April 9, 2018 / 11:13 PM / 3 months ago

Chinese real estate firms boost apartment rentals in line with Xi demands

HONG KONG (Reuters) - Major Chinese real estate companies are renting more of the apartments they develop as they respond to President Xi Jinping’s demand that China should produce homes to live in not to speculate on.

A corridor is seen at a so-called youth apartment by Chinese developer China Vanke in Shenzhen, China April 26, 2017. Picture taken April 26, 2017. REUTERS/Bobby Yip

But currying favor with authorities who want to provide affordable housing to maintain stability in the property sector comes at a cost as the developers will make little, if any, initial return from renting.

The net yields on rental properties for the biggest developers are only 5-6 percent, and for smaller firms with higher costs they may even be negative, according to the developers and real estate analysts.

By contrast, the profit margins on properties that are sold have usually been clear for all to see - averaging in the 20-30 percent range in recent years.

It isn’t just Xi and the central government that has been piling the pressure on the real estate developers.

Many cities started imposing restrictions on land sales last year, forcing developers to build some homes to rent rather than sell, making the properties much less lucrative and higher risk for companies. Not only are the companies looking at lower returns on the developments but they also have the balance sheet risks of continuing to own them.

This is all, in turn, set to speed up market consolidation and joint bidding as companies share the costs.

Vanke, the country’s No.2 developer by sales and one of the early comers to the rental market, plans to double the number of apartments it is renting out to 200,000 in 2018.

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Rental apartments “are not supposed to make a lot of money in the first place,” China Vanke (2202.HK) 000002.SZ Chairman Yu Liang said at an earnings conference late last month, adding that there has to be a balance between rental and sale markets.

He said that the rental market could be profitable in the longer term if the authorities put sufficient supportive policies in place. Local governments have recently been offering preferential lending rates and new fund-raising channels such as corporate bonds and securitization to help the rental business.

Clearly, though, the demand is there. L+Research Institute, the research unit of real estate agent Lianjia, estimated the number of tenants will reach 230 million in 2025, up from 160 million in 2015. It sees the total rental value of the Chinese market rising to 2.9 trillion yuan ($460 billion) in 2025 from 1 trillion yuan in 2015.

Lianjia also said the number of rental apartments in China grew 40 percent in 2017, compared to growth of less than 15 pct in 2015.

China’s largest developer by sales, Country Garden Holdings (2007.HK), which set up a rental business unit late last year and laid out an aggressive plan to own 1 million rental apartments in three years, told reporters that the business is “tough” for companies just getting started in the rental sector.

Profitability from rental property is lower than from sales, the company’s Chief Financial Officer Bijun Wu said at a media lunch in February. “But under government support, it will become a common business for the industry.”

Not only does it take longer to collect cash from rental housing, targeting young professionals with limited incomes means landlords can’t always charge the higher rents they would like, the developers and analysts say.

Developers, such as Vanke, are mostly leasing or buying under-utilized assets such as hotels, offices and warehouses and redeveloping them into rental units as that way the returns are much higher than they would get if they bought land and built new developments.

Vanke told Reuters last year that the gross profit margin on the redevelopment work was in the 20-30 percent range, which is in line with its gross profit margin of 26.2 percent for its property development business in 2017.

For rental apartments built from scratch, the average cost for Vanke is 300,000 yuan ($47,708.41) per unit, according to analysts, so with average rental income of 3,000 yuan a month it would take 8.3 years to pay back excluding any interest cost.

The net yield for Vanke on the rental apartments is around 5 to 6 percent, but for developers with smaller scale it would be lower.

“Initial yield for the business is around 4 percent, but in some bad cases it could just be breakeven” said CLSA analyst Nicole Wong. “If it reaches a big scale, developers can strike a good income, and also profit from a spin-off later on ... the leveraged return can then reach 8 to 9 percent.”

The developers, though, are working on ways to pull in more investors.

Country Garden obtained regulatory approval last month to launch 10 billion yuan ($1.6 billion) worth of quasi-Real Estate Investment Trusts (REITs), China’s largest such issue so far, for its rental housing projects.

Vanke said on Monday it plans to raise up to 8 billion yuan from the sale of rental housing bonds, while Beijing-based developer Longfor Properties (0960.HK) last month sold 3 billion yuan of such bonds, the first issue of its kind in China.

While not all developers’ plans are as aggressive as these behemoths, they are still showing the kind of commitments needed to keep the authorities on side, property analysts say.

“Some developers are doing it to show support for government policy; their project volume is not large in each city, but that small cashflow shortfall will help to get a good relationship with the city governments in the long run,” RHB Research analyst Toni Ho said.

Last month, state-owned China Overseas Land & Investment Ltd (0688.HK) said it will launch 3,000 to 5,000 rental units a year while Sino-Ocean Group (3377.HK) said it is targeting 100,000 rental units in 2020, up from 1,000 now.

“It’s only a start for us and not our major business yet, but we’ll actively make efforts,” Sino-Ocean chairman Li Ming said.

Reporting by Clare Jim; Editing by Anne Marie Roantree and Martin Howell

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