Chinese real estate PE funds begin to do genuine equity investment
Tighter regulation, end of boom has led to change in business model
Finally, Chinese real estate private equity funds are choosing to carry out the business they were intended to.
Until very recently, so called “PE funds” in China have simply channelled bank funding to developers in the name of “equity” investment.
But contrary to what the name “equity” suggests, they have carried little risk, as developers usually promised a fixed return.
They have become part of China’s vast shadow banking system, which sits cozily between bank funding and developers’ offerings, with little effort invested into active management.
A string of government measures to curb the banking sector since late last year have become unviable, or come to an end.
In February the authorities indeed banned asset managers from channelling funds to real estate investments in 16 major cities. And in May, the regulators’ probe on trust firm financing to developers forced those companies to halt the activity.
To survive, most PE funds shifted to a model that mixed debt and equity investment, with carefully designed terms created which avoided being considered by the regulators as “loans”.
Duan Kejian, executive vice-president of Realway Capital, a Shanghai real estate PE fund that manages about 10 billion yuan ($1.48 billion), said his has stopped offering “purely debt” financing altogether, while shifting to “equity-plus debt”, which means the fund launches a limited partnership company with a developer, normally becoming the second-largest shareholder (usually with a 20 to 30 per cent stake) before injecting more “debt” into the company.
Kejian said the fund will boost the equity part, because that’s where the most profit comes from.
“Handling debt is like acting as a fund carrier, and you only gain a thin spread. When the market is good and developers earn fat profits, it’s none of your business.
“So from now on we will not do it unless we can split profits between developers,” he said. “Debt is about quantity, while equity is about profit.”
Most established funds share Realway’s strategy.
Zhang Chuanxi, a director with the Five Bulls Fund, which manages 30 billion yuan in assets, said the heyday for debt investment was when the market rallied and developers could afford high-fixed returns, usually over 10 per cent, on their PE funds. Now developers’ margins have thinned.
The shift from debt to equity is not just about regulation, but also about the market.
Jiang Nan, senior vice-president with Goldstone Investment, a PE fund under Citic Securities which manages 70 billion yuan worth of assets under management, said funds do not “chose” to do debt financing, because during boom times, big developers with good projects wouldn’t allow funds to take equity stakes, while those who would, tended to be turned away by funds.
Xie Ping, the president of Yinghan Assets, said the current market actually offers great opportunities to funds with active management capability, but as trusts they are barred from financing developers during land acquisition phases, for instance. PE funds can actually do this, as shareholders.
Zhang agreeds that PE funds should look for companies that don’t have high corporate credit ratings, but standalone projects are good, and that requires professional judgement.