SINGAPORE (July 10): A layer of cream cheese floating on iced tea is as unpalatable as it sounds. But the HeyTea outlet at the recently opened Raffles City Shenzhen was doing a roaring business serving up mugs of the stuff to crowds of youngsters on a recent Friday evening.

A long queue could be seen snaking around the outlet at Raffles City Hangzhou the following Saturday. Almost unheard of until a few months ago, the upstart beverage retailer has opened 50 stores in various Chinese cities since it raised money from venture capital investors in 2016.

For CapitaLand, the constant emergence of new experiential brands such as HeyTea that draw crowds of increasingly wealthy young consumers is vindication of the big bet it took on China with its Raffles City-branded integrated developments almost two decades ago. Modelled on Raffles City Singapore, which opened in 1986, each of these properties comprises some combination of retail space, offices, serviced residences and apartments and is typically located close to major transport nodes in China’s gateway cities.

While they are capital-intensive and take years to develop, these properties also quickly begin earning double-digit internal rates of return when they open, and generate steady cash flow that grows as China urbanises. They also position CapitaLand to ride the economic shift in China from investment-intensive and export-oriented growth to consumption and services.

This year, CapitaLand will have three more Raffles City properties in China that are operational. Both Raffles City Shenzhen and Raffles City Hangzhou opened in April; Raffles City Changning was officially opened early this month. That will raise the number of operational Raffles City developments in China to seven. In total, CapitaLand has eight Raffles City projects in the country. Of these, five are in the Raffles City China Fund (RCCF), one is in Raffles City China Investment Partners III (RCCIP III) and two are joint ventures. Holding these assets through these structures enables Capita- Land to keep its balance sheet relatively light.

At Raffles City Shenzhen, the growing spending power of the city’s consumers was well on display. Besides the long queues at the HeyTea outlet, there was also a good crowd at the Starbucks Reserve outlet, an upscale Starbucks line that serves a special nitro cold brew coffee made with a machine said to cost US$50,000 ($69,116).

Shenzhen is home to burgeoning Chinese companies such as Tencent Holdings, Huawei Technologies Co and Ping An Insurance Group Co of China, and boasts a per capita GDP of US$30,000. Raffles City Shenzhen is located on Nanhai Boulevard, which connects Shenzhen’s up-and-coming financial centres — Qianhai and Houhai. The development sits atop a metro interchange that will open in 2019.

CapitaLand acquired the land occupied by Raffles City Shenzhen in 2008. The development had a gross floor area of 237,500 sq m, which included SOHO units that were strata sold. Now, the development has a remaining GFA of 121,831 sq m. The retail mall accounts for 51% of this GFA, offices account for 25% and residences some 22%. The office tower is currently only 40% occupied. CapitaLand expects the development to deliver a net property income (NPI) yield of 5% to 6% within three years.

Meanwhile, Raffles City Hangzhou is now the largest such property held by RCCF. The opening of the shopping mall at the development had been delayed by two years because of its complicated “tidal wave” design that is said to mimic the strange tides of Qiantang River.

CapitaLand paid RMB3,600 psm for the 40,355 sq m site. Including land cost, development cost was less than RMB10,000 psm. This compares favourably with the latest land sales of RMB20,000 psm at nearby sites. The project includes residential blocks, with familiar names such as Sky Habitat and Sky View. CapitaLand has also been selling strata-titled SOHO units at the development at as much as RMB40,000 psm.

Raffles City Hangzhou now has 298,276 sq m of GFA, of which 40% is retail, 13% office and 24% hospitality. The development has both a CONRAD hotel and an Ascott-branded serviced residence. CapitaLand officials figure NPI yield on cost will reach as high as 6% in Raffles City Hangzhou’s first year of operations. Although a Tier-2 city, Hangzhou is the home of Alibaba Group Holding. Hangzhou’s GDP per capita is around US$18,000.

As for Raffles City Changning, the property is located in a wealthy district of Shanghai. It is served by two operating metro stations, one of which is the famous Zhongshan Park station, and is surrounded by a catchment of a million residents within a 1km radius.

Shifting retail trends CapitaLand opened its first Raffles City in China in 2004, in Renmin Square, the economic, cultural and political centre of Shanghai. Today, that property draws a daily footfall of 70,000 and generates an NPI yield on cost of around 20%.

Retail trends have changed since then. These days, F&B tenants occupy some 35% of the lettable area at the malls, and space dedicated to “experience” has overtaken fast fashion and retail shops where people buy “things”. In fact, experience-oriented tenants — which include operators of cinemas, skating rinks, and even flight simulators — now account for more than half the space at some of Capita- Land’s newer malls.

“In 2004, when we first started our Raffles City Shanghai, the F&B component was 20%,” says Lim Ming Yan, CEO of CapitaLand. “We wanted more, but the F&B tenants could not afford to pay the rental and we had no choice. We still had to meet certain hurdle rates so we had a lower percentage of F&B. In 2004, when people bought a bowl of noodles, it was RMB5 to RMB10. But, in today’s context, people spending RMB100 on a meal is very common.”

In fact, among the tenants at Raffles City Shanghai is a HeyTea outlet that made headlines for the crowds it drew when it opened earlier this year. Such tenants, which draw shopper traffic and can afford to pay higher rents, are just what CapitaLand’s Raffles City properties need. “It gives us a lot more options,” Lim says.

More Raffles City projects Now, CapitaLand is hunting for suitable sites for more Raffles City-branded projects in cities such as Guangzhou, Pudong Shanghai and Beijing, according to Lucas Loh, CEO of CapitaLand China. “We’re on the lookout for other Raffles City projects,” Loh says.

In October, CapitaLand closed RCCIP III at US$1.5 billion. RCCIP III has a life of eight years, and its seed property is Raffles City Shenzhen. CapitaLand currently has a 41.7% stake in RCCIP III. The other investors include the Canada Pension Plan Investment Board, which has invested US$375 million in the fund.

With a debt-to-asset ratio of 50%, RCCIP III could invest as much as US$3 billion. “It’s not how big the fund is, but the key is how we can find the right investment opportunities. My sense is that the market is ready. It has a lot of liquidity looking for good investment opportunities,” Lim observes.

CapitaLand typically shunts properties it develops into different investment vehicles as they mature. Its stable of five real estate investment trusts, for instance, includes one that focuses purely on China-based shopping malls, one that focuses on serviced residences around the world, and one that invests in Singapore-based office buildings. But Lim says decisions on whether to invest in a Raffles City-branded project are made from the viewpoint of “a single balance sheet” that considers the return of the overall project. “If you measure by individual components, you spend time allocating what costs should go to the individual components,” he explains.

CapitaLand has been among the best-performing components of the Straits Times Index this year. The stock has climbed 17% compared with the STI’s 12% gain. Apart from its maturing portfolio of Raffles City-branded developments in China, the group is also benefiting from strong earnings contributions from its residential property developments in China. More than 6,000 units with a value of RMB10.5 billion ($2.1 billion) are expected to be handed over from 2Q2017, with 60% of the value to be recognised in the next nine months.

Maybank Kim Eng Research has a “hold” recommendation on CapitaLand and forecasts a 31% rise in earnings to $1.56 billion. Maybank KE has its revalued net asset value at $5.25 and accords it a valuation of $3.75, at a 29% discount to RNAV.

Morgan Stanley has an “overweight” recommendation on the stock, with a price target of $4.40, which is 1.06 times its book value of $4.16 a share as at March 31 and 13.4 times its forecast earnings for 2017.

CapitaLand’s Raffles City projects come of age as China’s retail sector matures

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