China officially launched publicly offered real estate investment trusts (REITs) in the infrastructure sector in 2020, seeking to invigorate the country’s large-scale infrastructure investment and financing market.
This could promote China’s new “dual circulation” development pattern, and it marks a milestone in the development of China’s capital markets and the guidance for equity investment in the infrastructure sector.
Figure 1: Structure of a typical REIT
Source: CICC Research
China’s REITs help create a market and pricing standards for infrastructure
Launch of China’s REITs could help create market for infrastructure. While some real estate-related assets such as warehousing and logistics facilities and data centers already have primary and secondary markets in China (despite being less mature and transparent), the investment and financing market for infrastructure remains almost absent.
As such, China’s REITs could play an important role in the establishment of an investment and financing market for China’s sizeable infrastructure assets. This may be a prerequisite for value preservation and appreciation of infrastructure assets, as well as marketization of infrastructure development, investment and management.
REITs and households
Overseas households have considerable exposure to REITs. According to relevant statistics, about 40–45% of US households directly or indirectly hold REIT products, mainly through pension funds. Some households directly buy REIT-related ETFs or publicly offered funds. Considering that equity REITs account for only 3–4% of the market cap of the US stock market, the allocation of US households to REITs is quite common.
Chinese households’ allocation to physical assets may have peaked and they could potentially allocate more to financial assets. In 2019, housing accounted for 59.1% of the asset allocation of Chinese households. Going forward, Chinese households could potentially allocate more assets to financial and capital markets.
Judging from the overseas experience, REIT products with stable returns could become an important part of the asset allocation for Chinese households. At present, Chinese households can only gain exposure to the real estate market by buying property. If China’s REITs expand to commercial real estate in the future, they could potentially provide Chinese households with more diversified, flexible and liquid options to invest in the real estate market.
Figure 2: Real estate accounted for almost 60% of total asset allocation of Chinese households in 2019
Source: PBoC, CICC Research
Figure 3: US households have balanced allocation between financial assets and real estate
Source: The US Fed Survey of Consumer Finances, CICC Research
Chinese investment institutions’ exposure to physical assets appears to have large upside potential
Chinese investment institutions still focus on bonds and stocks; their exposure to physical assets is limited but has upside potential. We find China’s leading long-term investment institutions only allocate less than 1–2% of their assets directly to physical assets (excluding quasi-bond non-standard products). This is mainly due to the underdevelopment of the relevant market. Development of China’s REITs and the entire infrastructure investment market may create new options for institutional investors’ asset allocation.
Investment in physical assets through funds and REITs could encourage direct financing
China’s physical asset investment shows strong characteristics of bond investment. Investment in physical assets through funds and REITs could better encourage direct financing, achieve effective risk control, gain access to the capital market, and support the building of specialized operation capabilities. At present, China’s real estate and infrastructure construction still rely heavily on the traditional model of “balance sheet and debt financing.” This model may not be able to meet the needs of sophisticated management given the increasingly complex market environment and investment targets, and may not be able to ease asset risks through reasonable diversification.
Formation of multi-level investment and financing system through capital market could be key. It may be necessary to improve the basic investment and financing model and promote the development of REITs (and fund manager models) to build a more flexible and suitable investment and financing system for real estate and infrastructure. This could be an important part of the supply-side reform in the physical market and the capital market.
In addition, it may also offer important opportunities for investors to further diversify investments and improve asset allocation. Given the considerable size of China’s physical assets, innovation of investment and financing tools and models may be important to the circulation of physical assets through capital market innovation that benefits both suppliers and investors.
For more details, please see our report China infrastructure REIT research series: The general report published in February 2021.