PE, known as “barbarian at the gate” in the Wall Street, not only transfuses blood into real estate enterprises to break up real estate speculators groups, but also displays the transmutation of the real estate operation mode and game rules.
By Xiao Qi
“It is changeable. Sometimes it is an angel; sometimes it is a devil; sometimes it has an angel face, devil figure and vicious heart”, which is a vivid analogy to PE.
PE refers to a kind of non-public tool used to privately raise money from specific investors and make collective investment.
PE was still an unfamiliar word to Chinese people 7 years ago, but now, it has become a hot word in the real estate circle.
At present, in the face of stricter macro-control, tightened bank credit, restricted trust financing, slackened sales account receivables, increasing cash withdrawal pressure, and continuous tense of the real estate capital chain, PE meets its overgrowth soil.
China’s real estate enterprises, foreign capitals, China’s trust institutions and the former real estate speculators groups all set foot in real estate PE. In 2010, there emerged more than 20 real estate PEs in the domestic market, and the real estate PE increased at a faster speed when entering 2011. A report from Zero2IPO Research Center showed that there were 5 real estate PEs with raised capitals of USD 959 million among 25 ones that can be invested in Mainland China.
But the crucial problem is that what else can “barbarian at the gate” in the Wall Street (PE) bring to real estate enterprises that are extreme lack of money other than capitals.
Transmutation of operation mode
Ling Ke, Chairman of the board of Gemdale Group said, there are two development directions for the future real estate, “one is the upstream to enter the real estate finance field, like real estate PE; the other is downstream to do product line, like apartment for the aged, commercial real estate, tourism real estate, etc.”But nowadays, national macro-control is becoming increasingly strict and the capital required for downstream development is growing increasingly tense; therefore, it has no better choice than moving towards upstream. In addition, the Partnership Enterprise Law of the People's Republic of China came into effect in the year of 2007, China’s RMB funds began to have the so-called partnership formation and obtained the promotion of lawful passport. Therefore, starting from the year of 2010, real estate PE made an obvious increasing trend. Up to now, both real estate PE raising and investment increased greatly.
Actually, it is only a superficial phenomenon that real estate PE can “broaden the financing channels for enterprises”, and transfuse blood into real estate enterprises. It displays the gradual transmutation of the real estate operation mode.
As one of the earliest real estate enterprises setting foot in the fund industry, WINS Investment Management Co., Ltd. (WINS Investment), undertaking full responsibility for the financing business of Gemdale Group, was established in 2009 in Hong Kong and wholly owned by Gemdale. According to Gemdale’s goal, by the year of 2015, its financing business will contribute about 20% profit to the company; WIN Investment’s capital scale will reach RMB 20-30 billion Yuan. Similarly, FORTE Group’s first PE also had reached RMB 500 million Yuan. Fan Wei, Chairman of the board of FORTE Group, said that FORTE would focus on promoting the rapid development of real estate PE, and expand the real estate investment and financing business platform on the basis of the adherence to development business. It is imagined that by the year of 2019, the investment business will contribute about 40% profit.
Zheng Jinqiao, Chairman of the board of Richlink International Capital Co., Ltd. (Richlink Capital) said, “The persons with development experience set foot in the PE field, which in fact shows a future trend. There have been many years since developers explored to transform from ‘Hong Kong Mode’ into ‘America Mode’. Now in China, many developers themselves are both developers and investors. And this exploration is no doubt a practice separating investment from development.”
The journalist knows that real estate PE involves not only in residential development project, but also in commercial real estate development, property holdings, urban complex development, and unlisted enterprises equity investment, enterprise merger and acquisition investment of the green intelligent building field, etc. These funds can become comprehensive equity investment funds, and their profit model consists of charging fund management fees and sharing excess profits.
Actually, real estate PE has another operation mode, called double funds matching 1+1 mode, with a typical representative of Jade Group.
Jade launched and set up the first Real Estate Investment Trusts (REITs) in 2002 since it had participated in the launch of the first PE in 1998. After that,PE “matched”with REITs which made the real estate “walks on two legs”. This is because REITs can only absorb mature property, but the work to incubate and cultivate high-quality investment property needs the help of the Group and PE investors. In another word, PE provides capital support to the project development to incubate and cultivate commercial property. After the commercial property grows mature, PE will transfuse projects to REITs and withdraw. In this way, the mutual support becomes the key part of Jade fund mode.
Remolding of rules
It is undoubted that PE is an innovation of real estate enterprise financing. Compared with the real estate PE established by other initiators, that with developer background surely occupies the resources of cooperating with governments and projects, and the capacity to develop and manage the real estate project, and the only thing to be considered is the potential profit conflict, which can be prevented and settled down with contracts and regulations based on reasonable fund term design.
The developers should make a professional and independent judgment on the enter price and conditions of the required project in accordance with their management team in order to make a sound settlement mechanism of the profit conflict. The exit mechanism should also seek guarantee through agreement.
The change of the real estate enterprise mechanism by PE cannot be underestimated during this course. This change will make real estate enterprises “unprofessional”in funds management, inevitably facing two challenges of fund operation experience and fundraising.
In respect of fundraising, PEs initiated by developers need to create a capital source channel that meet their own requirements. Compared with other industries, the return cycle on investment of the real estate equity is longer. General partner (GP) should find investment institutions and partners that have a large amount of investment capitals, less requirements for funds and are not so sensitive to the return cycle, and this needs a series of core technologies, that is, the selection, judgment, investment, implement, supervision of and withdrawal from invested projects. For example, a Limited Partner (LP) only possesses RMB 50 million Yuan, it is estimated that he/she will invest RMB 30 million Yuan, thus the GP will bear a heavy burden. But if finds a LP owning RMB500 million Yuan and RMB 30 million Yuan can used to invest, the management team will bear a relative lighter burden. Therefore, it is necessary to select investors who know of the real estate industry, in another word, it is necessary to select a LP with a purpose.
How to operate and select the withdrawal mechanism is also a crucial issue that a real estate PE needs to face with. At present, you have to sell your funds when you want to withdraw from it, and reverse selling happens a lot. Above all, if real estate enterprises find money by themselves to invest in themselves, and the invested project is unmarketable due to the downturn market, it is worthy to consider how to guarantee the profit of investors.
For FORTE Jingye Fund, the beginning investment point for personal LP is RMB 8 million Yuan, lower than that of institutional investors. The general investible capital quantity for their investors is very large. This is considered in respect of asset allocation, to make their allocation more rational and reasonable, it’s better to assure the allocation ratio at about 10%. Since PE has high risks and high revenues, without break-even concept, the general investible capital quantity to the extent represents the risk that investors can bear. Meanwhile, GP will also make a certain ratio co-investment. According to the standard practice, Insight Investment co-invested 10%. “In terms of project, FORTE investment accounts for at least 60%”, said Dong Weihai of Insight Investment, and he thoughtthat the common profits formed between substantial shareholders and all investors would make investors have a stronger sense of security and trust.
In terms of fund duration, FORTE Jingye Fund is generally 3-5 years, belonging to the medium and long-term investment. FORTE Jingye Fund has the mode of “3+1+1”, that is, its shortest duration is 3 years. The first “1” is decided by GP in accordance with the goal of revenue maximization; the second “1” is decided by the vote of all the investors. The fund will be liquidated and settled when it is due. In terms of profit distribution, Insight Investmentsaid it should be allocated strictly in accordance with the agreement among partners. Only when the actual income of partners exceeds10%, 20% exceeding the profit should be given to GP as a reward as agreed. Fund issuance is mainly under the responsibility of third-party financial institutions.
It thus can be seen that a new rule is being built during the realization process of such core technologies as the selection, judgment, investment, execution and supervision of and withdrawal from the invested projects made by real estate PEs, and each change of the rule is a reallocation of interests. This reallocation remodels not only the real estate enterprises that establish real estate PEs. Some industry participants told the Business Value that, real estate PE offers a direct way for establishing alliances between real estate enterprises with urgent need of money and investors who cannot help in investing; the profound impact of the new policy on the market further accelerates the cooperation pace between the two sides.
Under a variety of cross effects, the real estate market is undergoing a directional change. Despite in the face of many challenges and uncertainties, the majority within the industry still hold an optimistic attitude on the real estate PE. One of their points is that, as the operation mode of real estate PE is becoming more mature, real estate PE will take on an explosive growth; and the future kings of China’s real estate industry perhaps are the real estate enterprises that have set up private financing channels.
