February 20, 2017 / 2:30 AM / 6 months ago

'Quasi-REITs' catch on in China

* Central bank adds its backing to emerging asset class

* Interbank bond market opened to 'quasi-REITs' on case-by-case basis

* Move allows investors to monetise rise in property values

By Ina Zhou

HONG KONG, Feb 20 (IFR) - China's central bank has authorised the first sale of a "quasi" real estate investment trust (REIT) in the vast interbank bond market, in a move that greatly expands the investor base for the new asset class amid rising commercial property values.

State-owned Anhui Xinhua Media last week launched Industrial Wanxin Jiayue Real Estate Investment Trust Fund ABS, a 553.5 million yuan ($81 million) quasi-REIT structured like a securitisation, which may well be a precursor to the eventual launch of a listed REIT market in China.

After a series of private placements and one stock exchange listing, analysts have welcomed the introduction of the new format to the $7 trillion interbank market, home to the bulk of Chinese fixed income securities and regulated by the People's Bank of China (PBoC).

"PBoC's approval of Anhui Xinhua's transaction was on a case-by-case basis," said a Beijing-based ABS analyst. "It is uncertain whether more quasi-REITS will follow in the interbank bond market, but PBoC definitely wanted to add the new asset class into the interbank bond market."

The internationally recognised REIT format, where the trust has full ownership of the assets and sells equity units to the public, does not exist in China, due to hurdles like a lack of a clear legal framework, as well as double taxation.

While an equity listing is not yet possible, property owners in recent years have begun exploring the use of securitisation techniques to monetise their assets and access funding.

Around 16 similar quasi-REITs have raised funds in the stock exchange market in the past two years through private placements, including a twin issue from Anhui Xinhua Media in December, illustrating the growing interest from both investors and corporations – mainly property developers and commercial property operators.

The only public listing of a quasi-REIT was in Shenzhen in June 2015, when Penghua Qianhai Vanke REIT sold securities backed in part against a portfolio of office buildings from China Vanke. Up to 50 percent of its assets are fixed income securities rather than direct property holdings.

Underwriters said such quasi-REITs gave investors access to gains from commercial property assets at a time when China's commercial property market kept rising.

While regulators have placed tighter controls on financing for residential property developers since late last year, commercial developers are not as tightly controlled, according to the analyst.

For issuers, quasi-REITs receive off-balance-sheet treatment, while securities backed with rental incomes or property management fees do not. The format also allows issuers to raise more capital than a more conventional securitisation.

"Anhui Xinhua's issue targeted institutional investors rather than the public, so, in that sense, we still saw it as a quasi-REIT, although it resembles a standard overseas REIT in many ways," said a securitisation lawyer. COMPLEX STRUCTURE Given the complexity of the transaction, Industrial Bank, the sole lead underwriter, spent three months meeting potential investors one on one.

To put it simply, Anhui Xinhua's transaction packaged eight buildings, where its bookstores are tenants, alongside other shops, into a real estate investment fund and then raised 553.5 million yuan through securitisation of all the fund units in it.

Establishing a real estate investment fund allows the originator, Anhui Xinhua, to float equity in the fund in the future when a real REIT market forms.

On closer inspection, the underlying assets of the securitisation include not only equity, but also debt. Such a design, underwriters said, was intended to help reduce tax payments.

The proceeds of 553.5 million yuan from the securitisation were used to buy 100 percent of the five investment companies that own the eight buildings and to lend 368.5 million yuan to them.

Interest payments on the loan are tax-deductible in China, while dividends are not.

The securities comprise two tranches - a 330 million yuan senior A tranche, rated AAA, with a maturity of 18 years, and a 223.5 million yuan senior B tranche, rated AA+, with a maturity of 18 years.

Tranche A priced at 4.8 percent and B at 5.4 percent, both towards the wide end of indicative price ranges of 4–5 percent and 4.5–5.5 percent, respectively.

At the end of every three years, holders of the A notes have the option to redeem the securities, and the issuer has the option to adjust the coupon.

At the same time, Wanxin Leasing, a sister company of Anhui Xinhua Media with the rights to the rental income from the eight buildings, has an option to buy back the B notes at par.

Embedding Wanxin Leasing into the transaction is primarily intended to prevent the loss of control over state-owned assets (the eight bookstores), according to a banker familiar with the deal.

Payment to investors of both tranches ultimately depends on rental income from the eight buildings and asset values of the properties.

In China Chengxin's estimate, rental income from the eight bookstore buildings can easily cover payments to investors of both tranches.

While holders of the A tranche are first in line for repayment at maturity, B tranche investors are paid after the payment to A tranche investors, assuming there is no early redemption or a public listing.

If the property value of the eight bookstores goes up through the life of the securities, B tranche investors will get more than the principal and interest payment, and vice versa if the value drops. (Reporting by Ina Zhou; Editing by Steve Garton and Vincent Baby)

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