China has been a major driver of global investment flows into real estate in recent years. CBRE Research data shows that Chinese outbound investment in real estate rose from around US$8 billion in 2013 to just over US$35 billion ($45.7 billion) in 2017.
Following a government clampdown on debt-fuelled offshore investment and tighter scrutiny of overseas real estate acquisitions, buying activity slowed significantly in 2H2017 and is expected to weaken further this year as additional restrictions take effect. Chinese investors have purchased more than US$100 billion worth of overseas commercial real estate over the past five years, making headlines with numerous eye-catching deals involving trophy assets in global gateway cities.
High-profile transactions in 2015 included Anbang Insurance’s purchase of the Waldorf Astoria New York hotel for US$1.95 billion, and Evergrande’s acquisition of Mass Mutual Tower in Hong Kong’s Wan Chai district for US$1.6 billion.
After eclipsing Singapore as the largest source of Asian outbound capital in 2016, completing US$26 billion worth of overseas real estate acquisitions, Chinese investors maintained their strong momentum in 1H2017, with several deals inked during that period considered among the costliest recorded that year.
Regulatory change prompts a step back
Chinese authorities began clamping down on overseas investment at end- 2016 in a move designed to stabilise the renminbi, restrict capital flight and reduce financial risk.
Capital outflows subsequently weakened significantly. Data quoted at a news conference hosted by the Ministry of Commerce in July 2017 showed that overseas direct investment in the property sector fell 82% y-o-y in 1H2017, with discrepancies between official data and actual investment turnover reflecting the significant volume of Chinese capital already circulating outside the country.
This new wave was followed by Beijing publicly naming several of the country’s largest private conglomerates as having engaged in excessive borrowing for foreign acquisitions. Subsequently, in August 2017, the State Council and the National Development and Reform Commission formalised restrictions on Chinese companies engaging in overseas mergers and acquisitions in certain sectors.
NDRC listed three categories of overseas investment including those that are banned (for example, industries related to gambling); those that are restricted (for example, property, film and sports); and those that are to be encouraged (for example, investments that support the Belt and Road Initiative).
The inclusion of property on the list of restricted sectors subjected proposed overseas acquisitions by Chinese companies to additional layers of scrutiny, ensuring that buying activity slowed significantly in 2H2017, led by a fall in activity by insurance companies.
New restrictions further dampen investor appetite
Although Asian outbound investment continues to eclipse previous records and Chinese investors still comprise the largest source of capital, CBRE Research expects to see a continuation of the slowdown in Chinese outbound investment first witnessed in 2H2017, following the introduction of new capital controls.
This year’s CBRE APAC Investor Intentions Survey, which focuses on the forward-looking views of real estate investors in Asia-Pacific, indicates that Chinese investors are less keen to invest overseas in 2018. While overall interest remains reasonably firm, fewer investors intend to invest more than they did in 2017.
At the forefront of investors’ concerns is another set of outbound investment regulations, effective March 2018, that classify real estate as a “sensitive sector” and therefore subject to an additional layer of examination. The measures, unveiled by NDRC in December 2017, categorise outbound investment into “sensitive” and “non-sensitive” projects. While real estate is not specifically categorised as a “sensitive industry”, the previous guidance document released by NDRC in August 2017 included real estate on the list of restricted sectors, meaning that it meets the fourth criterion of a “sensitive industry” and that proposed overseas real estate acquisitions by Chinese companies will be subject to NDRC approval.
There will also be regulation of financial institutions, partnership business entities and Chinese individuals investing via offshore special- purpose vehicles or pledging domestic assets against foreign exchange loans to finance investments.
The start of a new chapter, not the end of the story
China still accounts for the largest source of capital in Asia-Pacific and will continue to play a critical role in the global commercial real estate investment market. CBRE Research believes Chinese outbound investment will continue, but the pace of capital deployment is likely to slow as investors adjust to the new rules.
Chinese outbound investment this year will be characterised by the following trends: Focus on Belt and Road: There will be a stronger focus on Belt and Road countries and logistics and industrial-related asset classes such as warehouses, industrial parks and ports, supported by more flexible regulatory treatment. CBRE Research’s China Investor Intentions Survey shows that although Chinese investors are less keen to invest overseas in 2018, interest in Belt and Road-related regions continues to rise.
CBRE Research has already observed a significant jump in the number of Chinese investors purchasing logistics assets in recent years.
Large portfolio deals: Transactions involving the purchase of large portfolios are expected to become more frequent in Belt and Road countries as investors shift their focus from traditional gateway markets in Asia-Pacific and the West.
Alternative sectors: Healthcare and data centres are likely to attract stronger interest from Chinese investors, as investment in these niche sectors can support the government’s policy of improving China’s technological R&D. Transactions will take the form of equity stakes or partnerships with local investors.
Changing composition of capital: The composition of Chinese outbound capital will change from property companies and insurance companies to sovereign wealth funds (SWFs) such as the China Investment Corp and the State Administration of Foreign Exchange. While outbound investment demand from several sources of Chinese capital is set to weaken, SWFs will retain a strong appetite for real estate, particularly for stabilised assets in major cities. However, acquisitions are very likely to be confined to markets allied to the Belt and Road Initiative. Corporations, particularly those engaged in e-commerce and manufacturing, are also expected to be active and acquire assets — especially logistics properties — to facilitate their global expansion.
Early Chinese buyers become sellers: Many Chinese buyers at the forefront of the early wave of outbound investment are expected to dispose of some of their assets to repay loans, or because they have already reached their expected returns for core assets. Conglomerates that have been the subject of the recent government clampdown will continue to liquidate major overseas real estate holdings to recapitalise or repatriate capital home. Some of this capital could be reinvested abroad, though.
Investment via offshore financial institutions: Large investors already have money in circulation via the balance sheets of insurance companies and other investment management platforms they have acquired. They are likely to use these offshore platforms to engage in property acquisitions, although these will have to be closely aligned with the Belt and Road Initiative.
Redeploying offshore capital: With capital controls making outbound direct investment more difficult, redeploying offshore capital is expected to drive some investment transactions this year. Given that they will also be subject to closer scrutiny by NDRC, however, such purchases will be considered very carefully.
Other routes: Other potential options for Chinese outbound investors could include taking positions as limited partners, purchasing smaller equity stakes of below US$50 million and participating in joint ventures.
Above all, it must be stressed that while Chinese outbound investment will be subject to tighter regulation, it has not been forbidden. CBRE Research expects to see Chinese buyers engage in low-profile, selective and strategic real estate purchases that align with their broader business objectives, eschewing the high-profile and speculative plays that characterised much of their previous activity. This will ultimately result in smaller transactions and slower deal flow.
By Sam Xie, head of research, CBRE China.