Of all the U.S. companies and private equity real estate funds that have invested in real estate assets and real estate operating companies in the People’s Republic of China (PRC), few have achieved demonstrable, positive returns above investor thresholds. Attendees of a recent U.S real estate conference underscored the point: only one of the more than 150 participants admitted to having made money in China. Past results, however, are not necessarily reliable indicators of future performance. Particularly at a time when real estate investment firms are sitting on billions of dollars in capital and foreign investors are increasing inflows to the region, China presents enormous potential for real estate investment growth. Distinguishing the winners from the losers moving forward will be planning and execution.
Like most countries, China is reluctant to let profits be repatriated and has a tax system and foreign currency regulations that can stifle investors – particularly those looking for quick returns. The PRC currency, the RMB (renminbi or yuan), remains closed and the government tightly controls cash and the ultimate repatriation of equity, which is likely subject to numerous taxes. As a result, it is important to understand investment lifecycles and create contingency plans to mitigate inherent risks throughout the process. Only investors committed to building long-term local relationships and trust will succeed. As one executive recently suggested: “It is not about making money, but preserving wealth” and waiting for the currency legislation to change.To operate sustainable and profitable real estate platforms, investors must rely on local partners and established foreign entities with western ties, such as investment firms, banks and professional services firms to help navigate an economy governed by different ideals, cultures, economic status and history. The complexity of venturing offshore requires extensive project and risk management experience including:
- Experienced leaders who are proven managers of international companies
- Strong financial management (including the people, processes and technology)
- Proven operational management teams and well-formed corporate structures
- Thoroughly addressed entity and legal issues
- Trusted partners in the PRC who are well connected in government and banking circles
All “C-level” executives, whether interim or permanent, should be versed in functional and industry matters, familiar with cross-border funding and government issues and good cultural fits. There should be no compromise leadership recruiting. Compensation packages should be highly competitive (with equity provisions) and potentially expatriate conditions (including tax equalization, immigration and relocation costs).
For successful growth, corporate infrastructures must be scalable, flexible and sustainable. Since it is often difficult to predict resource needs, interim strategies for people, office space, technology and other overhead considerations can play an important role. Management teams and employees must be cohesive and support scalability and sustainability. In addition, the corporate services infrastructure (IT / HR / Office) must be flexible, as the speed of growth is often uncertain. All of these factors will be particularly important when exiting the operating platform.
In addition to having in place strong leadership that combines financial, operational, industry, local and international expertise, cash management must be paramount. Enabling efficient currency movement through various methods (e.g., offshore currency hedging, cross-collateralized loans, transfer pricing and other forms of onshore / offshore offsetting reinvestment) is often necessary. When undergoing significant capital investment, including land purchases, development and large leases, rigorous government processes that approve the injection of capital onshore must be followed. (Government processes are even more difficult when withdrawing capital.) Finally, the need for strong financial systems and controls is critical for providing timely and transparent reporting to international and local investors.
Policy risk in China is always a major concern and can change without warning. For example, in the wake of recent inflation and an over-heated residential economy, the government developed restrictions, including lending rates and taxes, to curb investor purchases of homes. These restrictions and others have effectively flattened market-rate house pricing and illustrate the government’s ability to control market forces. As a result, the more closely aligned investors are with the government’s agenda, the easier business becomes.
