Key Takeaways
- We expect synergies to emerge between China's social housing initiatives and the country's infrastructure REIT market.
- Introducing social housing as an asset for infra-REITs is credit positive for the originators. While issuance would dilute ownership, the operators will continue to manage the assets and fulfill policy mandates.
- Limits on rental-income adjustments are an overhang for social-housing infra-REITs. Projects in higher-tier cities have better prospects for REIT listings than those in lower-tier cities, where demand for social housing is lower.
China's huge push to increase social housing may spur development of the infrastructure REIT market. S&P Global Ratings expects the number of social housing infra-REITs could double over the next 18 months and has potential to expand further.
We believe the markets have synergies. Infra-REIT listings could facilitate delivery of the social-housing mandate. Asset recycling supports originators by making asset-heavy investments less burdensome and accelerating future social housing projects. In addition, listings can help these originators to deleverage; most of the issuers are state-owned enterprises (SOEs).
However, not all social housing projects can fulfill the listing requirements, and one of the key constraints is return requirements. We consider projects in higher-tier cities to have better economics or at least sufficient returns to unit holders, but similar propositions may be hard to establish for lower-tier cities.
Another key issue is the financing cost. Alternative financing channels include low-rate bank borrowing from policy banks or even commercial mortgage-backed securities (CMBS). These options may lower incentives for state-owned sponsors to choose infra-REITs. Though listings can provide lumpsum funding to the originators, they also dilute the ownership.
Social Housing Scale And REIT Development Could Expand
More social-housing is on the way. To alleviate urban housing issues, including affordability, China has already built more than 80 million units of social housing and "shantytown relocation" up until 2021. Its five-year plan covering 2021-2025 targets the completion of 9 million new social housing units.
This undertaking will be costly, with the government planning to invest up to about Chinese renminbi (RMB) 3 trillion.
One emerging funding avenue is via REITs. Social housing is one of eight sectors allowed to list on China's infra-REIT market, with a total valuation of up to RMB9.4 billion, measured at the time of listing. However, this niche currently constitutes only a small portion of the pie to both the national social housing market and the infra-REIT market.
Per our tracking, five more listing proposals are under review (including two expansions to existing REITs).
Table 1
| China has only six listed social-housing infra-REITs thus far | ||||||||
|---|---|---|---|---|---|---|---|---|
| Infra-REIT | Launch date | Location of social housing | Original owner | |||||
| Hotland Innovation Shenzhen Anju REIT | Aug, 2022 | Shenzhen | Shenzhen Public Housing Group Co. Ltd. | |||||
| CMF Zhaoshang Shekou Rental Housing REIT | Sept, 2024 | Shenzhen | China Merchants Shekou Industrial Zone Holding Co. | |||||
| Guotai Junan city investment closed end fund | Dec, 2023 | Shanghai | Shanghai Municipal Investment (Group) Corp. | |||||
| CICC Xiamen Affordable Rental Housing Infrastructure-Fund | Aug, 2022 | Xiamen | Xiamen Affordable Housing Group Co. Ltd. | |||||
| China Beijing Affordable Housing Center Rental Housing-Fund | Aug, 2022 | Beijing | Beijing Public Housing Center | |||||
| China Resources Youchao REIT | Nov, 2022 | Shanghai | China Resources Land Ltd. | |||||
| Source: S&P Global Ratings. | ||||||||
Of the six listed social housing infra-REITs, the average occupancy rate is very high (over 94%), and most of these assets have a three-year operating history, as required. They are generally located in wealthier and larger cities such as Beijing, Shanghai, and Shenzhen.
In our view, the future of social housing infra-REITs does not just depend on the size of the underlying market. The ability to demonstrate a track record and gain market acceptance will be critical for their expansion, similar to the development of China's commercial REITs (see "Why Have China C-REITs Started So Slowly?" Aug. 07, 2024)
The Originators Benefits From REIT Listings
Proceeds from listing can help originators to further invest in social housing
Infra-REIT issuances could help asset owners by establishing an offloading channel. This allows entities to lighten their asset load and focus on investing, financing, building, and managing. They can then use the proceeds to accelerate future investments. We estimate they have raised a total of RMB6.5 billion thus far, likely going into more project construction.
Stable income to originators as property managers
Operators continue to fulfil their responsibilities to manage assets and implement government policy mandates, even as their shareholdings are typically reduced to 20%-50%. We expect the originators retain operating rights of the listed assets.
Managing social housing projects generates stable cash flows, which supports the continuous business transformation of these state-owned entities (SOEs) to become more commercially self-sustaining.
Table 2
| China listed REITs make some of their earnings through management fees | ||||
|---|---|---|---|---|
| Infra-REIT | Management fees in 2024 (Mil. RMB) | |||
| Hotland Innovation Shenzhen Anju REIT | 4.7 | |||
| CMF Zhaoshang Shekou Rental Housing REIT | 3.4 (3 months only) | |||
| Guotai Junan city investment closed end fund | 6.1 | |||
| CICC Xiamen Affordable Rental Housing Infrastructure-Fund | 12.7 | |||
| China Beijing Affordable Housing Center Rental Housing-Fund | 13.6 | |||
| China Resources Youchao REIT | 11.7 | |||
| RMB--Chinese renminbi. Source: S&P Global Ratings. | ||||
Chart 1
Equity financing helps to deleverage
For all these listed REITs, their distribution rates depend on the operating cash flow received and are not fixed like debt instruments. This approach alleviates some pressure on project liquidity if operating performance falls short of expectations.
The originator could lock in project return and mitigate volatility of future cash flow, such as decline in rent collection or occupancy rates.
Originators often seek to replace existing debt associated with the social housing with private capital during the listing process. A lot of these underlying assets are previously booked at historical costs. Listing, often done with asset revaluations, will typically generate gains on those assets. Projects with higher asset values can often attract more capital investments from investors and can pay off the debt more easily.
Our analysis of the listed projects indicates that their external debts were fully repaid before or upon listing as infra-REITs. The fiTst six listed social housing infra-REITs reported valuation gains (a proxy to value above the project development costs) from 1.1x to 3.0x (see chart 2).
Chart 2
Not All Social Housing Projects Suitable For Listing
Likely higher tier cities more commercially viable for these REITs
Project assets of the six listed REITs are all in higher-tier cities. However, considering the majority of social housing is in lower-tier cities, this could hinder the pace of development of social housing infra-REITs and their effectiveness in driving investments.
We believe assets from lower-tier cities or less-developed locations generally have weaker stand-alone financial conditions. Even with lower project development costs outside top-tier cities and discount on land prices, it may not compensate for the significantly weaker rental performance. And that means higher leverage and poorer returns.
For example, we estimate some social housing projects in lower-tier cities generate annual gross rental income of merely 2% against their total assets. In contrast, the six listed infra-REITs have ratios ranging from 5% to 20%, barring any ongoing government subsidies. This disparity is largely due to average unit rental price of top-tier cities being approximately 8x that of that of lower-tier cities, by our estimates.
Cost of capital is another key issue
Equity financing is often more expensive than the debt financing available to SOEs in a priority sectors such as social housing, particularly in the low-interest rate environment in China.
Potential originators in this niche are typically state-owned and should be able to secure long-term, low-cost financing at rates of 2%-3% per year, likely from state-owned banks or the CMBS market. In contrast, infra-REITs must target an annual payout yield of 3.8% or more in the first three years, according to listing requirements. Although the payout is based on asset performance and is not strictly guaranteed, it usually results in a higher cost of capital (see chart 3).
Chart 3
Additionally, originators will be liable to pay capital gain tax on any valuation gain, which also adds to their total transaction costs.
Non-financial considerations include strict requirement for financial reporting and disclosure on public-offered infra-REITs, which enforce regular reporting and transparency to the market.
Dovetailing Interests And Mutual Benefits
Infra-REIT listing is a viable funding option for originators or asset owners in social housing. This asset recycling method can give SOE originators an equity funding element that in turn spurs more social housing investment. Policy support could also add an impetus, given the mutual benefits to various reform and development targets.
For example, local governments and their SOEs have an incentive to structure social-housing projects with visible net positive cash flows. Incentives such as favorable terms like discounted land prices, capital injections and/or low-cost financing. Doing so would help them meet reform mandates for SOEs to be more commercially minded and less reliant on government budgets.
If meaningfully expanded, synergies could emerge. SOEs can become more self-sustaining, China's infra-REIT market could get more traffic, and local governments could, over time, attract more private capital to help them undertake the colossal responsibility of building out the country's housing infrastructure.
Related Research
- Why Have China C-REITs Started So Slowly? Aug. 7, 2024
This report does not constitute a rating action.
| Primary Credit Analyst: | Kendrew Fung, Hong Kong + 852 2533 3540; kendrew.fung@spglobal.com |
| Secondary Contacts: | Christopher Yip, Hong Kong + 852 2533 3593; christopher.yip@spglobal.com |
| Ricky Tsang, Hong Kong (852) 2533-3575; ricky.tsang@spglobal.com | |
| Research Assistant: | Harry Yuan, Hong Kong |
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