the govern- ment, so government relationships are very important. If you have those rela- tionships, you can avoid pitfalls. Also, you need to talk to the government be- fore your acquisition. Something else to consider is, if you want to convert
Analysis
Slicing and dicing
China’s CMBS and quasi-REIT structures offer new exit opportunities for investors
GoHigh Capital has been a pioneer in real estate securitization in China and has been involved in both commercial mortgage-backed securities and in quasi-REITs, securitized structures, which are part of the nation’s development of real estate investment trust products.
It is not often that someone can be said to have literally ‘written the book’ on a topic, but in the case of CMBS and GoHigh Capital executive partner Josh Zhou, it is correct. Alongside Chinese regulators, Zhou co- authored the rulebook for China’s CMBS structures, which di er slightly from the US model.
GoHigh structured the rst Chinese CMBS issuance in 2016 and has since been involved as an advisor and special servicer to subsequent issuances. The market has grown from nothing to 270 billion yuan ($39 billion; €34.2 billion) in 2019, but Zhou says the potential is enormous. “So far, it is a tiny fraction of the overall China real estate market, where debt is mainly bank and trust lending. In the US, CMBS issuance amounted to $1 trillion at the end of 2019.”
A unique development of the Chinese securitization market has been quasi-REITs, which are listed products backed by commercial and residential real estate assets. These have mainly been debt products, but some more recent structures have included an equity tranche. Quasi-REITs tend to have a ve-year maturity. Zhou says: “Our experience in these structures opens up multiple alternative exit possibilities for our investors as well as en-bloc or strata sales. In the future, these may well include equity REITs.”
The ultimate development for China would be a true equity REIT structure, widely regarded as an important step for the institutionalizing of a nation’s real estate market. Zhou has been involved in the ongoing process of development, testing and consultation for a China equity REIT.
April 2020 • China 17


Analysis
Case study – Aegean Square, Beijing
Aegean Square is a typical example of the sort of sizable and complex repositioning deals GoHigh is targeting
Located on the north third ring of Beijing with a total gross oor area of approximately 100,000 square meters (just over 1 million square feet), it was originally used as a shopping mall. On acquisition, the building came with a master lease until 2029 at a very low rental level. As well as purchasing the asset, GoHigh played an advisory role to the seller on how to restructure the project ownership structures to facilitate the acquisition and was able to secure the deal at a 25 percent discount to market price.
Subsequently GoHigh worked to unwind the master lease with the shopping mall, unlocking huge rental upside possibilities. The project will be repositioned from retail to o ce space and GoHigh expects it to be re- opened in its new guise by the end of 2021. Pre-leasing discussions are underway with a range of o ce tenants. GoHigh has obtained a M&A loan from onshore banks and another working capital loan for renovation is in the pipeline.
co-operating, we can create a structure that makes a bigger pie for everyone. When you co-operate with the seller you lower risk.
Of course, complexity is itself an ob- stacle for some investors, but it is what we want. We are not afraid of dealing with historical tax, legal or debt struc- tures because we have teams experi- enced in dealing with these issues.
QWhat is the nancing environment for value- added transactions?
Again, because each deal is unique, so is each nancing situation. More complex deals naturally involve more complex - nancing. If we can buy at a good price, it gives us a chance to use a little bit high- er leverage because the overall implied loan-to-value is not that high. We use
both senior debt and mezzanine nance in our transactions, when we nd the risk-return pro le justi able. Debt is not always that easy to come by for this sort of transaction. Chinese banks in general prefer to back large developers or state-owned enterprises with big tick- et lending. So, this is a situation where a strong track record, sound underlying assets and good relationships with banks means you can secure nancing.
“Liquidity is our rst priority and
it is much lower in second-tier markets”
QWhat are the typical deal sizes on offer and what range of returns can be
gained from repositioning deals?
There is a big range of deal size in the market. For the transactions GoHigh has invested in, the amount of equity invested ranges from 50 million to 2 billion yuan and a total deal size of up to 4 billion yuan.
However, we are looking for larger and more complicated deals today, so that means a lot sized at least 1 bil- lion. We have a track record of deliv- ering high returns, averaging an IRR of more than 20 percent since our inception in 2009. While we expect more uctuations in the market going forward, our target returns remain at 18-20 percent. ■
18 PERE • April 2020


For international investors,
how do you navigate this market and nd quality assets? Working with the right partners is crit- ical to success in this market. We have been fortunate to work with some very good partners – both foreign and local – who understand the market and have good assets. Equally important is hav- ing a team that understands the China market.
Q
Have real estate prices in
China run ahead of the fundamentals?
China is no di erent from the rest of
Analysis
Opportunities in maturing China
Guest Q&A with Jimmy Phua
The growth of the consumption economy is positive for real estate, says the Canada Pension Plan Investment Board’s head of Asia Real Estate
China has been on a path of economic transformation in the past few decades, moving from
an investment- and export-oriented economy to one driven by consumption. Real estate has played a pivotal role as demand for commercial and residential property have grown. Research has shown that China is now the world’s second largest institutional market in terms of investible stock and is expected to grow as structural themes continue to play out, backed by central and local government spending on infrastructure.
Canada Pension Plan Investment Board (CPP Investments) is one of the world’s biggest investors in real estate and infrastructure and has been invest- ing in Chinese property for more than a decade. PERE spoke with its head of Asia real estate Jimmy Phua.
QWhat opportunities do you see for real estate investors as consumption becomes an
increasingly important driver of China’s economy?
We have always looked at the real estate market in China through a consump- tion lens. If you look at the top eight to 10 cities in China, they are e ectively proper consumption-driven economies already with a very sizable middle class.
That means opportunities in both the traditional brick-and-mortar retail and
e-commerce – shopping malls, logistics and warehouses. Online retail account- ed for more than 25 percent of all re- tail sales in China in 2019, according to the National Bureau of Statistics, and is growing at more than 20 percent each year. But unlike in the more developed markets where the growth of e-com- merce comes at the expense of o ine retailers, the rst wave of shopping malls in China coincided with the rise of e-commerce, so o ine retailers and malls in China are much better adapted to e-commerce. Most tenants in shop- ping malls have both an online and of- ine presence. On top of that, the over- all consumption pie continues to grow in China as income rises.
Q
the world in terms of market cycles. The low-rate environment has enabled people to borrow cheaply and invest. While asset prices have had a run, I don’t think there is a bubble.
The government has been quick to respond with policy measures at any sign of asset in ation, especially in the residential market. In the long run, China remains a very compel- ling market as its economy continues to expand. It will be too big to ignore for any major real estate investors into Asia.
Q
I expect the market to mature signi - cantly and become more institutional- ized. It will borrow best practices from the West but also evolve its own unique practices. Investible products will grow both in scale and scope. Alternative sec- tors such as multifamily, senior housing, medical o ces and others still nascent or not present in China will take root. While foreign investors will continue to play a role, in the next decade, we are going to see a much larger domestic pool of capital in the real estate mar- ket. Chinese insurance companies and pension funds will play an increasingly important role in the market, which is currently dominated by developers and state-owned enterprises. ■
Where do you see the
market in 10 years?
April 2020 • China 19


Analysis
94%
Year-on-year increase in investments in Beijing real estate
Between 2011 and 2017, Chinese outbound investment into global real estate skyrocketed tenfold.
Organizations such as sovereign fund China Investment Corp and Anbang Insurance made their mark on the world stage with multi-billion-dollar purchases such as the Waldorf Astoria in New York. Much of this was fueled by borrowing – over the same period, total Chinese debt surged from 200 percent to 250 percent of GDP.
Then came the Chinese govern- ment’s crackdown on the shadow bank- ing system. Regulations on bank lend- ing and asset management, coupled with a gradual tightening of liquidity in the nancial system, took the air out of the world’s second largest capital ex- porter. Excluding ows to Hong Kong, overall out ows dwindled quickly from $31 billion in 2017 to $4 billion in 2019.
Meanwhile, domestic investment into standing assets in China fell by a third, allowing global investors an opportunity to grab a slice of Chinese real estate, with cross-border volumes growing by a third over the same peri- od. Tellingly, Chinese investors made up seven of the top 10 largest sellers in 2019, but only one of the top 10 buyers.
The $25 billion fall in outbound investment and $10 billion fall in do- mestic investment are but a drop in the ocean compared with the $200 billion increase in investment in development sites, which rose sharply from 2016-17 and has remained elevated at around $600 billion per annum since then. Res- idential land prices have soared, begin- ning with Tier 1 and 2 cities, and more recently even in lower-tier cities. ■
Chinese outbound
investments continue
to slide
After the heady heights of 2016-17, Chinese outbound investment in real estate dipped below 2012-levels last year. David Green-Morgan, managing director, Asia-Paci c at Real Capital Analytics, examines the 2019 data
$4bn $611bn
20 PERE • April 2020
Chinese outbound investment in 2019
Chinese outbound investment volumes ($bn)
35
30
25
20
15 10 5
0
Chinese investment in development sites in 2019
2010 2011 2012
2013 2014
2015
2016 2017 2018 2019


Top 10 metros for 2019
Investment volumes ($bn) Year-on-year change (%)
$1.6bn
Tianjin
91%
$10.9bn
Chinese investment volumes ($bn)
$0.6bn Chengdu
23% $0.4bn
Chongqing
-53% $0.6bn
$10.2bn Shanghai
2011
2013 2015
2017
2019
Guangzhou
$0.9bn Hangzhou
Hong Kong Japan
US Australia UK Singapore Poland France Belgium Other
Seller
Beijing
94%
120%
$0.4bn Nanjing
-13% $2.4bn
Shenzhen
800
700
600
500
400
300
200 100 0
67% 952% Top investors in Chinese standing assets
-76% Buyer
Location
Singapore China Singapore Canada Hong Kong US Switzerland Canada Bahrain Hong Kong
Volume ($bn)
1.98 1.67 1.64 1.56 1.36 1.34 1.34 1.34 1.34 1.19
Location
Volume ($bn)
1.64 1.34 1.34 1.24 1.15 0.99 0.99 0.95 0.90 0.75
GIC
ByteDance
Keppel Capital Brook eld AM
Link REIT
Carlyle Group Partners Group
SDP Investments
The Family Of ce China Resources Land
Greenland Group
Beijing Zhongkun Invt China ASE Group Taiwan JD Logistics China Tianjin Infra Invt China PGIM Real Estate US Yijing Group China Warburg Pincus US HNA Group China Beijing Pangushi Invt China
$0.6bn Suzhou
-12%
Top destinations for Chinese capital in 2019 ($bn)
0
0.5 1.0
1.5
2.0
2.5 3.0 3.5
China
Development sites
Standing assets
April 2020
• China 21
Analysis


Analysis
Urban attraction
Digital infrastructure development and changes to the hukou system are among the factors maintaining real estate momentum in China’s cities. Mark Cooper reports
The attractions of China to global real estate in- vestors have remained constant since the market was rst opened to them. The nation’s sheer scale
coupled with unprecedented urbaniza- tion and strong GDP growth created a perfect storm for investors. China’s investment in infrastructure has been a fundamental driver of growth.
China has spent trillions of dollars to build the power generation capacity and transport network required of a de- veloped nation in order to underpin the economic development that has seen hundreds of millions of people move from rural areas to the country’s cities.
The data for urbanization in China are dizzying: 500 million people have moved to cities over the past 35 years. By 2035, when the urbanization rate is predicted to hit 70 percent, nearly
1 billion people will live in China’s cit- ies. Urbanization creates demand for real estate space for the new urban pop- ulation and the jobs they undertake.
Harry Tan, head of research, Asia-Paci c at investment manag- er Nuveen, says: “Beijing, Shanghai, Guangzhou and Shenzhen are among the cities that are best positioned to bene t from the structural demograph- ic uplift in the coming decades. How- ever, from an urbanization, a uence and consumption angle, all Tier 1 and 2 cities will continue to attract immi- grants, resulting in an expansion of the services sector and deepening the labor market skill pool.”
Urbanization in China is compli- cated by the hukou system of residen- cy permits. These permits determine a person’s right to receive certain bene ts, such as agricultural land in the case of rural hukou, and access to
government jobs, subsidized housing, education and healthcare.
Migrant workers can be granted an urban hukou as long as they ful ll cer- tain criteria. These include level of ed- ucational quali cation, technical exper- tise and entrepreneurship, for example. The process is more complicated in larger cities where the labor market is highly competitive. To further com- plicate matters, some rural migrants to large cities wish to retain their home hukou and the land rights that accom- pany it.
Megan Walters, global head of re- search at investment manager Allianz Real Estate, says: “Real estate investors in China should pay close attention to government policy, particularly around the changes to the hukou system. There is a range of reforms and local experiments in cities to relax the system and allow greater urbanization.”
22 PERE • April 2020


China’s rst-tier cities, Shanghai, Beijing, Shenzhen and Guangzhou, have adopted a points-based system for hukou applicants, who will be scored on factors such as employment sector and academic achievement. These are not consistent across cities. For ex- ample, Shanghai is under population pressure and the city authorities are keen to stay under 25 million people while encouraging growth in satellite cities.
Meanwhile, second-tier cities have adapted their systems to attract gradu- ates. Chengdu in western China allows all university graduates to apply for the city’s hukou before they nd a job, while Wuhan permits all workers who graduated within three years to apply for its hukou.
Last year, a relaxation of the hukou system was announced for a range of smaller second- and third-tier cities, including Xi ’an, Harbin, Changchun, Taiyuan, Nanning, Dongguan, Su- zhou, Hefei, Jinan, Qingdao, Dalian, Xiamen, Ningbo, Kunming, Shiji- azhuang, Nanchang and Fuzhou.
Walters says: “These smaller cities are not usually on the radar of inter- national real estate investors. How- ever, now may be the time to start to look at these more closely, particularly
China’s urban population growth (bn)
those which are within the mega-city clusters, for example Wuxi, Hefei, and Suzhou.”
Cluster development
China’s mega-city clusters are the lat- est development in its innovation sto- ry. These giant urban agglomerations contain a mix of large and small cities linked by high-speed rail networks. There are three main city clusters that are expected to be a focus of GDP growth. The mega-city clusters have nation-sized populations and wealth and are larger than similar areas else- where, such as the Tokyo Bay Area.
In a centrally planned economy, the development of the clusters is not being left to the market. China’s plan- ners hope di erent cities in each region will focus on their own comparative advantages so that duplication is avoid- ed, areas complement each other and synergies are maximized. Hong Kong, in the Greater Bay Area, is focused on international nance and trade, while neighboring Shenzhen is an innovation hotbed and center for domestic nan- cial liberalization.
Walters says: “The three mega-city clusters will be of considerable interest to investors. Along with relaxation and reform of the hukou system, further
“Real estate investors in China should pay close attention to government policy, particularly around the changes to the hukou system”
MEGAN WALTERS Allianz Real Estate
reforms will relax foreign investment rules and restrictions on foreign com- panies setting up shop, for example in nancial services.”
Another factor that bodes well for the future of smaller cities within clus- ters is the reduction in transport time, which is expected to encourage decen- tralization. In the Greater Bay Area, Guangzhou is linked to neighboring Foshan by subway, making the smaller city an ideal overspill site for o ce de- velopments or for residential develop- ments for commuters. In Hong Kong, where housing costs are among the highest in the world, it has been sug- gested that some workers might prefer to relocate to the GBA, where property is more a ordable, and still be in com- muting distance of the territory.
Digital infrastructure
China’s infrastructure investment has been focused on transport links such as its high-speed rail network, and new airports such as Beijing Daxing. How- ever, it is also developing a digital in- frastructure and creating smart cities for the next stage of its development. Nuveen’s Tan says: “Smart cities will change the use of real estate over time. Beijing, Shanghai, Guangzhou and
1.0 0.8 0.6 0.4 0.2
0
1998 2000 Source: World Bank
2005
2010
2015 2018
Analysis
April 2020 • China 23


Analysis
China’s mega-city clusters
Greater Bay Area: This consists of 11 cities in the Pearl River Delta in southern China. The largest cities are Guangzhou, Shenzhen and Hong Kong, which are now connected by a high-speed rail network that has cut travel times dramatically. The GBA has a population of more than 68 million and GDP of 10.5 trillion yuan ($1.5 trillion; €1.35 trillion).
Yangtze River Delta: This eastern seaboard region includes Shanghai, as well as Hangzhou (home of tech giant Alibaba), Nanjing and a host of smaller cities. The cities will be linked by new transport infrastructure aimed at creating a 90-minute commuting circle to Shanghai. The area comprises 26 cities, a population of 222 million and GDP of 17.7 trillion yuan.
Jing Jin Ji: This 13-city cluster includes the capital Beijing, the busy port of Tianjin and a new city named Xiong’an, which is being built between the two. Xiong’an has been designated a smart and green
city, and will bene t from some state functions being relocated from Beijing. Harry Tan, head of APAC research at Nuveen, says: “Beijing has committed more than 200 billion yuan to 300 key projects focused on infrastructure, such as the railways connecting to the new Daxing Airport.”
A further 16 city clusters are being developed all over China.
Hangzhou are the leading smart cities in China.
“Guangzhou is arguably spear- heading China’s innovation and start- up movement. The city is develop- ing tech and innovation capabilities through various ambitious projects. For instance, construction is current- ly underway for the Sino-Singapore Guangzhou Knowledge City, which will comprise hi-tech business parks, commercial and public amenities, and housing for 500,000 residents.”
Walters adds: “China has a separate digital ecosystem running on a parallel path to the West, and in many instanc- es is in the lead. China is strong on mo- bile phone payment systems and also the rollout of 5G networks. For global real estate investors looking to diversi- fy and capture global growth prospects from technology, it is essential to be in- vested in real estate on the China side of the tech divide.”
China’s burgeoning digital economy is having a direct e ect on real estate markets. Broker JLL reports demand
for grade A o ce space by tech rms in second-tier cities will have doubled between 2016 and the 2020 year-end.
Environmental focus
As well as digital infrastructure, China is building more sustainability into its cit- ies, says Richard Hamilton-Grey, direc- tor of sustainability, Europe and APAC, at Nuveen. “China is rmly positioned on the world stage as a renewable ener- gy powerhouse – it is the world’s biggest manufacturer of solar panels and wind turbines and has the world’s largest hy- dro-power production capacity.
“However, China’s rate of urbaniza- tion has led to questions being raised over the pollution, sustainability and quality of life of its cities. The gov- ernment-led ‘eco-cities’ program has helped boost green transformation at the city level, with Shenzhen now broadly recognized as China’s most sustainable city, having established its ‘eco city’ program in 2005. Shenzhen has plans to go further, announcing a 1.2-kilometer elevated sky garden to
be built in the Qianhai district that will connect the waterfront with the town center and public transit.”
Last year, China announced a plan to make Shenzhen a global leader in terms of innovation, public service and environmental protection by 2025, as well as making it the ‘big data’ center for the Greater Bay Area. The plan even contained hints of political and - nancial reform, as well as environmen- tal innovations.
The most pressing environmental issue for most Chinese city dwellers is air quality. For real estate investors this is also an area where performance is measurable, making progress easier than with other environmental, social and governance factors.
Hamilton-Grey says: “Air qual- ity continues to be a focus for multinational companies looking to take space in China’s cities, so the abil- ity to curb the impact of air pollution and improve the quality of life for resi- dents will be a key factor in driving real estate demand.” ■
24 PERE • April 2020


China’s digital future
Guest comment by Bernie Devine
Yardi’s Asia-Paci c regional director on how technology will impact China real estate
China is home to some of the world’s largest tech unicorns and a host of smaller compa-
nies, which are producing technology with an impact on the real estate land- scape through e-commerce, smart cit- ies and building technology. And these themes have emerged in tandem with the well-known drivers of the Chinese real estate market.
China will continue to experience rapid rates of urbanization and gen- tri cation over the next decade, which will drive changes in demand and rates of consumption. There is pent-up demand for a better quality of life – cleaner, less congested streets and bet- ter housing – which also plays to wider concerns about sustainability and the environment.
The poor air quality in large Chinese cities is driving developers to nd inno- vative ways to improve the air quality in their buildings – technology can enable all of this. Smart city initiatives, such as those launched by Alibaba, should re- duce congestion and pollution.
China’s connected cities will be about providing a seamless hando between a complex and comprehensive set of apps. No single company will do everything, hence a platform where task and role-based apps can work to- gether to solve problems and deliver a user experience that is seamless is the most likely outcome. Companies that deliver operating systems, such as
Microsoft, Apple, Google and Tencent, are working hard on that seamless data handover, but it is not easy. Data priva- cy, security and governance all overlap and often con ict.
Data means insight
China retail has been relatively resil- ient to the e ects of e-commerce, not least because much retail development post-dates the emergence of online shopping. China’s tradition of trans- port node-centered mixed-use devel- opment, which follows its community culture, is more than just a place to shop, but a space to gather and eat.
This intersection of work, rest and play demands that seamless hando between many functional based apps. It has also been an area where land- lords are challenged to optimize ten- ant mix.
With more insight into behaviors and use, space allocation, category zones and adjacencies can be adjusted to optimize revenue and return visits. Location-based data is king, and in
“Location-based data is king”
China you have more sources than just cell phone data. As wages rise and traf- c gets more congested, the last mile of delivery is both more in demand and more demanding, with an expectation for instant or same-day delivery in most Chinese cities.
Covid-19 has tested supply chains and proven that a more local and loca- tion-based approach can work. While logistics might seem the least glamorous property sector, it is actually one of the most innovative. Developers are invest- ing in tech to make their warehouses run more smoothly to better serve the world’s most demanding consumers.
Data handling
The advent of big data means data gov- ernance is something most companies have just gured out they need to deal with, and most are doing it poorly. It goes hand in hand with cybersecurity and data privacy. That is a mixed up and con icted space that can be di - cult to navigate.
China’s surveillance and social cred- it systems will have a major impact on cities, communities and buildings in ways that are both altruistic and sinis- ter. There are bene ts for all at a cost to the individual. Not just in China but everywhere, mobile apps have lured us into a world where we give up some privacy for a bene t. No one knows where this will lead, but we are likely to rst see the impact in China. ■
Analysis
April 2020 • China 25


Analysis
Choppy waters for Hong Kong real estate
In the short term, Hong Kong faces a number of issues, but in the longer term what matters is how it nds its place in China, writes Mark Cooper
Hong Kong faces a unique set of problems. Coronavirus followed six months of political unrest and violence, as popular protests
against a now-shelved extradition law with mainland China became smaller, often violent, protests by young activ- ists. Prior to this, the retail sector had been on the slide since 2014 due to low- er spending from Chinese tourists.
The city has not su ered a total lock- down, though schools have been closed until after Easter, and most people have continued to work almost as normal. However, the closure of the border with mainland China has crippled the hospitality industry, with single- gure occupancy rates. The government has announced a series of moves to support SMEs, especially in the retail and F&B sectors, and plans to give HK$10,000 ($1,287; €1,173) to every permanent resident to stimulate the economy.
The protests began to a ect real es- tate in the latter part of 2019. Cushman & Wake eld data show o ce rents fell 2.5 percent city-wide and 6.9 percent quarter-on-quarter in the Central o ce district in the fourth quarter. The bro- ker predicts a further fall in the overall market of 10-15 percent this year, and 13-18 percent in Central.
Meanwhile, retail rents in the prime shopping district of Causeway Bay fell 13.9 percent in the last quarter of 2019 to reach a 10-year low. Rents in prime retail districts will fall a further
10-15 percent in the rst half of this year, Cushman predicts. Investment volumes (deals above HK$100 million) also fell to a decade low of HK$46.93 billion, just 30 percent of the ve-year quarterly average.
A strong local listed and private in- vestor market means fewer institutional investors are active in Hong Kong, al- though it has been a target for China and pan-Asia funds. The political up- heaval has been a headache for invest- ment managers, as some LPs, especial- ly those from the US, have designated Hong Kong as an oppressive govern- ment and thus somewhere they will not invest for ethical reasons.
Déjà vu?
The real estate community has been stoic, not least because it’s been here be- fore with the 2003 SARS epidemic. And the Hong Kong economy was stronger prior to the coronavirus than in the run- up to SARS, says Andrew Moore, chief executive of Hong Kong-based invest- ment manager Pam eet.
“SARS came only a couple of years after the bursting of the dotcom bubble and only ve years after the Asian nan- cial crisis, so the economy was severely weakened,” says Moore. “Prior to the coronavirus, the economy was in good shape, with very low unemployment. The retail sector, which had been su er- ing anyway, was a ected by the protests, but the o ce, logistics and residential markets had kept on rising.”
So far, Hong Kong real estate
professionals expect the coronavirus to behave like SARS, with a sharp dip in activity, followed by a strong recov- ery once the virus dissipates in warmer weather.
There have been a number of dis- tressed asset sales, mainly by over-lev- eraged residential investors, but the investment market is largely stalled, say brokers. Moore says: “Most Hong Kong real estate investors are low- geared and under no pressure to sell. They are particularly reluctant to sell because everyone remembers SARS and the huge gains made when the mar- ket started to recover.”
The rst question for investors is whether the recovery will follow the same pattern as SARS. Simon Smith, head of Asia-Paci c research at Savills, says: “If this outbreak is similar, we can expect the worst economic damage to occur over the rst half of the year, with a swift recovery in the second.
“However, a lot depends on how you model the recovery phase, whether it’s a ‘V,’ a ‘U’ or an ‘L’. As businesses re- turn to work and nancial markets right themselves, a second half pull back is possible but is now looking less likely due to the spread of the virus elsewhere and the impact on the global economy. The critical variable at the moment is how covid-19 impacts European and North American economies at a time when the outbreak seems to be stabiliz- ing in Greater China.”
The second question is whether the protests and violence will resume again
26 PERE • April 2020


Analysis
A model for covid-19?
The data below highlight SARS’ effect on Hong Kong’s economy and property market. However, in such a fast-moving situation it is important to note that it remains unclear whether the impact of the covid-19 outbreak will follow similar patterns.
SARS’ impact on the economy
-1.6%
Q2 2003 GDP growth year-on-year
-6.7%
H1 2003 retail sales
SARS’ impact on the property market (H1 2003)
-11%
Grade A of ce rents
-3%
Prime shopping center rents
-1%
Prime street shop prices Source: Savills
-20.7%
H1 2003 visitor arrivals
8.5%
June 2003 unemployment rate
-5%
Grade A of ce prices
-7%
Prime street shop rents
in the summer or when the the virus re- cedes. Opinion is divided on this; many expats in the real estate business are gloomy about Hong Kong’s prospects as they see no change of rapprochement between government and protestors. In- termittent protests could permanently reduce mainland China visitor numbers and subdue the retail and hospitality markets.
However, others believe a political settlement is around the corner. Allan Lee, managing director at Pam eet Hong Kong, expects reforms to be in- troduced prior to the Legislative Coun- cil elections in September, allowing vot- ers more say, which will take the sting out of the protests. There are also plans to deliver more public and private hous- ing, as housing a ordability is the main gripe of the city’s residents.
He is sanguine about the post-re- covery opportunities: “The di culty is in nding a willing seller of an en-bloc asset.”
Yet he also notes that new capital is already circling the market: “We see new families and new funds in the mar- ket, while the previously active are not doing so much.”
In the longer term: “The key to Hong Kong’s future is integration with the rest of the Greater Bay Area, which opens up huge opportunities for individuals and businesses. The GBA needs Hong Kong’s legal and nan- cial systems to speed up its reform and development.”
Hong Kong is now linked to the Chinese mainland by high-speed rail networks that can take commuters to Guangzhou within an hour. Being part of the GBA e ectively increases Hong Kong’s land mass. However, so far the public has been wary of the project and of further integration with China, even though it is enshrined in law.
Lee says: “Many of the real estate opportunities in Hong Kong going for- ward will be related to the GBA. There is a lot of growth there to exploit.” ■
April 2020 •
China 27


Data room
Capital watch
Closed-ended fundraising falls in 2019, while core-plus strategies dominate
China-focused fundraising, 2013-19
Capital raised ($bn)
10
8 20
7
6
6 15
5
4
4 10
3
2 1 0
China-focused capital raised by risk-return strategy, 2013-19 ($bn)
Core
Core-plus Value-add Opportunistic Debt Fund of Funds/Co-investment
Number of funds closed
25
9 8
25
0 2013 2014 2015 2016 2017 2018 Top 10 China-focused real estate funds closed, 2013-19
2019
0
2013
2014 2015
Capital raised ($bn)
3.70
1.76
1.53
1.50
1.50
1.44
1.40
1.00
0.68
0.63
2016
2017 2018 2019
Fund name
GLP China Logistics Fund II
ARA Harmony VI
GLP China Logistics Fund I
D&J Zhiyan Equity Investment Fund
Raf es City China Investment Partners III (RCCIP III)
GLP China Value-Add Venture I
Mapletree China Opportunity Fund II
GLP China Value-Add Venture II
CITIC Capital China Retail Properties Investment Fund
ERES APAC II-China Outlets
Source: PERE
Fund manager
GLP
Target size ($bn)
3.00
N/A
1.50
1.50
1.50
1.44
1.00
2.00
0.60
0.75
Risk-return strategy
Opportunistic
Core-plus
Opportunistic
Core-plus
Core-plus
Value-add
Opportunistic
Value-add
Opportunistic
Core-plus
Year closed
2015
2016
2013
2016
2016
2018
2013
2018
2013
2019
ARA Asset Management
GLP
D&J China
CapitaLand
GLP
Mapletree
GLP
CITIC Capital
Nuveen Real Estate
28 PERE • April 2020


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