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Distressed Real Estate in China, Anyone?

Capital Beat blog: A local developer is betting on the country’s turnaround.

Wall Street’s foray into Asian real estate investing has, alas, ended with broken promises. Morgan Stanley’s former China real estate head, Garth Peterson, is under investigation by the Securities and Exchange Commission for alleged corruption , and Merrill Lynch is selling its $2.65 billion Asian Real Estate Opportunity Fund, effectively shutting down its real estate investment in Asia . But a Chinese property developer thinks it can score where Wall Street failed by banking on its long-term local experience, and it is trying to sign on institutional investors in the U.S. for a targeted $1 billion distressed Chinese real estate fund.

I recently sat down with William Yip, founder and chairman of Hong Kong–headquartered, Australia-listed and aptly named Canada Land (CDL) . The Hong Kong–born and Canada-educated businessman (who, with a Doctorate of Law from Concordia University in Montreal, prefers to be called Dr. Yip) has led his company in the past decade or so to develop three high-rise apartment buildings and one tourist attraction in Guangdong province in Southern China.

Yip has no previous investing experience, but he believes that the A$6.4 million market cap Canada Land has the operational expertise to succeed. “Our unique structure means a real estate developer would be the fund manager,” says Yip. “The fund will be run by someone who knows the business, the details and the relationships.”

The strategy of CDL China Real Estate Opportunity Fund reflects its focus on operations. It will not buy real estate equity or debt. Instead, it will acquire whole developments — mostly distressed multifamily residential properties in Guangdong province that are suffering from liquidity problems or ones that are only partially completed. It will then fix or complete the construction and sell the homes, hopefully at a profit. “The recession has made these types of distressed properties more amply available,” Yip says.

The fund is betting on a recovery for both China’s economy and its real estate market. It seems this faith isn’t misplaced: The country achieved better-than-expected 7.9 percent growth in GDP in the second quarter . During the past two months, China’s property prices rose 0.2 percent and 1.0 percent consecutively, following price declines during the previous six months .

The strategy, however, is a hard sell to cash-strapped and risk-averse U.S. institutional investors. Clark McKinley, a spokesman for the California Public Employees’ Retirement System, the country’s largest public pension, says his fund probably won’t have any short-term appetite for real estate in Asia following its $500 million investment in Asian Dragon Fund in the fall of 2007. That investment is part of roughly $20 billion real estate portfolio, which suffered a loss of 35.8 percent for the twelve-month period ended March 31.

“We are in the process of restructuring our portfolio,” says McKinley. “Though our opportunities are in emerging markets in the long term, short term we have to better position ourselves.”

CDL’s fundraising adviser, William Nobrega, a managing partner at Miami-based consulting firm Conrad Group, is counting on Asian and European investors to pick up the slack. CDL has already secured $220 million in soft commitments from Asia-based investors, says Nobrega, who expects one third of the total fund to come from European investors. Though American investors are more skeptical, he has found a receptive audience among those who already have a presence in Asia, and therefore appreciate the current opportunity more.

“The time to invest in Chinese real estate is now,” asserts Nobrega, adding that the right fund to invest in is one that has no Harvard MBAs sitting at desks all day crunching numbers. “We have a hundred-plus engineers actually building things.”

Xiang Ji (Nina) is the capital markets reporter at Institutional Investor, covering mergers and acquisitions, debt and capital markets from an institutional investor’s perspective. Xiang Ji was formerly with BusinessWeek in China covering the wider business world. Send email to capitalbeat@iimagazine.com .

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