Initial public offering (IPO) underpricing and overpricing in the Chinese real estate investment trusts (C-REITS) market

Abstract

China officially launched its public Real Estate Investment Trusts (REIT) market on May 31, 2021, introducing 9 REITs focusing on infrastructure sectors like parks, warehousing and logistics, ecological environments, and transportation. On 24th January 2025, the market expanded to 60 REITs. Underpricing occurs when a company's initial public offering (IPO) is priced lower than its market value. If the stock ends with a price higher than the initial IPO price after its first trading day, it is considered underpriced. Currently, 54 out of the 60 C-REITs are underpriced, causing the issuing company to raise less capital than it could have if the shares were priced closer to their market value. Therefore, this research focuses on the underpricing and overpricing phenomena observed in C-REIT IPOs. This study aims to compare the extent of underpricing in C-REITs against that in the broader Chinese stock market to identify any significant differences in IPO pricing behaviors. The research will also explore how, under a highly controlled system with fixed P/E ratio methods, property and franchise-type REITs with differing income sources, growth potentials, and asset durations will react to this regulation. This study have conducted a t-test using data from the Hithink Royal Flush Information Network and WIND databases to identify significant differences in IPO pricing behaviors between the broader Chinese stock market and C-REITs. The statistical evidence strongly supports the conclusion that a substantial difference exists between the means of the underpricing ratio of C-REITs and that of all IPO listings from different sectors in the Chinese stock market. To analyze the factors influencing IPO pricing discrepancies among C-REITs, we have conducted an OLS regression analysis, focusing on 60 REITs listed on the Chinese stock market. My approach involved building regression models to examine the impact of several factors on the IPO underpricing ratio. From the literature review, regulatory pricing restriction, investor sentiment, and information risk are the three most important drivers for underpricing in China. These factors included the property ownership types, subscription ratio, market conditions before the IPO, firm age, and the size of the firm's assets. My findings indicate that the model effectively captures variations in the underpricing ratio. The subscription ratio and the type of property ownership emerged as significant predictors of underpricing. Additionally, the regression results highlight that property-type REITs are associated with a higher underpricing ratio than franchise-type REITs. Property-type REITs will have a higher underpricing ratio, while franchise-type REITs will have a lower underpricing ratio. After identifying the underpricing pattern in C-REITs, this research will also investigate the reason behind the severe IPO underpricing – government policy. In China, government regulations significantly impact IPO underpricing through enforced price restrictions by the China Securities Regulatory Commission (CSRC). Implementing an earnings-multiplier method with caps of 23 and with IPO quotas. By setting a ceiling on the Price-to-Earnings (P/E) ratio, typically below market equilibrium, IPOs are priced artificially low, further exacerbating the underpricing issue. Due to their tangible assets, C-REITs' IPO underpricing is less severe than in other sectors. C-REITs' real estate investments offer apparent, measurable valuation factors, enabling more accurate IPO pricing. This reduces underpricing compared to industries like technology or biotech, where asset intangibility increases price volatility. That explains why the IPO underpricing of C-REITs is less severe than in the broader Chinese equity market. Property-type C-REITs, owning underlying assets like industrial parks, have higher IPO underpricing ratios than franchise-type C-REITs, which only have operational rights. This inconsistency arises because property-type C-REITs' asset ownership offers higher long-term potential growth and intrinsic value, attracting investors and causing higher underpricing to fit market valuation and investor interest. That explains how the ownership of underlying assets influences these underpricing dynamics. One contribution of this study is to provide insights into factors causing IPO underpricing in China's highly regulated REIT market. This helps investors make more informed decisions about REIT investments and understand the factors contributing to IPO initial returns.