Chinese wall won’t stop the outflow of capital

Beijing is attempting to curb capital from leaving the country, but it will still find a home in European real estate, writes Lauren Parr.

Outbound investment from one of the biggest suppliers of capital to European real estate is facing headwinds. China represented €3.8 billion of European property transaction volumes in 2016 according to Real Capital Analytics.

The Chinese government has recently clamped down on capital outflows in the face of a weakening currency and concerns over the strong rise in property investment abroad since the floodgates to overseas investment were opened in 2012. China’s State Administration of Foreign Exchange has begun vetting transfers abroad of $5 million or more and is increasing scrutiny of major outbound deals.

As a result of this intervention, it is unlikely that Chinese spending abroad will reach the heights it did last year. A record $22 billion of commercial real estate investments were made around the world; $33 billion if you add the residential piece to that; a 50 percent year-on-year increase, JLL data shows.

China’s yuan has depreciated and the economy has slowed down, yet there is strong investor momentum to go global.

“Mainland China is fascinating right now because it has seen almost annual announcements on curbs on outbound capital, but if you look from a global capital flows perspective China is now firmly entrenched second after US investors,” says Alistair Meadows, head of UK capital markets at JLL and who has more than 20 years experience in Asia-Pacific. “The China outbound story and structural shift of capital out of China continues at pace.”

A closer inspection of the curbs that have been introduced reveals a government beeline for what Meadows calls “irregular, non-core M&A activity”. There was a lot of activity last year around hotel platforms by Chinese groups and the intention is “to try to stop loss-making steel manufacturers buying gaming companies in the UK”, for example.

With regard to the real estate element to this, the key has been a $1 billion ceiling on industrial deals. However, the vast majority of acquisitions are less than a billion in value.

The possibility of Chinese investment in European real estate bring curtailed as a consequence of the state’s actions to stop wealth leaving has been a discussion point over the last two to three years, although it has not happened yet, according to Jeremy Waters, a veteran capital markets consultant who has advised Asian investors in Europe for the last 10 years. “Volumes are still there and there are still new funds coming through; investors seem to find ways round it,” he says.

Despite changes in government restrictions some Chinese funds based out of Hong Kong are filtering through Hong Kong families. This was demonstrated in the uptick in Hong Kong investment into the London market after the UK’s Brexit vote.

“The movement of capital from mainland China into Hong Kong played its part, therefore a lot of Hong Kong private investors took profits by selling to mainland Chinese groups looking to deploy profits in a safe haven market like the UK,” Meadows says. This move took people by surprise, but he explains that Asian private investors are often quite opportunistic so where volatility in currency markets presents an opportunity, they strike.

From a Chinese point of view, the desire to diversify into global property is very much there and the number one location to invest within remains London. “It’s all about currency and stability,” Waters says. “For a lot of these investors it’s as much about the pull factor of currency as it is the push factor of diversification so they will be watching the impact of Brexit but if they’re buying core City or West End buildings with secure income they’re fairly comfortable.”

Typically, Chinese investors pay cash or finance assets with relationship lenders. “It’s not foolish money coming out because they don’t have to spend it” Waters says.

The three markets Chinese investors have gone into on a consistent basis are the UK, Australia and the US. The US overtook Australia and the UK to become the biggest destination for Chinese capital in 2015, yet the market now looks more challenging politically.

“With Brexit, arguably the currency play has outweighed political ramifications. Regarding the States, Asian money won’t stop looking but it’s probably making them stop and think a little bit,” says Waters. “If you were instructed to sell a prime office in London with a price tag of up to £550 million (€641 million) you would immediately get on plane to China and talk to the main institutions,” he adds.

One school of thought says uncertainty linked to the US political environment could play into the hands of the UK and broader European market. London is still seen as the easiest market to enter, France and Germany thereafter. Competition from German funds for prime assets in their home market makes Germany a tougher market to penetrate, however. Chinese desks are now springing up within German institutions to handle Chinese investment.

There is potential for Chinese flows to moderate, not least because it would be difficult to sustain 50 percent year-on-year growth. At the same time however, new funds are still coming out of China. Demand for European real estate will likely remain strong in 2017 as Chinese investors continue to look for diversification on the back of the expectation of lower cap rates for core assets in China, and may approach the US with caution.

Meadows expects to see slightly depleted deal volumes this year as controls on capital outflows likely lengthen the time it takes to complete transactions, but he adds. “This isn’t the first time the Chinese government has moved towards a clamp down on overseas investing, yet significant growth has ensued.”

Korean and Japanese investors explore Europe

Germany has been a hotspot for Korean investors over the last 12-18 months. Says Waters: “It has been about hitting cash-on-cash return targets for these income-driven investors, who have not been able to hit their hurdles through London returns.”

A key deal was Samsung SRA’s purchase of Commerzbank’s headquarters in Frankfurt for €730 million last October. German lender Helaba has seen more Asian investment including Korean investors buying shopping centres in Poland, where “long term Asian institutional money is really coming in”, according to Michael Kröger, head of the bank’s international real estate finance team. It means more opportunities on which to lend, and at better margins than in core Western Europe.

Kröger notes that Asian banks’ activity in Europe has been concentrated so far on the UK market, with less of a presence on continental Europe.

A source of latent capital with the potential to move the needle in Europe is Japanese money – whether it is Japanese sovereign wealth funds that have been gearing up to enter the global real estate market or the numerous Japanese funds starting to invest on the indirect side in Europe.

“We haven’t seen it yet but this could be a precursor to new Japanese investment in the direct market” says Waters, noting that the scale of investment that could come out of Japan is huge.

“Some of the drivers relate to currency; the fact Japan has an ageing population; returns are low on a global basis; and the country has a very low weighting to international real estate”, Waters says.