More tax breaks?
China’s plans to introduce real estate investment trusts (REITs) mark a crucial step to urge private money to fund infrastructure such as toll roads and sewage systems, however authorities have their work cut out in creating a fully-fledged market.
In several countries REITs are used as a way for investors to own property via the stock market, enjoying the financial gain from projects such as tenanted office blocks, while permitting developers to free up their balance sheets for new ventures.
The test, experts say, is whether or not Beijing is able to develop a more market-based means of financing future growth, which evolve slowly but has the advantage of enlarging the pool of available capital and weaning off inefficient state players.
Half a dozen infrastructure experts, fund managers and lawyers media outlets that setting up a REITs market in China could prove tricky, pointing to difficulties such as lack of sufficient returns, stakeholder reluctance as well as legal and tax issues.
In the foreseeable future, for example, in the next five years or so, I don’t think the scale will be too large. just a dozen products nationwide initially.
Under the pilot unveiled last month by the National Development and Reform Commission (NDRC), the state planning agency, assets eligible for issuing REITs include data centres, toll highways and sewage systems among others. They have to be operational for a minimum of three years.
Though property is presently excluded for fear of stoking an asset bubble, the REITs might unlock funds for the next wave of job-creating infrastructure projects as China strives to revive economic growth amid its worst downturn in three decades.
$3 TRILLION MARKET?
A broader China REITs market that eventually covers property may reach over $3 trillion, Goldman Sachs estimates – surpassing the United States as the world’s largest.
Yet, consultants say developing a market even a tenth of that size would first need authorities to handle some fundamental problems.
The biggest snag is finding projects for China’s REITs that provide attractive returns since few, funded by low-cost state loans, were designed with market-level returns in mind.
“Return in infrastructure is especially low in China compared to in other markets,” Jumbo Consulting’s Zhang said.
Infrastructure funded through public-private partnerships (PPP), which have to date led China’s efforts to draw in private investors, usually yield at best between 5% and 6%, compared to between 12 and 15% for those in Western economies, according to Zhang.
The low-returns problem has stung Beijing before, when it stumbled in its 2016 push for PPP Asset-Backed Securities (ABS) as some seemingly promising projects suffered losses for consecutive years.
NDRC and the China Securities regulatory Commission (CSRC), who jointly issued the circular in April, didn’t reply to requests for comment.
TAX, LEGAL UNCERTAINTIES
Even for higher yielding projects, questions remain over whether or not the current shareholders – local authorities and others – would have enough incentive to sell into REITs given they’re currently enjoying the returns on their initial investments.
Taxation is another issue.
The risk is that under current rules the asset owners – still probably to be the government vehicles, with REIT-holders owning the right to the income stream – are liable for high income tax and numerous value-added taxes.
There are calls for tax breaks to help kickstart the new market, however these will be complex to set up on a project before the REIT containing it is successfully listed.
“In my view some tax policies will be given at the operational level of REITs. But how to give them on the project offloading level, it’s going to not be that simple,” said Deloitte partner Yu Na in Beijing.
Legal problems also loom large given China’s lack of a well-established legal framework.
“If the aim is merely to explore new funding sources to alleviate local government investment vehicles’ debt burden temporarily, without optimising the legal, execution and information disclosures on the fundamental assets, it may well be too flawed to draw in long-term investors,” said Kenny Wu, head of China Credit research at Hong Kong-based asset manager BFAM Partners.