Sunday, January 27, 2008

One Reason REITs are Slow to Develop in China

One headline this morning that is sure to keep the CSRC from accelerating any plans to put out any legislation on REIT formation on the mainland comes to us from Hong Kong. Apparently former Link Chairman Paul Cheng-Ming-fun affirmed what many believed was the reason he left China's most famous REIT, the Link REIT. He said that indeed, the motion by Link's largest shareholder, The Children's Investment Management (TCI) to accelerate rent increases on smaller shareholders went against Mr. Cheng's ethical standards of conduct and he refused. So, the REIT ousted him and the Chief Executive officer Victor So in favor or two westerners.

Mr. Cheng's reasoning was that the majority of the rents would affect smaller retailers. Indeed, Hong Kong's democratic-style government did not disrupt these retailers when they protested the steep rental increases.

A year later, the protest seems meaningless in monetary terms as the rents are going up steeply as Hong Kong's commercial real estate vacancy rates dipped to a five-year low at under 3% (and the boom has also prompted a five-year high of over 400,000 square meters of planned commercial office space to come on market in 2008 (CBRE)).
There is no doubt that the regulators in Beijing understand that REITs are a very sophisticated type of fund. Sam Zell's goal when he created REITs in the 1960s, other than to make colossal returns, was to "enable to average investor to enjoy returns from the country's most prime office buildings." That's fair. The only problem is that this is land - not factories, not energy, not widgets, not commodities, not foreign exchange. How can the government possibly enact legislature for packagin 10 buildings together when it still has not figured out how ownership for even one building plus the land underneath is to be clearly defined? Furthermore, there is such tremendous pressure on the central government to keep speculators from buying up and building on more land, that the very last thing they need to worry about is greedy fund managers cornering 10 buildings in Lujiazui and then unilaterally forcing up rents and wrestling away what little control the government still has over rental rates. They already have the protests to worry about all over the countryside. Center-urban protests would just add insult to injury.