Soho China buys Shanghai property from Morgan Stanley fund

Beijing-based commercial property developer Soho China makes its first investment in Shanghai, buying a 52-storey office building from MSREF for Rmb2.45 billion.

Soho China, the Beijing-based commercial property developer, has made its first move into Shanghai with the purchase of a 52-storey office and retail building from Morgan Stanley's real estate investment arm. According to a release issued yesterday, Hong Kong-listed Soho China will buy the company that owns the property at a total cost of Rmb2.45 billion ($359 million) plus an amount equal to the working capital held by the company when the deal closes.

Cash-rich Soho China has been pondering an expansion into Shanghai for some time and said the location of, and easy access to, this property at the heart of Nanjing Road West CBD in the city's prosperous Jing'an business district were "compelling attributes" for the acquisition. The area includes a concentration of five-star hotels and high-end shopping centres as well as two metro lines and Shanghai's main east-west thoroughfare, the Yan'an Elevated Highway. The property is within walking distance from city landmarks like the Portman Ritz-Carlton Hotel, Plaza 66 and the Kerry Center Shanghai.

Soho China's CEO Zhang Xin also told FinanceAsia over the phone last night that, while residential real estate prices in Shanghai have been bid up significantly in recent months, potential commercial properties are still "relatively distressed" and vacancy rates are high. Or as the company put it in the press release: "Shanghai commercial real estate is undervalued with sufficient upside appreciation potential."

This particular building, which is currently known as Dong Hai Plaza but will be rebranded as The Exchange-Soho, is not distressed in the classic sense as construction was completed in June 2008. However, leasing has been slow to pick up and at present only 30% of the building is occupied. All the tenants are multinational companies.

Soho China believes its business model, whereby it sells its office developments on a strata basis to high-net-worth individuals or companies, most often as a pure investment, is well suited to this situation and Zhang notes that the company's buildings in Beijing are on average more than 95% rented, compared with a 70% occupancy rate for Beijing office properties in general. A contributing factor is no doubt the after-sale services that Soho China provides to the high-net-worth acquirers to help them lease the strata units to small- and medium-sized companies.

Soho China also continues to market and manage the properties. According to the company, the leasing of individual units to SMEs is significantly easier than to lease large chunks of an entire building to Fortune 500 companies, which is the usual approach by private investors of office property in China. And that is especially true right now when large companies are downsizing rather than expanding.

The aim is to sell all the units in the Shanghai building to other investors using this model in the coming months.

"Though we have primarily had a focus on the Beijing city centre to now, our nationwide client base and brand name, as well as Shanghai's high income levels and commercial vibrancy, should enable us to achieve comparable sales results there as those we have seen in the capital," the press release quoted Soho China's chairman Pan Shiyi as saying. "In fact, by broadening our property portfolio to include prime areas in China's financial and trade centre, Soho benefits its client base of high-net-worth individuals with a greater diversity of channels for obtaining rental yield and appreciation potential."

Soho China will pay cash for the property, although $230 million of the cost will be covered by bank financing. The company is cash rich following its $1.9 billion initial public offering in Hong Kong in October 2007, record pre-sales in 2008 and a conservative acquisition strategy in the past. As of March this year it was sitting on Rmb10.7 billion ($1.6 billion) of cash and around the same time it signed a five-year contract with Bank of China that will give it access to another Rmb20 billion of M&A loans. In June it secured a composite credit line of up to Rmb10 billion with China Merchants Bank to be used for working capital loans, project loans, M&A loans, letters of guarantee and trade financing among other things.

Morgan Stanley Real Estate Funds (MSREF) bought Dong Hai Plaza in 2006 for about Rmb2 billion after two local developers had already been involved in the project. Having seen the construction through to completion, MSREF is selling the now mature investment at a price that implies a return of 22.5% over three years. Morgan Stanley didn't actively market the asset and the sale was negotiated between the two parties, but according to sources, the seller was also approached by a few other bidders.

In the press release, Zhang noted that the transaction is "truly" one of mutual benefit for Morgan Stanley and Soho China. "For them, the sale allows them to realise value and cash out on an investment property that is now close to being ready for market. For us, it allows us to procure a highly desirable location and further add brand value to it by leveraging our expertise in marketing, sales, and property management supervision."

At 217 metres, The Exchange-Soho is among Shanghai's tallest skyscrapers. It has a saleable above-ground gross floor area (GFA) of 71,671 square metres and a below-ground GFA of 8,838 square metres for parking and storage.

While Soho China's first entry into Shanghai, the acquisition marks a continuation of the company's current strategy of taking over completed or nearly completed projects that can be turned around and promptly brought to market at relatively low cost. The property also meets the company's stringent acquisition criteria: it is commercially focused, in a prime city centre location, has excellent accessibility and potential for price appreciation.

In an interview with FinanceAsia in March this year (Oversupply plagues China's property market), Zhang said the company had identified a number of commercial property projects for potential acquisitions and if possible it would like to snap up all of them. 

"We will buy a lot. We have at least 10 projects that all qualify in Beijing and Shanghai. I don't know how many of those we can close in the near future, but I think quite a few of them," Zhang said at the time. "Our strategy is basically -- in a bull market, keep very little leverage and sell as much as you can, and in a falling market, leverage up and buy as much as you can."

If Soho China were to buy all of these 10 projects, it would more than double its current inventory. The company currently has 10 projects in Beijing and also owns a 32-house development by the Great Wall and a resort development on Hainan Island, which are both managed by the Kempinski Hotels Group.

Soho China's share price is trading at the low end of a HK$4.25 to HK$5.20 trading range that it has occupied since mid-May. However, the stock rallied strongly in the three months before that and yesterday's 1.6% gain to HK$4.38, which came before the acquisition was announced, left the share price 95% above the February low and about 35% above its trading levels 12 months ago.

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