Soho China to build portfolio of investment properties

The CEO of the Hong Kong-listed commercial property developer talks to FinanceAsia about a shift in strategy, opportunities in the distressed market and about staying disciplined.
Property stocks may still be out of favour with investors but while the credit crunch is forcing smaller developers to shut down, the chief executive officer of Soho China is confident that the listed Chinese developers will ride out the current difficulties. She describes the difficulties as temporary and to a large extent caused by government policies as the Beijing government tries to control inflation.

In the meantime, the lack of readily available credit is actually causing opportunities for a cash-rich commercial real estate developer like Soho China, which focuses on commercial mixed-use properties in Beijing that include retail space as well as integrated office and residential units. The company focuses on prime locations û particularly the cityÆs central business district - and is recognised internationally for its architecturally innovative buildings.

In a recent interview with FinanceAsia, Soho China CEO Zhang Xin also expressed optimism about the rental development for prime retail space in particular and to take advantage of that, the company will be changing its strategy to sell virtually all of its property projects and gradually increase the portion of investment properties on its books.

ôIn five years, we plan to hold about 1 million square metres of commercial space in central Beijing, which will represent 70% of our net asset value,ö Zhang says, noting that retail rents in Hong Kong are still 20 times higher than they are in Beijing but the gap is narrowing. Rents may not catch up entirely, but even a reduction of the gap to 10 times will mean a lot of upside.

ôBut we are still very much focused on earnings growth. And earnings growth still comes from selling properties. The Soho brand is about selling and we can sell at higher prices and faster than others. It would be a shame if we donÆt capitalise on that. So we will continue to sell,ö adds Zhang, who is married to Soho ChinaÆs chairman Pan Shiyi. The pair co-founded the comapny and controls 66.5% of it through a trust.

The strategy shift wonÆt have much impact on Soho China's day-to-day business since it continues to manage the properties that it has sold, including helping the buyers to lease them out. The company sells its properties on a strata basis to individual investors who typically donÆt buy for their own use.

ôThese are high-net-worth individuals who may have a coal mine or a factory in Guangzhou and who want to buy downtown commercial property for leasing and for asset appreciation. So we sell to them. Now we think we should move on to own a bit more ourselves,ö Zhang says, adding that the locations for some of these properties are ôirreplaceableö and, if it sells, the value of that will be lost to the company.

At this point, the company has three properties in mind for its growing investment portfolio: Tiananmen South, a planned redevelopment in traditional style with hutongs, courtyard homes and traditional Beijing shops, for which it is still awaiting government approval; Chaoyangmen Soho, which is its newest acquisition; and Guanghualu Soho II, which is located in BeijingÆs central business district and was the first project that Soho China bought after it listed on the Hong Kong stock exchange in October 2007.

At present, the company has 10 projects in Beijing, of which four are competed, three under construction and another three newly acquired. It also owns a 32-house development by the Great Wall and a resort development on Hainan Island, which are both managed by the Kempinksi Hotels Group.

Chaoyangmen, which it acquired in May this year, is an example of the type of project where Soho ChinaÆs large war chest of cash is a real advantage û even after this latest acquisition it has about Rmb11 billion ($1.6 billion) of cash on hand û as other developers are finding it hard to come up with the financing.

The project, which comprises almost 500,000 square metres and is located along the second ring road û a location Zhang describes as ôperfect for a commercial buildingö û had turned into a distressed debt asset after the original developer ran out of money to complete it. At the time Soho China bought it, the first phase was already completed and half of it had been sold to Bank of China. The rest of phase one was empty, while only a small portion of phase two had been built and phase three, which accounts for about 70% of the total, hadnÆt yet been started.

ôThis is a classic distressed asset that we like. There is still so much empty land that we can build on and yet the project was approved a long time ago and it is already an offshore company,ö says Zhang. The lender to the project, Minsheng Bank, was also worried that this asset might end up sitting on its balance sheet and turn into a non-performing loan, so when it heard that Soho was renegotiating, it extended more facilities to help the company buy it.

The deal was worth Rmb5.5 billion in total, with the equity accounting for Rmb2.2 billion and the remainder made up of debt.

According to Zhang, when negotiations started in January there were eight developers interested in taking over this particular project, but the others had to drop out because of a lack of credit and the fact that they were unable to come up with the necessary amount of cash.

ôItÆs this kind of large-scale project that needs a lot of cash that plays to our strength,ö she says. ôAt the moment the market is distressed. But this is temporary and it is policy-driven. The key issue for the government right now is to fight inflation and it is doing that by tightening credit, mortgages, foreign investment.ö

ôWe really want to take advantage of this temporary distress as we donÆt know how long it is going to last. Perhaps [the government] will relax policies very quickly after they have seen the results of the credit control û because it is resulting in a lot of the smaller companies having to close down. They donÆt want to let that go on for too long and once inflation gets under control a bit more IÆm sure credit will be relaxed a bit.ö

The way that Soho China plans to take advantage is by making more acquisitions while the competition is finding it hard to come up with the financing. At the moment it is monitoring and negotiating several projects with altogether almost 3 million square metres of gross floor area. All of them are large-scale commercial properties in central Beijing and half of them are already in private hands, but are at this point semi-distressed. The other half will be on the auction market in the near term.

ôWe wonÆt be able to get all of them, but even if we only get a portion it will be enough (to cover the companyÆs development needs) for the next five years,ö Zhang says.

At the same time, though, she stresses that the greatest challenge for Soho China is to remain disciplined in terms of its expansion and not get dragged into the race to become a nationwide developer, as have so many other companies that have gone public. The risk is especially high for developers that started out in the high-margin cities of Shanghai and Beijing and then expanded into lower-margin areas, she argues.

ôWhen you are asked for the one millionth time æhow big is your land bank?Æ it is very tempting to [expand to new areas]. Having the discipline to stick to a business that is high-margin is the key,ö she says. ôWe are looking at Tianjin, but we are very cautious.ö

With regard to the outlook for commercial property prices, Zhang says neither rents nor selling prices have come down in the central areas of Beijing, and land prices remain robust.

ôThe key is still to get the right location. The market has come down a little bit and the euphoria of chasing up the land is definitely gone. It is more rational now, it is easier to negotiate and terms are better, but it is not as if the price of land has fallen drastically, especially not in the city centre.ö
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