The Wreckage Of The Chinese Investment Frenzy Shows Why It’s Not Coming Back Anytime Soon
The years between 2013 and 2017 in the global commercial real estate market were, in large part, defined by the waves of capital pouring into the world’s gateway cities from China.
When Chinese real estate firms placed billions in huge bets on trophy office assets and luxury residential developments in London, New York, Los Angeles and San Francisco, it wasn’t just a big deal for real estate. It was a sign that China’s huge economy was beginning to mature, exporting wealth around the globe and diversifying beyond its own borders.
Buying and building chunks of the world’s biggest cities was a way of establishing physical roots abroad. When ABP, a private developer owned by founder Xu Weiping and his daughter, Nancy Xu, signed a deal to build a 4.7M SF office park in east London’s former docklands in 2013, Chinese President Xi Jinping and then-UK Prime Minister David Cameron attended the event.
Like many of the deals signed in that era, ABP’s investment has gone sour. The first 700K SF phase of that scheme has been built and lies entirely empty. ABP’s lender foreclosed on a £98M loan and put the 21 empty offices into receivership.
It is just one of myriad examples of big purchase and development schemes undertaken by Chinese firms between 2013 and 2017 that have hit the rocks recently. Lenders have foreclosed on loans and taken back some projects, while other Chinese firms have sold assets at a loss or seen big developments go billions of dollars over budget.
Some deals undertaken by Chinese companies in the U.S. and UK have turned out to be wildly successful, and the problems at the other properties aren’t unique to the Chinese — both domestic and foreign owners have faced financial turmoil as the market has become more volatile in the past couple of years.
But China stands out, because of the size of the bets its companies made, the scale of the losses involved, and because of the significance these losses have for how the world’s second-largest economy will engage with the world in future.
“You get these liquidity booms that originate in overseas markets and leads investors to head abroad,” Seaforth Land founder and chief executive Tyler Goodwin said. “The Chinese had that, and now we’ve seen the implications.”
The problems faced by its real estate investors have reaffirmed to the Chinese government that real estate investment isn’t a strategic priority for the country for the foreseeable future, experts told Bisnow. The overseas investments the country makes in any sector moving forward are now more likely to be debt-free and made with caution.
In late 2016, the Chinese government instituted a set of capital controls that remain in place today. Xi's government was getting worried about the amount of capital pouring out of the country into deals that seemed risky in sectors like real estate, entertainment and sports, particularly soccer.
Real estate deals weren’t expressly forbidden, but to undertake overseas deals in the sector, the transaction had to be submitted to a government committee for scrutiny. Chinese investors essentially undertook a form of self-censorship, steering clear of sectors where deals would require oversight.
The outbound investment rush started in 2013, and 2017 was its high point, with $41B pumped into overseas real estate deals, according to data from MSCI. But in 2018, Chinese outbound investment dropped to $21B, data from MSCI showed, and in 2019, it dropped to $8B.
More than five years after those controls were put in place, as new deals have largely dried up, the deals from the era of frenzy continue to plague the developers who made them, resulting in astronomical losses.
A canary in the coal mine was the 2019 sale by conglomerate HNA of two London office assets for well below the price it paid just a few years earlier. Those sales both closed before the pandemic, when the London office market was still healthy and robust.
In New York, HNA saw 245 Park Ave., an office building for which it paid $2.2B in 2017, go into bankruptcy in 2021, and it was ordered to pay its local partner in the deal $185M last month. Insurance company Anbang paid $1.95B for the famous Waldorf Astoria hotel in 2015 and planned to spend $1B to turn it into a smaller hotel and luxury condominiums. But the development cost has spiraled to $2B, the scheme’s CEO departed earlier this year, and Manhattan’s condo market is a shell of what it was when the plans were laid.
A few miles away, Chinese developer Oceanwide earlier this year lost control of a site where it planned a supertall luxury residential tower in lower Manhattan following a debt default. Lenders also took over the company’s stalled, semi-complete project in the heart of San Francisco. The Oceanwide Center was supposed to be the city’s second-tallest skyscraper, but it currently sits as an abandoned construction site.
In London, listed Chinese developer R&F announced in March it was selling Vauxhall Square in south London, a site with consent for 1.4M SF of residential and office space, to Far East Consortium International, a Hong Kong-based developer with several projects in the UK, at a £69M loss.
Last week, the company secured £770M of debt needed to complete One Nine Elms, a scheme near Vauxhall Square comprising two towers of 56 and 42 stories that will include 730K SF of residential apartments and a 173-room luxury hotel.
Ironically, R&F made its name in London in 2017 by picking off some of the assets of Dalian Wanda, one of the first wave of Chinese firms that needed to sell out of London to pay back debt.
There are many other examples, and in many ways this is a story that real estate in the UK and U.S. has seen before; overseas investors going big into a market and getting their fingers burned is a regular part of the real estate cycle.
“There are a lot of reasons that explain why these investors are the first to get toasted when the cycle moves the other way,” said Colin Lau, the founder of Hong Kong-based Bei Capital and the former head of real estate at China Investment Corp., the Chinese sovereign wealth fund.
In the late 1980s and early 1990s, it was Japanese investors in London and New York who bought big and took significant losses. In the late ‘90s, it was German investors in London. In the mid-aughts, Australian and Irish investors rose and fell across Europe and the U.S. And in the mid-2010s it was Chinese firms, flush with liquidity created by their own domestic property and economic boom, and looking to spread abroad.
But the deals Chinese companies decided to chase can be a lesson to any firm looking to venture beyond its home turf. Partly the issue faced by the firms that have hit problems was simple, and a repeat of previous cycles: They paid too much.
“They targeted trophy assets and paid the prices for them, rather than targeting more mature, less risky assets,” said Eric Anton, a senior managing director at Marcus & Millichap and the director of its Global Capital Group. “Building ground-up luxury residential is risky. Buying the best large hotel in the city, which is unionized, for more than anyone else would pay for it, that is more risky than buying a good three- or four-star hotel.”
Like many interviewed by Bisnow, Anton pointed to the fact that many of the firms that have faced problems didn’t partner with local developers or asset managers, instead choosing to undertake projects themselves.
“They think because they can do development in China, they can do it overseas,” Lau said. “That’s a big mistake.”
To justify heading abroad, global investors inherently need to undertake large deals that can “move the needle,” Goodwin said — they weren’t going to head to an entirely new country just to buy a small office block. Coupled with a desire for prestige, that meant the wave of newly liquid Chinese investors were always likely to be drawn to those big, trophy and inherently risky projects.
But while the issues that beset Chinese investors aren’t unique to them, there were some factors, inherent in the particularities of Chinese real estate and the Chinese economy, that set them up for their lack of success.
Many of the firms that bought buildings or projects in the U.S. and UK did it using large amounts of leverage, Lau pointed out. When taking into account that firms might be using a mixture of secured debt and unsecured credit facilities to fund overseas investment, deals were being done essentially using 100% debt. Real estate in the U.S. and UK might be wary of leverage right now, but in booming China, in the middle of the last decade, debt was in fashion.
But when the market turns — or there is a liquidity crisis like the one precipitated by the slow-motion collapse of massive Chinese developer Evergrande — being highly leveraged means lenders can take control of assets. And overseas schemes are the first to suffer.
“Cash flows and capital chains are broken,” Lau said. “Right now, if you are not able to do well domestically and you can’t find liquidity or refinance debt, then overseas assets are the last priority.”
In China, where the economy grows by at least 6% a year, and new millionaires are being minted daily, building luxury apartments in the best part of a city, or huge business parks, might not seem such a risky idea. The speed of China’s domestic growth also highlights the difference in the zoning and planning laws. In China, developers know they are going to be able to get their approvals and build within a couple of years, whereas in the UK and U.S. that process can take a lot longer, meaning the market can turn against you.
“I’ve been going to China for more than 20 years,” said Goodwin, who was a senior executive in JPMorgan Chase’s Asian business for more than 10 years. “I stood in a field outside Tianjin, and came back a couple of years later, and it was a booming business park.”
In China, the price of land makes up a far larger part of the overall cost of a development — about 50%, compared to 20%-30% in the UK or U.S., Lau said. Through that lens, the prices HNA and Anbang paid for assets might not have seemed so high. But when inflation caused a spike in the cost of materials and labor, it meant they could very quickly run out of money.
Goodwin pointed out that without local knowledge, it can be easy to transpose the economics of one market to a very different one.
“They came in, often didn't partner with the right people, or with anyone, and found out the hard way that development can be very risky,” Anton said.
“I don’t think it will be any greater proportion of Chinese investors that have problems compared to other foreign investors,” said Meridian Capital Senior Executive Managing Director David Schechtman, a New York investment sales broker.
But given how many investors and developers have found high-profile issues, the 2016 move by the Chinese government to curtail real estate investment seems prescient. And given the problems that are now manifesting, the chance of the control being reversed in the short or medium-term seems slim.
Lau said state-owned or linked enterprises have certain key performance indicators they need to hit, and private companies have been encouraged to focus on domestic projects. Whatever sector the investment is happening in, if companies are investing abroad, they need to be doing that in a lower-risk, lower-leveraged way.
For the Chinese government, there are certain sectors that are seen as being of strategic importance for the country’s growth and future economic prosperity. Investing in those sectors abroad is encouraged.
Real estate isn't one of them.
“Manufacturing, green and climate tech, agriculture and technology, those are the important sectors,” Lau said.
Some sectors of real estate might be on the agenda, for instance, logistics, with its importance to global supply chains, or healthcare and life sciences, with their post-pandemic importance having grown.
“But just buying another office building or residential development?" Lau said. "What’s the urgency?”