Private real estate investment opportunities are expected to emerge in China as the country’s most heavily leveraged property developer, Evergrande, offloads assets to meet liabilities.
In August, China’s central bank and banking watchdog issued a rare warning that Evergrande needed to reduce its debt risk and prioritize stability. That same month, the property developer warned in an earnings report that it might not have sufficient cash to pay its debts. Sitting on a reported total debt of $88.5 billion, and $300 billion of liabilities, the real estate developer had missed its third bond payment in three weeks at press time while cracks were beginning to appear with other indebted Chinese property firms – all of which could have serious implications for China’s economy more broadly.
Private real estate firms might be in a position to capitalize on Evergrande’s troubles.
“Where there is smoke, there are opportunities,” Richard Yue, chief executive and chief investment officer at Hong Kong-headquartered real estate firm Arch Capital, told affiliate title PERE.
Non-bank financing could be one area of opportunity for private real estate firms. With fears of having another Evergrande on their books, banks are expected to become more cautious in lending to real estate developers. China CITIC Bank, for example, is among those scrutinizing real estate loans more carefully, Reuters reported. Private real estate firms could step in to fill the gap left by traditional lenders.
A managing director at a North America private equity real estate firm told PERE that opportunistic buyers can also expect Evergrande and its peers to offload some of their better-quality assets over the long term. Indebted real estate developer R&F Group is one such business, having sold a majority stake in the Greater Bay Area’s largest urban logistics park to Blackstone for $1.1 billion last year in a bid to deleverage itself.
Still, real estate participants aren’t expecting any large-scale fire sales. “When the government is helping and giving these developers relief, they are not going to sell cheap,” a senior executive at a pan-Asia private real estate firm told PERE on condition of anonymity. The executive observed that there has not been significant distressed sales stemming from the bankruptcy of Chinese conglomerate HNA Group this year.
A CBRE report also suggested Evergrande’s situation could play out like that of HNA Group, which has been embroiled in a lengthy restructuring process with state-owned enterprises over the past year. Last week, Chinese media website Cailian reported that Guangzhou-headquartered Hopson Development was in the process of acquiring a 51 percent stake in the property management division of Evergrande. This was an early hint of the Evergrande restructuring process being anticipated by the market.
Henry Chin, global head of investor thought leadership and head of Asia-Pacific research at CBRE, does not expect the prices of hard assets in China to drop like they did in the US during the global financial crisis. This is because China’s banks are largely SOEs and therefore more tightly controlled than they would be in the US. While many opportunistic investors are hoping to take advantage of significant price drops, Chin did not anticipate that happening.
Indeed, private investors may be unable to access Evergrande’s residential projects – which represent the bulk of its businesses – due to increasing government controls. Beijing has pushed to slash residential developers’ excess leverage as of late to ensure that houses are “for living in, not for speculation,” according to CBRE. China also banned domestic private equity funds from raising money to invest in residential property developments in August as it attempts to deleverage the sector.
“When you are restricted by the prices and the speed you can sell at, you are taking the free market forces away and this makes it very difficult for private equity real estate firms to underwrite market risks,” Arch’s Yue said.
Investor responses to the situation have so far been mixed, Yue added. “Some investors might pause as there might be too much risk and uncertainty in the system while other investors who are longer-term and bullish on China might find this to be an opportune time to find good assets in non-residential sectors being released by the developers at more reasonable prices,” he said.
Regardless, Evergrande’s troubles are a reminder that investors must tread cautiously in China at present. “The macro risk is higher so we have to de-risk as much as we can on deals,” the managing director source noted. “We need to be much, much more careful, much more selective.”
This article first appeared in affiliate title PERE