China's red-hot real estate market has hidden one segment that has remained stone cold: REITs, or real estate investment trusts.

Last month, the China Banking Regulatory Commission circulated the draft provisional rules on real estate fiduciary activities by trust and investment companies to solicit comments from the public.

The move was widely seen as a positive signal the regulator intended to secure the health of China's quasi-REITs, said Li Xiaogang, property editor at International Financial News, a newspaper based in Shanghai.

As many mainland property developers are seeking funding from various channels, in addition to loans from banks, especially since the central government announced credit-tightening measures, CBRC is taking steps to standardize REITs' operation and improve risk management.

Why? CBRC wants to protect the legitimate rights and interests of affected parties, and to ensure the sector's sound, long-term development.

Previously, real estate financing, through trusts, was limited by a regulation that prohibited a trust plan from raising money from more than 200 investors.

The new regulation, if implemented, will eliminate that limitation. "Widening the scale of real estate financing will pave the way for the promising formation of China's REIT market," Li said.

REITs have already begun taking shape in China.

Last December, Beijing International Trust and Investment Corp Ltd (BITIC) and France-based supermarket Auchen announced plans to launch a quasi-REIT product, the "Collective Trust Investment Plan," for Auchen's mall in Tianjin.

It is widely believed BITIC's innovative product is the first REIT in the Chinese mainland.

But how does it operate? BITIC used money raised by the trust plan to buy the property rights to a commercial centre -- for a fairly low price. BITIC then rented the property to Auchen.

As a result, investors in the trust plan will receive stable, and handsome profits over the next few years.

All parties involved in quasi-REITs benefit from the financing scheme.

There were 24 such investment-trust products, which raised a combined 2.7 billion yuan (US$325 million), in China in the year's second quarter. In the first quarter, there were 29 such products, which raised a combined 3.2 billion yuan (US$385 million).

Earlier this year, the nation's regulators, after probing some investment trusts, uncovered many irregularities, which resulted in non-performing assets.

Given the potential threat that posed to the industry, CBRC officials clamped down on under-performing trust companies.

As the property sector accounted for the majority of the trust companies' transactions, it was time to reshuffle the trust industry, and to ensure the robust development of real estate investment trusts.

"The effects will continue to be felt over the long term," Li said.

As financing costs of a trust plan for property sector is comparatively higher than that of a bank loan, property developers who joined trust companies to attract money consider REITs to provide access to short-term loans rather than sources of long-term, stable credit, Li said.

Property developers on the Chinese mainland have been searching for alternative funding sources since June 2003, when the People's Bank of China, the nation's central bank, implemented credit-tightening measures.

China's property industry now resembles that of United States. Given the overheated real estate market in the 1980s, the US' property market stagnated, due mainly to credit-tightening measures.

But REITs ensured US developers access to funding.

It will take several years for REITs in China to mature, as some problems remain.

First, it is difficult to liquidate assets.

However, a major advantage of REIT investment in the United States is liquidity compared with traditional private real estate ownership.

One reason for the liquidity of REITs' investments is their shares are primarily traded on major exchanges.

Second, quasi-REITs in the Chinese mainland are designed as investments in specific projects. REITs, however, should be positioned to invest in multiple property projects.

What's more, trust companies, rather than property developers, initiate quasi-REIT schemes in China, which can result in a lack of professionalism and expertise.

(Business Weekly November 24, 2004)