China's easing of the rules on infrastructure REITs won't meaningfully address LGFV debt, in our view. Local government financing vehicles (LGFVs) from developed regions have limited need for the instrument. Those from less affluent regions have few REIT-eligible assets.
What's Happening
In July 2024 China's economic planner, the National Development And Reform Commission, announced decree 1014 promoting wider REIT adoption. We believe the new rules were aimed at bringing liquidity to asset-heavy sponsors.
- The decree expanded the assets that could be injected into trusts including certain tourism properties, elderly care facilities, some rental housing, and some industrial properties that are inseparably linked with commercial assets.
- The decree also removed a minimum return and yield requirement on new REITs.
- It allows sponsors to use a maximum 15% of proceeds from the REIT listing for working capital, from a prior cap of 10%.
Why It Matters
By some estimates, China's LGFVs collectively have more than Chinese renminbi (RMB) 180 trillion in total assets, as of end 2023. In theory, REITs could be a useful tool for monetizing these assets, aiding in deleveraging.
In practice, however, LGFVs and local state-owned enterprises have listed 24 REITs that have raised just over RMB80 billion since China piloted the instrument in 2021, a fraction of their funding needs. The REITs' underlying assets were just 2% of the sponsors' total assets.
The listed REIT assets are mainly based in developed provinces or larger, more affluent cities. These LGFVs are least in need of liquidity from a REIT. Such sponsors have diverse, low-cost funding options to manage leverage and new investments. They would also likely opt to hold onto core profitable parts of their portfolios, as these could be leveraged more cost-effectively than by structuring the assets into a REIT.
Chart 1
LGFVs and local SOEs from less affluent regions with keen deleveraging need could plausibly benefit from the instrument, or indeed any instrument that raises their liquidity. However, the entities have yet to embrace REITs, for these reasons:
- Government toll roads, which account for most toll roads in less developed regions, are not yet eligible for REITs. Industrial and tourism assets typically are of subpar earnings quality.
- The cap on government subsidies at 15% of the project revenue limits eligible assets, given the high use in those regions of public-private-partnership projects, which often rely on subsidies.
- Mixed ownership and debt encumbrance complicate asset separation.
- Sponsors can only use up to 15% of REIT proceeds for working capital, which limits their use to repay debt.
What Comes Next
After listing, China LGFV-sponsored REITs face the following challenges:
- Geographically concentrated assets that compete with nearby assets likely owned by the same sponsors.
- Inflexible pricing of government-regulated toll tariffs and rentals limits upside.
- A conservative regulatory leverage cap (by which total assets can be no higher than 140% of net assets) and limited retained cash constrain portfolio rejuvenation.
- Fund managers typically don't have a strong say in constructing the portfolio relative to the sponsors.
We believe there will be a slow but steady take-up of REITs given the policy push and the political backing. Although eligible assets may not be significant against large existing stock, REITs could make a meaningful difference for raising funds for new projects.
Background In Brief
The Chinese government has carved out a category of trusts that it labels "infrastructure REITs". This is something of a misnomer, in that they mix infrastructure into a real estate investment trust. The underlying may include transport (e.g. toll roads), utilities (e.g. renewables, high efficiency coal-power, water and waste treatment facilities) and other assets (e.g. elderly care facilities, tourism assets).
Editor: Jasper Moiseiwitsch
Related Research
- Credit FAQ: Why Have China C-REITs Started So Slowly? Aug. 8, 2024
- Where Are China's Overinvestment Risks? Aug. 7, 2024
- China Infrastructure REITs Inch Toward The Fast Lane, Nov. 28, 2022
- China's Infrastructure REIT Market: From Slow Start To Big Bang? Oct. 22, 2020
This report does not constitute a rating action.
| Primary Credit Analyst: | Yuehao Wu, CFA, Singapore + 65 6239 6373; yuehao.wu@spglobal.com |
| Secondary Contacts: | Christopher Yip, Hong Kong + 852 2533 3593; christopher.yip@spglobal.com |
| Charles Chang, Hong Kong (852) 2533-3543; charles.chang@spglobal.com | |
| Research Assistant: | Shuyang Liu, HANGZHOU |
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