Fitch Ratings Says China Real Estate Yields Too Low for REITs

China’s government says the country is ready for real estate investment trusts (REITs), but according to analysts at Fitch Ratings, even if the legal codes are in place, rental yields need to rise before REITs become a reality on the mainland.

In a statement published this week the financial ratings agency predicted that REITs are unlikely to be rolled out in a meaningful manner in China until asset values come down or rental rates ratchet up.

According to Fitch, many of China’s investment properties are of poor quality with low rental yields of less than four percent. With domestic borrowing costs on the mainland averaging above six percent, the current environment leaves little opportunity for REIT unit-holders to realise profits.

Under the current conditions, REITs are only an option for investors who are confident in the future capital appreciation of the assets held by the REIT.

China Eager to Make REITs a Reality

Mainland authorities have been moving toward REITs for some time and in May this year, the first REIT-like product, Qihang Specific Asset Management Plan was launched by Citic Securities on a special section of the Shenzhen Stock Exchange. Access to this trial investment trust was restricted to a few institutional investors, and had a time horizon of a maximum five years, both of which are inconsistent with traditional REIT practices.

However, China remains determined to have real REITs, with the central bank saying in September 2014 saying that a REIT pilot scheme will be promoted to support reasonable funding needs of property developers. Just this month the director of the Policy Research Centre of China’s Ministry of Housing affirmed the government’s plan to launch REITs by saying that real estate assets in China are ready for securitisation.

REITs as an Alternative to Shadow Banking

By allowing developers another avenue for raising funding directly from the public, REITs are interesting to the government as a way to improve funding structures and alleviate the need for developers to seek out expensive private trust funding.

REITs would also provide a new avenue for retail investors to participate in the real estate market, without having to buy properties directly. As of yet, however, current stock market regulations in China do not support the listing of REITs.

Poor Rental Returns Hurt REIT Potential

Despite the need for more funding, Fitch believes that relatively few commercial assets are available to be securitised into marketable REITs, because of high valuations and low rents.

Until either valuations come down, or rental rates rise, only a few developers that enjoy low funding costs are seen as promising reasonable yields to investors, which Fitch believes would increase their chances of successfully listing REITs.

In its statement, the rating agency pointed out China Resources Land (BBB+/Stable), Franshion Properties (China) Limited (BBB-/Stable) and Dalian Wanda Commercial Property Co. Ltd. (BBB+/Stable) as candidates with high potential for REIT creation because of their mix of high-quality retail or office properties in prime areas and low cost of financing.