China property

Funds must adjust to less returns in China’s property investments

One of China’s largest real estate private equity funds says 10 per cent would be a ‘good’ return

PUBLISHED : Tuesday, 01 August, 2017, 5:02pm
UPDATED : Tuesday, 01 August, 2017, 8:05pm

Grand China Fund (盛世神州), one of the largest real estate private equity funds in China with investment in the mainland and the US, has cautioned that funds investing in the mainland’s property market need to accept a lower return as the days of fat margins are over.

“Consensus within the industry is, long gone are the days when a big fortune is secured as long as you get a plot [of land]. At that time, developers can accept high-cost funding from PE funds, but when their margins were squeezed thin, they cannot afford such funding,” said Li Wanming, CEO of Grand China Fund, which manages over 20 billion yuan of renminbi-denominated assets and US$1.5 billion of US dollar assets.

Li said in the company’s early phase of development five years ago, debt financing for developers, which was almost risk-free, could yield an annualised 20 per cent, or even 30 per cent return, as the borrowers’ returns could be much higher because of the surging home prices and high leverage.

At present, the fund’s average 10 per cent yield was considered “good” by industry standards, he said.

Li said during the 2010 to 2013 boom for private equity (PE) funds, funds even struck profit-sharing agreements with developers, based on the selling prices.

For example, for flats that were sold for under 5,700 yuan per square metre, funds earned a basic return. But when the selling price reached between 5,700 and 6,000 yuan, funds earned a 20 per cent of the additional earnings, and when prices exceeded 6,000, the percentage shrank slightly.

With selling prices rising continuously, it came to a point where developers became reluctant to agree to such terms, and only agreed to fixed returns.

Consensus within the industry is, long gone are the days when a big fortune is secured as long as you get a plot [of land]
Li Wanming, Grand China Fund

But with increased risks in the current property market, coupled with the government’s cooling measures, the preference has returned to a performance-based profit-sharing structure, where funds pick projects based on risk analysis.

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Li said one of Grand China’s strengths was that some of its major shareholders are big developers, including Sunshine 100 China Holdings and Forte Group.

This means that when a project runs into difficulty, the fund can pass it on to the right developer to take over the development.

The fund operates on two business models: cooperation with listed developers and unlisted smaller developers, where in the latter, it would be actively involved in the management.

Active management means being involved in overall planning, product positioning, pricing and major tenders. Two representatives of the fund would be assigned to the project company to oversee the financial and engineering aspects. All matters in these areas would require the approval of the two representatives.

Grand China has been involved in 33 domestic projects since 2010, and invested in 22 US projects since it first entered that market in 2012.

The US projects, cooperations with local partners that include apartment buildings, student apartments in New York, Dallas, Huston, Orlando, have delivered annualised returns of over 15 per cent.

The partnership formats include a minority stake in the projects for the partners, or outsourcing property management to a local firm.