China pauses but keeps eyes on Europe

Institutional investment will continue despite a pull-back from residential, writes Christie Ou.

Several last-minute postponements of Chinese investments in overseas real estate markets towards the end of last year sent a worrying sign of the possible withdrawal of Chinese outbound capital and the impact this could have globally. A notable example was when Beijing-based insurance company Anbang pulled its £750 million acquisition of Heron Tower, one of the tallest commercial buildings in central London.

Heron Tower: Anbang withdrew interest
Heron Tower: Anbang withdrew interest

But many market professionals are measured in their response. “We haven’t seen any significant changes yet, but if there is a slowdown, due to capital flow restrictions, it would probably be the private rather than institutional investors, and it’s going to be on the residential rather than the commercial side of investment,” says Gunnar Herm, UBS’s head of real estate research & strategy in Europe.

Fickle economic policy and the stock market tumble in China may have reduced the purchasing power of small private investors and caused them to invest more cautiously. This means they won’t drive residential pricing the way they did in the first three quarters of 2015. However, for institutional investors which have traditionally focused on core assets, the trend is still pointing upwards.

“We continue to look into opportunities in the market. CIC have built up a significant portfolio and we believe they will continue to do what they do,” notes Robert Scholten, head of real estate finance Asia Pacific at ING Bank. ING Real Estate Finance works with big institutional investors, with 14 deals worth €2.5 billion, accounting for a 14.1 percent market share in the European commercial real estate market in 2014.

Economic recovery

A report from Real Capital Analytics (RCA) shows that China’s outbound investment increased from $15.5 billion in 2014 to $26.7 billion in 2015. There are several reasons supporting that growth. The underlying economic recovery of Europe is definitely one of the most attractive factors. Moreover, continental European deals open up higher yield possibilities outside the almost-saturated markets of London and North America.

Recent deals which have evidenced the appetite for continental Europe from Asian investors included the acquisition of the 56-storey Torre Espacio (Space Tower) in Madrid’s central business district by the billionaire Philippines-based investor Andrew Chan in 2015, while an earlier example was the purchase of Edificio España, a 117-metre tall landmark building in Madrid by the Chinese property developer Dalian Wanda Group in 2014. The building was later converted into a luxury hotel and shopping centre.

RMB depreciation is driving more domestic capital to seek opportunities in overseas markets. “As RMB becomes a more market-driven currency, it will devalue,” explains Frank Khoo, AXA IM – Real Assets’ global head of Asia. “This will drive the long-term capital to continue to invest abroad. Chinese investors are thinking that they’d better get out now because the depreciation will make it more expensive to get out later.”

The slowdown of the Chinese economy is encouraging institutional investors to look at building global portfolios for better diversification. Many will remain prudent and seek low-risk, low-yield real estate assets that serve to balance the risks they face domestically. Some leading institutional investors may continue to chase assets that offer higher yield, but are likely to refrain from high-risk investments. Consequently, they tend to invest in core or core plus product in major gateway cities.

Active developers

Comparatively, developers have been more active than institutional investors, with some of the leading developers that are engaging in offshore expansion willing to take on moderate levels of risk to obtain higher returns. According to a CBRE report, developers and other corporate investors may seek offshore sources of foreign-denominated income to fund expansion into new markets, in part to counter slowing economic growth in mainland markets.

Although Chinese outbound investment is expected to continue, some in the market still fear the impact of a short-term pause. John Mulqueen, CBRE’s head of transactions EMEA, is not one of them: “There won’t be a huge impact. Principally because there is a very deep and wide pool of capital globally available for real estate… there are others that are willing to replace the equity, like [those from] the United States.”

Despite regularly making the headlines, the presence of Chinese capital overseas has often been exaggerated. In fact, it accounts for only 1-3 percent of the total investment in Europe, with most of the money still coming from domestic buyers. No reason for panic, then.