Finding opportunities in Chinese property

For many years, China’s real estate sector was at the forefront of the country’s development, accounting for as much 20% of its overall economic activity¹. But starting in 2020, the fortunes of this monolithic industry began to turn and housing quickly became a major headwind for the economy. Homeowners started to see the value of their house decline, with a year-on-year fall in 4.9% house prices as of July².

Despite this gloomy backdrop, there are still attractive opportunities in Chinese property – especially for investors in private assets. Where to find openings in the market was the subject of a panel discussion at the HSBC 11th Annual China Conference, held in Shenzhen in September.

Distressed debt

The challenged real estate market creates opportunities for specialists in distressed debt to find deals where they can lend to property owners at an attractive rate, using a valuable real estate asset as collateral. They can also purchase assets at a discount price from owners that need cash quickly.

The ideal asset is one that is performing well, with positive cashflow, but which is owned by a company that is under financial stress. The owner may have, for example, borrowed too much money, forcing them to put their better assets on the market.

“We want to buy the crown jewels, and not the underperforming assets,” said Rebekah Woo, Limited Partner and Limited Partner Advisory Council Member of ShoreVest Partners.

The scale of the downturn is so large that investable assets with healthy cashflow are available across the entire property sector – from residential and commercial, as well as newer categories such as hospitality. The current environment has also opened up new geographies for distressed debt investors who seek deep value pricing.

Renting for longer

Although the market for new apartments is under stress in China, there are still pockets of opportunity in residential property – especially the rental market. This is mostly due to changes in the structure of Chinese households, with people staying single for longer.

In 2010, the average age for getting married was 24. By 2020, it had risen to 28.7 and was as high as 30 in some provinces³. A natural consequence of this demographic trend is that couples are also having children later in life.

Marriage is a major catalyst to buy a property; the home where a couple will start a family. Single people and unmarried couples do not have that sense of urgency and are therefore putting off buying a property.

Another reason that people are delaying getting on the property ladder is the downturn in the market, as today’s twentysomethings are the first generation to see house prices come down. They know that real estate is not a guaranteed path to wealth generation, and they are waiting for the market to turn around.

Even though young Chinese people are postponing buying the first property, they still need somewhere to live, and they are increasingly meeting their housing needs by renting for longer.

The panel discussed how the rental market provides an opening for institutions to work on rental projects. This is still a very new sector of the market in China. Even in the biggest cities, like Beijing and Shanghai, there are very few institutions acting as landlords on large developments.

Developers are interested too, and some are asking for permission to rezone the commercial part of the developments as rental units. The main problem they face is raising the necessary capital, which can be provided by an institutional investor.

Realising retail opportunities

Away from residential property, retail stands out as an attractive segment of the real estate market. This might sound counterintuitive considering the concerns over a consumption downgrade in China, as well as deflationary pressures, said Randolph Zhao, Managing Director, Real Estate Equity, KKR.

But he pointed out that the cycle for retail property peaked much earlier than residential property. The top for retail properties occurred in the first half of the last decade, when ecommerce started to disrupt the business model of traditional bricks and mortar stores. Then came the pandemic, which put more pressure on shopping malls, as Covid restrictions further reduced foot traffic.

As a result, shopping malls have adapted to the new environment. They are less interested in tenants that sell luxury goods, but more towards food and beverage outlets, as well as family focused services – such as tutoring centres and soft-play areas.

Mr. Zhao described the ideal retail asset as a shopping mall in a central location surrounded by a strong catchment that has survived the downturn and renewed its offering to meet the needs of nearby residential communities that provide sticky customers. And from a broader investment perspective, the risks are now relatively small.

“Rents are low enough that I think that the downside risks are much more manageable,” he said. “I would argue that today’s environment for retail is actually much better than two or three years ago during the pandemic.”

The potential to find attractive assets in the retail space, along with the nascent rental space, shows that there remain pockets of opportunity in China’s troubled real estate sector. The investors who are able to do the necessary research and find the right assets on the ground, will be the best placed to capitalise on this challenging market.