Funds eye Risky Chinese Property, But Deals May Be A Year Away

HONG KONG (Reuters) – Property investors are pencilling “second-half, 2009” in their diaries as the likely time to start pouring money into China again as they search for bargains in its ailing real estate market.


But they are wary of slowing economic growth, overbuilding in some areas, difficult partnerships with developers and red tape.


Private equity fund manager Gaw Capital Partners is looking to raise up to $1.5 billion for Chinese property, while ING Real Estate is marketing a $750 million fund it wants to launch in the first quarter of next year.


“I think it’s a good time to start looking,” said Goodwin Gaw, co-founder of Gaw Capital, which manages $4.7 billion of assets in 14 Chinese projects. “2009 and early 2010 could be a sweet spot.”


Many among the 540 investor groups at the MIPIM Asia property conference in Hong Kong last week pinpointed China as the market that would recover quickest from the global economic crisis because of growing domestic demand for housing and office space. And they are keen to raise funds to prepare.


Behind the enthusiasm is a hope that capital-starved property firms will offer plum investment deals to foreign investors looking for internal rates of return of 25-30 percent.


Chinese developers are suffering because capital markets have clammed up and banks clamped down on loans to the industry as part of government efforts to stamp out property speculation and cool the economy.


Beijing’s moves sparked property price slides of as much as 20-30 percent in some cities, particularly in the south. Now, faced with cooling economic growth and the prospect of higher unemployment rates, the government is back-pedalling, trying to stimulate the housing market to boost domestic demand.


“We don’t see them taking the brakes off completely because they still want to encourage affordability,” said Nicholas Brooke, the chairman of consultants Professional Property Services.


“They had a nice Chinese way of managing things. But then they get the financial crisis on top of it. That has rather thrown out their planning.”


Investors and developers are now eschewing the luxury end of the housing market, which was the most lucrative and speculative segment in recent years, and are targeting mass-market housing. They also favour “second tier” cities such as Chengdu, Chongqing and Dalian.


Beijing, afraid of social unrest, has tried to promote construction of low-cost housing and stop prices spiralling out of sight for average urban residents.


“You have got to go in the direction of the government — don’t fight them,” Gaw said.


China has announced 4 trillion yuan ($586 billion) in fiscal stimulus measures, with 800 billion yuan going to low-income housing and 1 trillion yuan on infrastructure spending.


While economists admit they do not know how much is new spending, they believe more steps are in the offing — probably tax and interest rate cuts and perhaps more spending in earthquake-hit Chengdu.


Fund managers say they are still seeing demand for China exposure from U.S. and European investors, as well as sovereign wealth funds, who are bullish on the country’s future despite the current economic slowdown.


In 2007, China overtook the United States as the greatest contributor to global growth. Although its economy is still four times smaller than the United States, China has been growing at an average annual 11 percent rate since 2005.


And even if economic growth slows to 7.25 percent or 7.5 percent in the next couple of years because of slowing exports, as some economists predict, urbanization and the emergence of a middle class will still spur housing demand.


China is one of the few markets in Asia, along with Japan and South Korea, that offer the kind of scale that would attract institutional investment, said ING Real Estate’s Asia chief executive, Richard Price. But investment also carries dangers.


“In second-tier or third-tier cities, you could not only not make returns but walk away from equity,” Price said.


Among the risks are red tape associated with setting up a company to invest in China and repatriating profits, and oversupply in some areas — for example, office blocks in Beijing, and shopping centres in major cities.


“There are 200 shopping centres going to be built in China and India over the next two years,” William Glover, the Hong Kong-based international director of property recruitment consultancy MacDonald & Co., said. This crisis “is not all about investment banks”.


As big, established listed companies are now desperate for funds to finish their projects, foreign funds are no longer limited to hatching deals with shady small developers.


But having heard many horror stories, many investors are wary, including Tim Grady, who is in charge of Merrill Lynch’s new $2.65 billion fund for Asia property.


“I can give you the best building in Shanghai, for free, with a bad partner and it will end in tears, recriminations and law suits,” Grady said.

By Alex Frew McMillan
($1=6.830 Yuan) (Editing by Kim Coghill)