CHINA UNFILTERED: Will a Cold Chinese Economy Lead to a Flu in U.S. CRE?
Connect’s China Coverage – The full report
This is a full report combining the five-part series about China and U.S. commercial real estate that Connect Media published last week. Read our report unfiltered.
One can’t discuss the global economy without mentioning China’s impact. The commercial real estate industry is no different, as China’s investment in the United States is significant. With recent economic uncertainty in the world’s largest country, what will happen next? At Connect Media, we have put together this special report on Chinese real estate investment.
Emerging China Takeaways
1- Summer vacation: A recent cold Chinese economy, while worth noting, is not likely to have long-term impacts on continued Chinese investment in U.S. commercial real estate. Experts consider this period as the market catching its breath. The Chinese are viewed as long-term players, not looking to flip investments unless they have to.
2- Favored Nation Status: U.S. CRE’s relatively mild-risk safety, stability, transparency and income potential remain powerful draws for continued investment, compared to riskier options available in China.
3- Building A New Chinese Wall: A broadening array of Chinese investors is working to build their global portfolios. It is early for a new class of Chinese investors actively pursuing investments in the U.S. market with big commercial real estate allocations to fill.
How Big is Chinese Real Estate Investment?
Real Capital Analytics (RCA) reports that Chinese investors were involved in direct commercial real estate investments totaling $38.3 billion globally in the last 24 months. For the United States, the figure stands at $5.8 billion over the last 12 months.
Real estate economist Jim Costello of RCA told Connect Media, “That’s real money, but it is important to put these figures in context. Total activity in the U.S. came in at $499 billion in the last 12 months, so in total it’s roughly 1.2 percent and most likely larger than that. Capital out of Hong Kong was involved in transactions totaling $2.1 billion, and out of Singapore, $8.6 billion, and some of that money likely came from Mainland China in various fund structures.” In all, Asian investment came in at $21.7 billion, making up four percent of total activity.
Admittedly, that figure isn’t much, but the concern for U.S. markets is that the Chinese have been important buyers in key markets. Costello noted that acquisition activities likely led to new record prices for hotel properties, in such places as Manhattan. Chinese buyers accounted for nearly nine percent of total direct-property purchases in the New York City borough, he said. So, the buying pool of the latter market could feel turmoil, at least in the short term, if the market reassesses as it nervously waits for another shoe to drop.
Ranking Top Market Destinations For Chinese Capital Globally Last 24 Months (In Millions)*
Market/ Total Props/ Total Volume
Manhattan/ 23/ $5,748.5
Sydney/ 81/ $5,678.0
London/ 14/ $5,617.3
Johor Bahru/ 3/ $2,076.6
Singapore/ 18/ $1,836.0
Melbourne 87/ $1,722.2
Tokyo 9/ $1,707.7
Los Angeles/ 11/ $1,124.0
New Territories 8/ $1,008.7
Other 243/ $11,763.4
Total 497/ $38,282.4
Ranking Top Market Destinations for Chinese Capital in U.S., Last 12 Months (In Millions)*
Market/ Total Props/ Total Volume
Manhattan 14 $4,491.7
Los Angeles 5 $262.2
Chicago 5 $248.8
Houston 2 $139.6
San Jose 3 $93.7
Monterey 2 $87.7
San Francisco 3 $83.5
Miami 1 $74.7
Seattle 5 $57.4
Other 24 $334.9
Total 64 $5,874.2
*Source Real Capital Analytics September 2015
Emerging China: Chinese California Investment Is Serious
There have been a host of investments made by the Chinese across the Southern California region, starting in the early 1990’s, primarily involving commercial office buildings, mainly in Downtown Los Angeles, and shopping centers. By 2010, Chinese investors began branching out into hotel and office-building assets.
Additionally, as Chinese families came to live in the United States, purchasing a home was considered both smart and safe. Today, the National Association of Realtors reports that Chinese Nationals are the biggest foreign buyers of U.S. housing, having purchased $28.6 billion worth of residential real estate in 2014. While that’s not chump change, it is a smaller slice of the $105.1 billion that Juwai.com reports Chinese Americans spent on U.S. real estate in 2014. Obviously, the United States has found favor with the Chinese.
Jerry Wang, head of Charles Dunn’s international division, has assisted numerous Chinese investors acquire commercial real estate in Los Angeles, Pasadena and other Southern California cities. “The majority of the investments turned out very well,” Wang told Connect Media. “Generally, these investments had minimum to no mortgage, which resulted in a much higher positive cash flow compared to domestic investors.”
Let’s look at a few of Chinese California investment ventures in the southern part of the state to better understand their scope.
Representative Chinese Projects in Southern California
The list of current Chinese investments is spread from Downtown Los Angeles, the Westside and even behind the Orange Curtain in Anaheim.
• Metropolis: Greenland USA – which has committed more than $6 billion combined into 28 acres of development in New York City and L.A. – is investing more than $1 billion to bring Metropolis to life. The property will feature three residential towers, a boutique hotel and a curated retail center planned for completion in phases starting in late 2016 through 2018. It promises to serve as a key link in an emerging “Avenue of the Angels,” a pedestrian-friendly walkway between downtown’s financial district and the entertainment district.
• Oceanwide Plaza: Oceanwide Properties – also another big investor in New York – acquired a 4.6-acre site across from Staples Center in 2013 and is moving forward on Oceanwide Plaza, a $1-billion development slated to include three high-rise residential towers encompassing 900 condominiums, 200 hotel rooms and nearly 170,000 square feet of retail space. It is Oceanwide’s first investment outside of China. New York investments followed the company’s L.A. purchase.
• W Hotel: Developer Shenzhen Hazens Real Estate Group Co. acquired the Luxe Hotel and two adjoining sites downtown in 2014 and is working on plans for a $700-million complex that would include a hotel, condos and retail space. Reports say a 250-room W Hotel will be incorporated into the mix for this development, forecast to open in 2019.
• W.H. Grand: One of the first Chinese companies to arrive in Los Angeles in a big way was Shenzhen New World Group, which acquired the Marriott Hotel at 333 S. Figueroa St. in 2010. The 469-room hotel is being rebranded under the independent W.H. Grand flag.
• One Beverly Hills: On the Westside, The Wanda Group, China’s largest developer of commercial properties, is moving forward on One Beverly Hills, a $1.2-billion condominium and 134-room hotel development that has a 2019 opening in the works.
• LTG Platinum Center: In Orange County, Chinese developer LT Global Investment Inc., a U.S. subsidiary of Beijing’s LT Commercial Real Estate, is planning LTG Platinum Center, a nearly $500-million residential, hotel and retail complex next to Angel Stadium in Anaheim. Slated to be completed in 2020, the 14-acre site would include a 28-story condo tower, a 26-story hotel, a theater, outdoor dining and an indoor surfing park.
Will the Chinese Capital Tap Stay On?
As reports of early U.S. commercial real estate success filtered back to China, so too did demand, increasing activity. JLL and CBRE Group concur that despite recent turmoil in China, it is unlikely the capital tap for U.S. real estate will be shut off, given long-term appetite and favorable investment conditions.
CBRE’s capital markets group recently reported that Chinese outbound-capital flows into global commercial real estate markets exceeded $10 billion in 2014, the first time that Chinese investment eclipsed that mark in one year. Over the past four years, China-sourced outbound flows to commercial real estate experienced a compound annual growth rate of approximately 72 percent, said CBRE. This dramatic rise in investment comes from Chinese institutional, corporate and high-net-worth individuals. CBRE noted that what began with China’s sovereign-wealth funds and tier-one insurers acquiring high-profile trophy assets abroad has now spread to acquisitions by mid-tier insurers and corporate investors.
Drilling down to country-by-country statistics, the United States is experiencing significant interest. JLL pegged Chinese investment in commercial real estate at $1.7 billion in 2014, a jump from $61 million five years earlier, and it notes that capital flow already hit $1.2 billion by mid-year 2015.
“In overall terms, however, this number is fairly small compared to the total U.S. investment volumes, so any short-term market volatility caused by the RMB devaluation is unlikely,” Steve Collins, president of Americas Capital Markets for JLL, told Connect Media.
Expected Short- and Long-Term Impacts
U.K., U.S., and Australian cities are the top three commercial real estate markets for Chinese investors, according to CBRE. They primarily involve residential properties, as well as premium office and hotel assets in gateway cities.
“The explosive growth in purchases of offshore real estate by Chinese investors has presented a new class of investor to global markets,” Chris Ludeman, Global President, CBRE Capital Markets, told Connect Media. “As these investors and developers gain experience and become more confident in overseas markets, we expect that an increasing amount will start to look for opportunities across a wider range of geographies and a greater variety of asset types.”
CBRE found that U.S.-bound flows were more than one-fifth of total outgoing investment from China in 2013 and 2014. Over that two-year period, purchases of hotel and office assets in New York City, Los Angeles, Chicago, Houston and San Francisco accounted for more than 60 percent of U.S. commercial real estate buys. Premium offices and hotels in New York and Los Angeles made up about half of that.
JLL’s Collins reported the movement is toward long-term potential for Chinese investors to support real estate volumes through both direct and debt investment. He offered four key reasons investment should continue despite recent turmoil:
1. Devaluation is important in strategic terms, but unlikely to impact the ability of Chinese investors to afford foreign-exchange (FX)-denominated assets in the short term because the devaluation was small, at three percent, compared to others such as Russia, which got hit with a 50-percent drop.
2. The devaluation underlies the challenges facing the Chinese economy. With GDP at its slowest pace in six years, and five consecutive months of manufacturing contraction, it will drive investors toward risk-free assets such as U.S. Treasuries, keeping downward pressure on yields.
3. Chinese corporations will be forced to more actively manage their FX exposure. Though Chinese corporations are estimated to hold some $1.3 billion of denominated debt, it is matched by its huge FX reserves of more than $3.5 trillion. That will make it more expensive to service this debt, so corporations will be incentivized both to reduce debt levels and store more FX, OR to hold FX-denominated assets as a hedge against future Yuan devaluation.
4. A move to risk-free assets is also driven by Chinese capital. Turmoil effectively creates a wall of Chinese capital looking to invest in low-risk assets with stable returns, supporting the argument for real estate.
What Drives Chinese Investment in the U.S.?
There were multiple drivers for Chinese real estate investment in the United States over the past several years, Bob O’Brien, Deloitte’s U.S. and global real estate services leader told Connect Media, noting that volume picked up in the fourth quarter of 2013.
“A variety of entities, including large real estate developers in China, were seeing a dwindling number of opportunities within China, and at that time, it became difficult for developers in the U.S. to raise capital,” said O’Brien.
He also noted: “We had high-net-worth individuals in China looking to invest to, in effect, diversify their own portfolios. They were looking for the stability that the U.S. market presented, so invested personal wealth in the U.S.”
What’s attractive about the United States is that investors find comfort in the transparency of its markets, and the rule of law for U.S. real estate transactions. But O’Brien also pointed out: “Many times the reasons Chinese invest in the U.S. is because it is personal. They have an affinity for the U.S. Maybe their kids went to school here, or they want them to go to school here.”
A primary driver behind the Chinese seeking out U.S. commercial real estate is because the economy and government are stable, said Charles Dunn’s Wang. Additionally, the cost of real estate in the United States is cheaper than China.
“China had a large trade surplus in the U.S., so the Chinese government encouraged [investment here],” said Wang. “The Yuan was also appreciating which allowed Chinese to exchange more U.S. dollars for Yuan. Lastly, Chinese investors have concerns with the Chinese government policies and view the U.S. as a haven for investments.”
Relative to other investment options, the Chinese have always loved buying real estate and owning land, Wang pointed out. “They believe land and real estate will appreciate while other businesses are unstable. Also, owning commercial property such as office buildings and retail centers involves much less work and less risk than running a business.”
Pain Points: What’s the Chinese Tolerance for Risk?
The root concern about China perhaps runs deeper than recent turmoil. Wang reported that China’s economy has slowed down from double digits to single digits due to higher labor and operations costs. Additionally, middle-income families have increased, thus creating greater demand for better living accommodations and general services. Housing prices have risen dramatically, making affordability a large issue in China. Air and other pollution issues have also raised concerns among China’s general population, he said, causing the Chinese to look West.
The pace of growth in China has slowed down for several years and seems to be slowing at an accelerating pace because of overcapacity, said Deloitte’s O’Brien. Consequently, real estate, developments and manufacturing facilities are facing overbuilding, which is having a negative impact.
Though experts agree the recent turmoil in China may be short-lived, it has gotten everyone’s attention. Long-term solutions as to what ails China may be found in what Wang pointed out as larger reforms currently underway.
“The Chinese government needs to privatize state-owned enterprises such as power plants, railroads, shipping, airlines, banks, oil distribution etc.,” he stressed. “This economic reform will make the economy more flexible, but it will take 10 years-plus to achieve their goals. Chinese also need to shift from low-cost labor export to the domestic service and high tech industry. Now that the Chinese have more money, there is a larger demand for domestic services.”
However the concerns are addressed, in the short term at least, when it pertains to investing in the United States, China’s “main concern is the U.S. dollar appreciating,” Wang concluded.
Going forward, what can the United States expect in the way of continued Chinese real estate investments? Since early August, the float of the Chinese Yuan led to currency and equity market turmoil, as well as concerns about continued U.S. investment.
But as economist Costello of RCA told Connect Media, “There is no direct mechanism for the turmoil to come through. Equity markets are priced by the pico second, price discovery for real assets is a longer process. What has moved in the equity markets is the risk-adjusted present value of expected future income.”
But investors are clearly worried about risk. Costello pointed to the behavior of the long end-of-the-yield curve. The 10-year U.S. Treasury had been close to 2.3 percent before the turmoil started, fell below the two-percent barrier for a little bit and is back up into 2.15-percent-to-2.2-percent range. Risk is off and investors are looking at investments with more stable income, which generally points to commercial real estate, as long as the real side of the economy holds up.
“Real side, meaning what companies produce, what consumers buy, how much hiring etc. – on the face of it, that part of the economy has ignored the turmoil,” Costello reported. “GDP was up 3.7 percent in the second quarter. With that kind of growth, commercial property income should remain steady and even continue to climb so long as construction continues to remain in check.”
And Costello likes commercial real estate’s position, given the large pool of buyers pursuing assets in markets such as Manhattan, where it is has been common to see upwards of 20 bidders line up. Even if four percent to nine percent of the winning bidders pull back, it is a smaller portion of all the potential buyers, and there’s a deep pool of capital seeking yield opportunities in commercial real estate globally, he noted.
The Chinese aren’t likely to turn against U.S. real estate, concurred Deloitte’s O’Brien. “U.S. real estate markets, in the near term, won’t be significantly impacted. Developers or high-net-worth investors in China will still be attracted [to U.S. real estate] for the same reasons that originally attracted them.”
And he notes that Chinese are still seeking development opportunities with high rewards. “They still want to buy assets in markets like Manhattan to protect their money,” O’Brien said.
Longer term, O’Brien believes there’s likely going to be an impact if there’s not the same level of wealth creation in China that has happened over the last decade. In the near future, it is not going to impact the U.S. real estate markets significantly.
Conclusion: It Is the Early Innings for a New Investor Class With Deep Pockets
There is nonetheless good reason for concern about the impact of recent turmoil in China, though not for panic. Fundamental questions are being raised about China, an economy which now accounts for 15 percent of global GDP and around half of global growth.
RCA’s Costello points out there are a number of forces at play as to whether turmoil in China ultimately will have an impact on commercial real estate investment. “For Chinese investors, the fall of the Yuan will start to make U.S. commercial real estate look more expensive,” he said. “That price impact may start to reduce some of the demand for investment in commercial real estate outside of China.”
Still, Costello noted that’s not the only force at play: “Equity market volatility is generally good for overall real estate investment.” When oil prices drop, typically there’s a pick up in Middle East investment into commercial real estate. With low levels of leverage and development, commercial real estate is well positioned. Costello would not be surprised to see a pick up in Chinese commercial real estate cross border flows, which will show up in the numbers over the next two quarters.
So then, what can be expected, in terms of Chinese investment strategy going forward? According Deloitte’s O’Brien, “The Chinese are investing for the long term. They are not looking to flip. That long-term perspective aligns well to real estate. When they’ve looked at New York, San Francisco or other markets in the U.S. or even London, they recognize those markets have ups and downs, but they are unique and they’re looking at the long-term potential for return.”
Conversely, O’Brien points out some of China’s other investment plays have different objectives. For instance, when the Chinese invest globally in such options as agriculture land, mines, resources, or energy – a portion of that objective is geared to make sure they have access to them for their own economy. In those cases, O’Brien says: “They’re motivated to provide access rather than making a return on investment.”
Whatever the reason or motivation, it is clear the Chinese have just whetted their whistles and could be primed for a deeper dive into U.S. real estate. “Chinese investors are only beginning to tap into the vast set of opportunities available to them in the U.S. As competition in gateway cities continues to increase, Chinese investors will need to include other large metropolitan areas, such as Atlanta, Boston, Dallas, Denver and Seattle in the hunt for better investment opportunities,” predicts Brian McAuliffe, Executive Managing Director, Americas, CBRE Capital Markets. “Institutional investors are also beginning to take note of the attractive returns offered by industrial and logistics properties. As Chinese investors widen their search to new markets, they will also need to develop a more sophisticated understanding of local dynamics.”
On a grander scale, RCA’s Costello suggests that since many Chinese institutions are starting from scratch on building global portfolios, the turmoil is not likely to deter them from long-term investment strategies. This early stage puts these investors in long-term holds for assets. Investors are not likely to sell assets unless and until they need the cash back home to cover other losses – and while the Chinese stock market is down this summer, it is still up for the year.
The irony is that investors certainly could view U.S. commercial real estate as more expensive and avoid it, but conversely and more importantly, it’s likely viewed as a safer and less volatile investment. At the same time Costello notes, investors still have big commercial real estate allocations that need to be filled. So, while immediate concern over the recent turmoil in China is inevitable, the experts to whom Connect Media spoke with say the odds of U.S. commercial real estate markets coming down with the flu as a result are a bit unfounded.