China Ponders Launching a REIT Market

Two types of potential REIT markets have been mentioned in China, each sponsored by a different Chinese regulator. The key differences are in the ownership structures and the markets where the REITs will be traded: one in the financial markets regulated by the China Banking Regulatory Commission, and the other in the equity markets regulated by the China Securities Regulatory Commission.

By Howard Roth, Global Leader of Real Estate, Ernst & Young L.L.P. & Howard Altshuler, Partner, Ernst & Young, China

China has been considering whether to establish a REIT market for some time. A January 2009 announcement by the State Council Information Office revealed government plans to launch REITs, but no timetable for the launch was specified. The government, however, is pushing the REIT model forward, and several Chinese companies have started the process of moving toward REIT status and are working on assembling properties and getting funding.

Two types of potential REIT markets have been mentioned in China, each sponsored by a different Chinese regulator. The key differences are in the ownership structures and the markets where the REITs will be traded: one in the financial markets regulated by the China Banking Regulatory Commission, and the other in the equity markets regulated by the China Securities Regulatory Commission.

The CBRC REITs will be owned by financial institutions and traded on the interbank exchange. Participation in this market is expected to be more akin to financing than equity ownership. The CSRC REITs, on the other hand, will be owned by the public and therefore similar to the REIT markets that exist in other countries. It is anticipated that the CBRC REITs will go forward first as they have fewer regulatory hurdles to clear than the CSRC REITs do. However, the CSRC REIT market will probably become the more substantial one in China as there is ultimately likely to be a larger market for the public than the banks. In addition, the banks can accomplish a similar outcome with bonds and other financing without the burden of maintaining REIT status, which is an issue faced by most jurisdictions with REIT legislation. That said, neither is going to attract much traction from private owners until the tax laws are changed so that a sponsor can contribute properties to a REIT without triggering taxes associated with a sale.

Whether the CSRC REIT market will be available to foreign investors will depend on whether the stock market in China (i.e., A shares) is open to foreigners. Currently, foreigners can invest in the stock market, but it is difficult, especially since the yuan is not freely convertible. If the overall market opens up, there is a possibility that foreign investors could participate. The question is whether there will be investment appetite from offshore. At this stage, it is too soon to tell. At a high level, many are cautious about investing in China because the market still lacks transparency, has not fully implanted international accounting standards and demands an understanding of the local ways of doing business. At the REIT level, it will also depend on how the REITs are structured (e.g. with large or concentrated portfolios). Early discussion suggests that the REITs will have a large portfolio of properties. In addition, there will be uncertainties regarding tax issues. Although Chinese REITs will likely be tax pass through entities in China and dividends paid to foreign shareholders, there will likely be subject to withholding taxes, regardless of the tax position of the holder.