Li Ka-Shing is Selling His China Real Estate – Should KKR Be Worried?

Asia’s richest man made headlines earlier this month by announcing plans for two companies that he controls to sell their stakes in a Guangzhou mall, which followed soon after the August announcement of plans for one of the companies to dispose of an office building in Shanghai.

The decision by Asia’s richest man, and the investor that many see as the Warren Buffett of China, to begin selling mainland real estate assets may indicate that foreign investors, particularly private equity firms who are currently crowding into the China property market, may want to reconsider whether this is really the best time to start buying China commercial real estate assets.

In the mall transaction, Li’s two primary holding companies, Hutchison Whampoa and Cheung Kong Holdings, announced that they will sell their respective 50% stakes in Metropolitan Plaza in Guangzhou’s Liwan district to an offshore company for US$390.7 million.

That deal was preceded on Aug. 21, by a report that Cheung Kong planned to sell its Shanghai Lujiazui Agricole OFC office asset for more than US$973 million.

Li Ka-Shing Knows When to Sell

Through Hutchison Whampoa and Cheung Kong Holdings, Li owns real estate in markets across Asia, and has a record of being able to predict the mainland property market.

In 2004, Hutchison developed the 98,300 square-metre office tower, The Centre, in central Shanghai, and made a substantial profit selling it to Hong Kong-based Asia Pacific Land for RMB 4.9 billion in the summer of 2008.

At the time, Asia Pacific Land (APL), and many market observers, thought the acquisition was a great opportunity to own a prime commercial building. However, APL’s view of the transaction changed significantly by 2011 when it was forced to sell The Centre to a Chinese insurer for RMB 4.4 billion – a 500 million RMB loss.

Obviously, the global financial crisis had a major impact on how this deal turned out, but on the more micro-level, APL bought an office building just as rental rates were falling off in Shanghai, and was apparently unable to refinance the highly leveraged asset when it’s cash flow could not cover financing costs.

Yes, China’s Real Estate Market Can Come Down

In a move which one 15 year veteran of China’s real estate industry describes as “a classic case of foreigners mis-reading the China markets,” international private equity firms have raised record amounts of cash to invest in the country’s real estate, at what may be a market peak.

Just this month we saw KKR co-founder Henry Kravis visiting Hong Kong to discuss his firm’s intention to spend part of their record $6 billion Asia fund on acquiring China real estate assets, and Carlyle announcing a $400 million investment in China’s warehouse market.

And during August we witnessed Sam Zell’s Equity International buying into its own China warehouse deal, and Blackstone acquiring a Hong Kong real estate developer for $322 million – primarily to increase their access to the China market.

Shanghai Office Rents Already Falling Off

Commercial real estate economics is not all that complicated – especially for office space. Landlords buy or develop a building, rent it out, and if rents are more than costs, then they are making money. So rents going up means the potential for profit is growing, and if rents are coming down then times are getting tougher.

And Shanghai rents appear to be heading south.

According to brokers advising on transaction in the Shanghai market, during the last few months rents at some of the city’s prime office developments have already begun to decrease. Landlords have also begun to incentivize brokers by offering higher commissions and other deal sweeteners to stimulate cashflow.

In particular, Plaza 66, a landmark building on Shanghai’s Nanjing West Road has already begun to lower its effective rental rates, and the nearby Wheelock Square building, another prime office property and the tallest structure in the Puxi section of Shanghai is also said to be lowering its rental rates.

When rents are on the way down, and asset prices are still on the way up, then the market would appear to be headed for a correction in the not too distant future.

What’s Really Driving China Real Estate Investments

While fund managers like to project an image of scientific impartiality and numbers-driven decision-making, and there is a lot of analysis performed, investment decisions are also driven in no small part by what markets a firm can raise money for, and what type of deals a particular fund’s competitors are investing in.

Li Ka-Shing, who has the luxury of making his own investment decisions, is apparently focusing on investments in Europe, where he sees the potential for greater returns and less competition.

However, Europe is not the story that most investors want to buy right now, and China may be a better story to tell when on the fund-raising trail.

Once private equity firms and other financial companies have raised this money, they are typically under pressure to show some activity to justify their management fees, and one of the primary triggers for this pressure is headline stories about competing firms buying assets.

So while investors may have strategy teams devising a plan, and research squads crunching numbers, investment board decisions tend to rely on what they see other investment boards buying.

A bit like teenagers all buying the same jeans to wear to school, but the teenagers don’t make as many claims regarding analysis.