MNI INTERVIEW: China's Nascent REITs Market Needs A Tax Cut

--China REIT Market Could Eventually Be Worth CNY10 Trillion

--But Key Researcher Says It Needs Tax Cut To Prosper

     BEIJING(MNI) - A move by China to authorise the creation of real estate

investment trusts to securitise public infrastructure projects and ease the

financial burden of heavily-indebted local governments may need to be

accompanied by tax breaks if is to be successful in creating a new asset class

which could one day be worth as much as CNY10 trillion, a leading researcher for

the country's top government body told MNI.

     Securitising existing infrastructure would lower debt levels now

approaching 80% of revenues at some local governments and their financing

vehicles, allowing them to channel more resources into the high-tech projects

such as 5G stations and data centres now becoming a national priority, said Meng

Xiaosu, who leads REITs research at the Development Research Center of the State

Council.

     In contrast to REITs abroad, which concentrate on commercial property,

China will initially focus on government-owned assets. Warehouses, toll roads,

airports, industrial estates, urban utilities, sewage and garbage processing

facilities will be among the first to be securitised under the programme

announced by the National Development and Reform Commission and the China

Securities Regulatory Commission on April 30. The resulting REITS will be bought

and sold like stocks on the country's exchanges, allowing local governments to

sell debt-funded public infrastructure to individuals or investment funds, to

create a market that could one day be worth CNY8-10 trillion, according to Meng.

     "China has accumulated a massive amount of infrastructure...After the CNY4

trillion stimulus package following the 2008 global financial crisis, China

borrowed even more than CNY10 trillion a year to boost infrastructure

investment," said Meng, often referred to in Chinese media as the God Father of

the real estate market, who started his career as secretary to former Vice

Premier Wan Li in the 1980s. He later became chairman of China National Real

Estate Development Group, creating the country's modern housing market, and has

been calling for the development of REITs for 15 years.

     --SECOND ATTEMPT

     A previous attempt to develop REITs in the property sector in 2005 was

crippled by tightening housing regulations aimed at averting excessive leverage,

Meng said, adding that this led him to argue that it would be easier to start by

securitising government assets instead, even if some of their characteristics,

such as time limits on road toll concessions, presented challenges for their

conversion into equity products. More classic REITs focussing on real estate

will come later, he said.

     "My biggest concern is the taxation on REITs," Meng said, adding that

freeing special-purpose vehicles from corporate tax would be crucial to the

programme's success. In the U.S. and other developed REIT markets, the vehicles

do not pay tax, with the holders of the securities instead paying tax on the

profits distributed as dividends. This avoids double-taxation, Meng said.

     The fact that REIT special-purpose vehicles will usually be managed by

local governments and should encourage infrastructure spending should help

persuade the authorities to remove the taxes, he said.

     The government should also convert implicit subsidies for public

infrastructure, such as help servicing some of their debt, into explicit

subsidies, Meng said, arguing that this would boost REIT returns.

     --RETURNS

     The products should offer rates of over 6% to tempt investors, according to

Meng, who also called on the government to ensure that top quality projects were

among the first to be securitised in order to get the market off to a good

start.

     "In developed Western countries, REITs can still offer returns from 5% to

6%, even though interest rates are very low in those countries. China still has

pretty high interest rates, so it would be a bit strange if it had REITs with

rates lower than 6%," Meng said.

     Authorities also need to overhaul procedures allowing local governments to

inflate valuations on infrastructure procedures in order to get better terms on

bank loans. This is often accompanied by a payment to the bankers to compensate

for the additional risk, which Meng called "a waste of money."

     "China should have a separate asset appraisal system for REITs," said Meng,

noting that calculations of returns on assets would rise correspondingly if

their valuation was reduced to reflect reality.

--MNI London Bureau; +44 203 865 3829; email: jason.webb@marketnews.com

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