S&P Global Ratings had anticipated more than US$5 trillion ($6.6 trillion) of commercial assets to be packaged into REITs. According to a recent report, the assets in commercial C-REITs totalled just US$1.95 billion.
Commercial C-REITs start slow
Four commercial C-REITs have been listed since March 2023. The assets include shopping malls, department stores and farmers' markets.
In mid-July 2024, Chinese regulators tweaked regulations to encourage more IPOs. For instance, originators or sponsors can now use 15% of the net cash they collect from REIT issuance to supplement their working capital, up from 10% earlier. However, originators are still unable to use funds from the divested assets for residential development in China.
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S&P says: "The originators, usually also property developers, are prohibited from using the fund for residential development. As such, REIT issuance cannot help them to raise liquidity for their capital-intensive property development business."
Restrictions on the use of proceeds from REIT issuance were evident on April 17. During a briefing to announce the potential IPO of CapitaLand Commercial C-REIT (CLCR), Gerry Chan, CEO of CapitaLand China Trust's (CLCT) manager, said the proceeds from the sale of CapitaMall Yuhuating, currently owned by CLCT, into CLCR would be used to pare debt. However, he was asked time and again whether the proceeds would be paid out to unitholders or for unit buybacks or both.
In being flexible, CSRC has stipulated that C-REITs can now include offices and hotels that are owned by the same originator and physically inseparable from consumer-related infrastructure (for example, shopping malls); the gross floor area of such offices and hotels is capped at 30% of the total of the underlying assets (or up to 50% in extreme cases).
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Regulators have ended the qualification requirement for a minimum distribution yield of 3.8% for the REIT's first three years of trading. The minimum distribution yield is the net projected annual distributable cash flow divided by targeted funds to be raised based on the net asset valuation.
"Even with the recent rules easing, the instrument remains just moderately useful to investors and issuers, in our view. REITs present an exit route for owners seeking to sell assets. However, REIT issuance is a complicated process. At IPO, originators can typically only sell a few assets if China's limited C-REIT record is a guide. Moreover, regulators restrict the use of funds. No more than 15% of net cash from REIT issuance can be used to supplement the originator's liquidity or pay out to minority shareholders in the underlying assets. This percentage is after repaying existing debt, paying taxes and fees, and excluding the originator's own purchase of units," analysts at S&P Global Ratings explain.
Introducing CLCR
On April 17, CapitaLand Investment (CLI) announced the application to list the long-awaited C-REIT, CLCR. The initial portfolio will be seeded by the sponsor group and focus on operating assets CapitaMall SKY+ (in Guangzhou and owned by CLI and CapitaLand Development (CLD)) and CapitaMall Yuhuating (in Changsha and owned by CLCT), with a total valuation of RMB2.8 billion ($504.8 million). Yuhuating was last valued at RMB785 million as at Dec 31, 2024. Based on its net property income (NPI) in 2024, the NPI yield was 6.4%.
Yuhuating was selected because it was one of the smaller assets in CLCT's portfolio, contributing 4% of NPI. "We were also looking for an asset that is already mature and we have already reaped the asset enhancement initiative (AEI) potential with the benefits of NPI increase in 2024 and 2025, and this fits with the logic of divesting a mature asset to unlock value and recycle," Chan says.
CLI, together with CLCT and CLD, will collectively hold a minimum 20% in CLCR. CLI will be the property manager and operate the assets post-listing. The fund or asset manager will be a Chinese entity.
The C-REIT listing ties in with CLI's focus on China-for-China. During the April 17 briefing, Chan outlined the key reasons for the move.
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"This is a strategic opportunity to differentiate ourselves and get access to an onshore C-REIT platform through which we can tap largely captive domestic liquidity in China to recycle assets and unlock value," he says.
Chan continues: " This is also a strategic opportunity for CLCT to become a key stakeholder of a C-REIT and broaden its access to China's domestic capital market as the only S-REIT with access to China's C-REIT market."
"China's domestic capital market and investor base is largely untapped by global REIT players," adds Chan. In addition, Chan hopes CLCT itself can tap qualified domestic debt and equity investors. In 2023 and October 2024, CLCT issued its first FTZ offshore CNY bonds and CNH400 million bonds, respectively.
Trading above book
Some C-REITs are trading above their book value, which could be encouraging for CLCR. CLCT is trading at 0.64 times book value. As of April 22, GLP C-REIT is trading at 1.06 times book value, while ESR C-REIT is trading at 2.27 times book value.
Chan says: "The C-REITs themselves have upside potential. Domestic investor interest is strong due to the limited options for investors, given that government bonds are trading below 2%. If you look at the IPO price increase for consumption C-REITs, post-IPO performance has been strong."
Chinese regulators first introduced the pilot scheme for REITs in 2021.
The GLP C-REIT IPO raised more than RMB5.8 billion based on 1.5 billion shares priced at RMB3.89 per share. The institutional tranche was oversubscribed approximately 6.7 times, while the retail tranche was oversubscribed almost 10 times.
Six cornerstone investors pre-committed 52% of GLP C-REIT ahead of the public issue. These include Taikang Life (20%), Shoucheng Holdings (10%), Dajia Investment Holding (8.39%), CICC Wealth Management (8.33%), CCB Trust (3.5%) and China Insurance Investment Fund (1.78%). GLP retains a 20% ownership interest in GLP C-REIT.
GLP C-REIT's initial portfolio comprised a portfolio of seven modern logistics assets located in the core logistics hub areas of Beijing, the Yangtze River Delta and the Greater Bay Area with over 700,000 sq m (7.5 million sq ft) of gross floor area (GFA) and a lease ratio of 98.7% as of December 2020.
In June 2023, GLP C-REIT had a follow-on equity offering of RMB1.85 billion. The placement was supported by 16 domestic institutions, including asset management firms, securities companies and insurance companies. The new assets acquired were three logistics facilities: GLP Park Qingdao Qianwan Port, GLP Park Jiangmen Heshan and GLP Chongqing Urban Distribution Logistics Centre.
ESR C-REIT was listed in January this year with three stabilised logistics facilities that have retained an average occupancy rate of over 90% in the last five years. The seed assets - Jiangsu Friend Phase I, Phase II and Phase III, spanning a total gross floor area of over 427,000 sq m - are tenanted by leading multinational companies in logistics, e-commerce, fast-moving consumer goods and the automotive sectors.
The IPO raised over RMB2.1 billion, based on 800 million shares priced at RMB2.628 per share. ESR C-REIT attracted 12 cornerstone institutional investors for its IPO, with ESR retaining a 41% stake.
Chan says assets in C-REITs must be 100% owned by the REIT and the originators or sponsors must hold at least a 20% stake on which there is a five-year moratorium. As he sees it, the restrictions placed on commercial C-REITs indicate that CLCT and CLCR are unlikely to compete for the same assets.
Tapping onshore capital
Commercial C-REITs are focused on income-producing retail assets. "Even though we are both investing in retail, there is a different spectrum of retail. We at CLCT are happy with doing AEI and we are happy to take some assets that are not so mature and need AEI. We can then reap the upside, which we have done in a few of the assets that we bought, including Rock Square. CLCT can also undertake some development. There may be a situation where we need to do a big redevelopment to reap the highest and best use of certain assets," Chan explains. CLCT is more flexible, he adds. It can acquire assets from anyone. Only the originators can divest assets into CLCR.
"We see CLCR as an alternative growth path for CLCT, with CLCT leveraging on a broader ecosystem, recycling capital and investing the capital in higher-yielding opportunities (third parties or even possible value-add deals). While investors may question the overlap in the mandate, we believe such conflicts can be addressed internally, with CLCT taking on broader value-added opportunities. At the same time, CLCR, given tighter restrictions onshore, will be a stabilised retail-focused play," says DBS Group Research in an update.
Before China's post-Covid slowdown, CLCT was popular with international institutional investors. CLCR is primarily targeted at domestic investors. "We continue to see CLCT as a suitable entry point for international money for exposure to CLI's China REIT platform, and at a higher yield spread. The successful growth of this ecosystem could help compress the yield spread differential between CLCT and CLCR over time. Alternatively, if CLCT continues to trade at a significant discount to book, markets could start to question the viability of CLCT with questions around its possible privatisation will arise once more," DBS adds.
