China Crisis? Outbound Investment To Stay Stagnant And Economic Uncertainty Grows
In the snowy climes of the 2017 Davos World Economic Forum, Chinese President Xi Jinping raised the prospect of China becoming the leading force of globalisation. Xi used U.S. President Donald Trump’s decision not to attend the conference as an opportunity to position China as an outward-facing agent of global trade.
China’s real estate investors had been working to make their president’s message a reality. Mainland Chinese firms invested a record $41.5B outside of their own country in 2016, according to Real Capital Analytics, and in 2017 they topped that, spending $42.5B abroad including CIC’s €12.25B ($14B or £10.8B) purchase of Logicor, the largest deal in European history.
Fast forward to January 2019 and the first day of Davos and the picture is altered completely. China is dramatically more inward-looking. The country is locked in a trade war with the U.S. Xi and the ruling Communist Party have reined in outbound investment flows.
The U.S. and UK real estate industries have reason to be nervous.
Chinese investment into other countries fell by 45% to $23.6B in 2018, the lowest figure since 2014, according to provisional RCA data. When Hong Kong is taken out of the picture, outbound investment is down more than two-thirds.
In the U.S., investment was broadly flat but came mostly in the first quarter, and in the UK investment levels dropped from $7.5B in 2017 to just $580M. In a slowing global real estate investment world, the market for big complicated deals and trophy assets is a lot thinner, and is likely to stay that way.
What is more, there is another reason for U.S. and UK real estate to glance nervously to the East. Given the secrecy of the government, measuring the real health of the Chinese economy is notoriously difficult. For that reason, the sharp drop-off in sales reported by Apple in China was a cause of concern, and seen as a potential canary in the coal mine indicating a possible Chinese slowdown, especially when coupled with reports of the Chinese banking system facing record levels of non-performing loans and the fact that in 2018 China's economy grew at the slowest pace since 1990.
The old cliche used to be that when America caught a cold, the rest of the world sneezed. The same is true today of China. Does the world economy — and perhaps real estate in particular — need to have tissues at the ready?
RCA data showed outbound Chinese investment fell quarter by quarter in 2018, from $14.1B in Q1 down to just $2B in Q4, and this pattern is expected to continue in 2019, partly due to conditions in the Chinese domestic markets, and partly because of government regulation.
Commercial real estate transactions by Chinese firms are not expressly forbidden, but essentially all of them, and certainly the larger deals, have to be given government approval. That has created a climate of self-censorship, according to one Chinese investor with a sharp insight into government policy.
“I think 2019 will be another disappointing year for Chinese outbound investment,” Bei Capital founder and former head of real estate at CIC Collin Lau told Bisnow. “For private companies it is hard to send money abroad, and in fact their focus will be on refinancing domestic loans. For state-owned companies, they still feel they need to be careful.
“The No. 1 factor is self-censorship,” he said. “You can still apply, but it takes longer to process. That makes deal closing and execution a lot more uncertain.”
Lau said some deals will find favour from regulators, if they are seen as being strategically important for the Chinese state. But this will discount a lot of real estate deals, particularly of the kind undertaken from 2014 to 2017.
“They will look at deals and ask, is there anything that can be learned from this deal, anything of substance that adds value to the real economy? So things that focus on healthcare, or tech or retail; if Alibaba or Tencent wanted to buy a new subsidiary, that would be fine. But the Chinese government sees real estate as part of financial services, so I think just buying a trophy office building wouldn’t work.”
“Sovereign wealth funds and institutions across the world are still keen to put money into real estate, but the one place that is different is China,” CBRE Head of International Capital Markets Chris Brett said. “I think for the time being international diversification is off the agenda. I haven’t seen a bid on an asset from a Chinese investor for a long time, and they are refocusing their attention on their home markets. You have seen some major assets bought by Chinese investors in their home markets recently that a few years ago would definitely have been bought by international firms like Blackstone or Brookfield.”
The push factor of government regulation is combined with the pull factor mentioned by Lau, the need to focus on a domestic market that is looking less robust.
“I was in Hong Kong before Christmas, talking to existing and potential investors, and there is a lot of nervousness there about reports on market conditions in second-tier Chinese cities, rising levels of bad loans and a credit bubble,” Tristan Capital Head of Research and Strategy Simon Martin said. “A lot of focus is going in to refinancing domestic debt.”
But that has gotten trickier.
“What you hear from people on the ground in China is that in 2018 debt became much more difficult to access,” RCA Senior Director of Asia Pacific Analytics Petra Blazkova said. “The biggest groups, many of them state-owned, can access finance and get projects going, but for the smaller and medium-sized groups it has become much harder.”
To a certain degree other investors from Asia have stepped into the gap left by mainland Chinese investors. Overall, Asian outbound investment in 2018 was flat at $118B, showing that the slowdown by mainland Chinese investors was filled by other groups. Hong Kong investors bought £1B assets in London (including UBS’ HQ), and Korean investors also put a record amount of money into the UK capital.
But it will not be as simplistic as “one in, one out.” The nature and geography of Asian investment is likely to change, Tristan’s Martin said, with the U.S. and UK perhaps missing out on Hong Kong investment in particular.
“For investment in the U.S. you have the issue that higher interest rates are leading to increased hedging costs, and then there is the fact that, as a result of the trade war, investors from Hong Kong and China maybe don’t feel as welcome,” he said.
“In the UK, you get the sense that there is a little bit of disappointment about some of the investments made so far. There was the sense that investors were buying in cheap because of the drop in the value of Sterling, but performance hasn’t surprised on the upside, and it has been quite hard to monetise any gains that there have been. That means investors are increasingly looking at Europe.”
Who will be hardest hit by the exit of mainland Chinese investors from global markets? As Lau said, one of the sources of buyers of large trophy office buildings is essentially out of the market, so if you are selling one of those you are going to have to work harder.
Chinese investors were also major investors in large platform deals like Logicor and major urban development projects. In the hotel sector in particular, Chinese firms were acquisitive buyers of large portfolios, so the private equity firms that bought into this sector between 2013 and 2015 now need to find an alternative exit route.
The issue with development projects is more complicated. It is unclear whether major Chinese firms that have bought development sites will be permitted under regulations to export the significant amounts of capital required to build out the schemes.
That could have a major impact on some global cities. In Los Angeles, Dalian Wanda sold its $1B One Beverly Hills development to Guggenheim Partners. In London, Hong Kong-listed but mainland-China domiciled R&F has a development portfolio of 4,000 London homes, which will cost it £4.5B to build.
“It is not clear how it works, but some firms seem to have the blessing of regulators to carry on investing,” CBRE’s Brett said.
The overall feeling is that this is just a bump in the road in terms of the growth of Chinese investment, which over the long term will play a much bigger role in global real estate markets. The country’s pension system is estimated to hit $4.4 trillion by 2020, which would make it about half the size of that of the U.S., but growing much faster.
“There is still a desire to diversify internationally,” Allianz Real Estate Chief Executive François Trausch said. “The larger, more sophisticated investors are studying how to do it in a more measured way, that matches their assets and liabilities, in the same way that we would.”
Beyond outbound capital, just how worried should global real estate investors be about the possibility of a Chinese slowdown? It is not yet a clear and present danger, but as the globe enters a period of slower economic growth, it is certainly something to keep an eye on.
Some experts Bisnow talked to are generally optimistic about China’s health.
“If you talk about a slowdown in China, you are talking about a slowdown from 8% to 6%, which will still keep domestic and multinational firms very happy,” Lau said. “E-commerce is growing nicely. Apple’s main worry is the growing competition and the fact that it is running out of truly innovative breakthrough products.”
On the potential for refinancing issues for Chinese real estate he said: “You have to remember, when you hear about RMB100B ($14.7B) of bad loans or refinancing, that all numbers in China are big.”
Trausch said Allianz and other global investors are not being deterred from investing in China.
“We are not slowing down our investment there,” he said. “We are developing logistics and buying offices in Beijing and Shanghai, which we consider very safe.”
But others are wary, and point to the fact that the nature of the current trade war makes its impact hard to predict.
“If you look at GDP figures, the U.S. and China are not too far apart, so you have to take note,” Martin said. “China is still growing at a healthy pace, but it is increasingly struggling to keep that pace up.
“The thing about trade wars is, normally one side is much bigger than the other, as was the case with the U.S. and Japan in the 1980s, which makes them shorter and easier to quantify. But China and the U.S. are wrestling and they are about the same size. That makes it much harder to measure the impact on supply chains. But you can probably say that the recent poor economic data coming out of Germany was an auxiliary impact of this. And the Apple effect is interesting. If you kick China and Apple takes a hit, then you think twice about kicking China again.”
China’s economy and real estate sector have now reached the scale where they have an impact on property around the globe. Xi is absent from this year’s Davos conference. Maybe real estate should buy him a ticket to Switzerland for 2020.