As the world’s second largest economy (measured by GDP) China has long been a key target for foreign real estate investors. However, given that domestic funds have been very aggressive until recently, reasonably priced assets have been few and far between, limiting the opportunities available. But the domestic liquidity crunch over the last two years means that things are changing and there is a growing buying opportunity for international investors.

With the prospect of sustained restrictions on China’s property developers looking a possibility, as the authorities seek to further cool an over-heated market, international real estate investors could be presented with a window of opportunity in the near future.

The main opportunities lie in the debt market. Data from Bloomberg suggests approximately US $70 billion of Chinese real estate loans will require refinancing over the next five years – by far the biggest debt market in the Asia Pac region. Government restrictions, introduced with the aim of deleveraging the economy, including by clamping down on the shadow-banking sector and raising the bar on onshore bond issuance, have led to many smaller real estate developers seeking mezzanine finance and considering off-shore sources.

This has been a boon to private equity companies. Infrared NF has extended more than US $650 million of mezzanine finance backed by Chinese assets. CapitaLand has also launched a US $750 million China debt fund to target mezzanine lending in China’s first and second-tier cities.

With a ban on developers using finance generated by the residential pre-sales of one project to fund the construction of another, and talk of the outright banning of pre-sales in some projects completely, the opportunities have grown further. The measure will lead to more funding gaps emerging, and therefore offer an opening for real estate investors to step into the breach.

For specialist investors with experience, China is also home to approximately RMB 2.2 trillion of non-performing loans (NPLs) and RMB3.6 trillion special mention loans, although the portfolios involved tend to be small scale. This hasn’t deterred Bain Capital, Lone Star, PAG, Oaktree Capital and KKR who have collectively spent around US $1.5 billion on NPLs in the past two years and have the ability and experience to recover the debt.

For others, the nuisance of attempting to recover the debt across a multitude of small assets in multiple cities may be enough to put them off, unless the Government regulates to help them enforce and recover the loans. There is also competition in the sector from domestic sources, as some of China’s largest developers look to snap up the debts of their rivals as a way of consolidating their positions.

For those that know what they are doing, Chinese real estate debt therefore offers big opportunities, particularly as average returns tend to be much higher than those currently available on government bonds. The potential returns must be weighed against wider political and economic forces, as well as the risk of default, but overall the more restrictions on domestic developers the more possibilities for international investors.

Further information

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