The U.S. commercial real estate market could soon find out what happens when the government of the world’s largest country tightens the spigot on overseas investments from its citizens. Last week, the State Council of the People’s Republic of China officially announced measures to curb outbound investment – a move Chinese officials had been hinting at all year. 

Announcing the new measures were intended to promote the “healthy growth of overseas investment and prevent risks,” the new directives from China’s State Council cover all overseas investments in companies, projects and properties. 

Prominently listed on the restricted list of the new investment guidelines are real estate, hotels, casinos, entertainment, sport clubs, outdated industries and projects in countries with no diplomatic relations with China, as well as “chaotic regions” and nations that should be limited by bilateral and multilateral treaties concluded by China. 

In addition, China said it would direct overseas investment to support the framework of its 2013 “Belt and Road Initiative.” More specifically, China said it would encourage domestic investors to put their money into eligible projects in Southeast Asia, Pakistan and Central Asia, and beyond to the Middle East, Europe and Africa. The State Council said it would encourage companies to invest up to $1 trillion in that initiative, with the goal of strengthening China’s trade links in those regions, which has surged this year. 

Mergers and acquisitions by Chinese companies in countries that are part of the 68 countries officially linked to the Belt and Road Initiative totaled $33 billion year to date, surpassing the $31 billion tally for all of 2016, according to Thomson Reuters data. 

At the same time, Chinese investment in the U.S. has plunged by 50% in the first half of 2017, according the American Enterprise Institute and The Heritage Foundation’s China Global Investment Tracker. However, despite the huge drop, the amount of Chinese money flowing to the U.S is still likely to be the second-highest for Chinese investment in the U.S. on record, including mergers and acquisitions the two groups reported. 

Chinese investors have accounted for $160 billion of investments into the U.S. between January 2005 and June 2017, according to the Tracker. 

U.S. real estate, which is now on the outs as an investment target with China’s government, has played a huge role in the sale and financing of major CRE projects and portfolios. Year to date, Chinese investors have accounted for $4.14 billion of deals over $100 million compared to $3.5 billion for the same period last year, according to an analysis of commercial property sales in CoStar COMPs data. 

What Do New Curbs Mean for U.S. CRE?

There’s no question that further clampdown on one of the largest buyers of U.S. investment property will have broad impact across the institutional investment spectrum. However, analysts believe there are more than enough other investors out there to counter any decreased investment from China. 

Chinese investors have accounted for only about 5% of all CRE transactions of $100 million or more since the start of 2016, according to CoStar. The other 95% share of those buyers have accounted for $285 billion of property sales over $100 million since the start of 2016. So there is still an abundant supply of capital, both foreign and domestic flowing to U.S. CRE. 

In fact, China was only the third biggest source of cross-border capital into real estate in the first half of the year, behind Germany and the United Kingdom, according to JLL data. 

However, experts expect Chinese investors will continue to play a significant role in U.S. real estate. Dr. Henry Chin, head of research, Asia Pacific in China for CBRE, said “while property’s inclusion on the list of restricted sectors mean any proposed overseas acquisitions by Chinese companies will be subject to additional layers of scrutiny, the impact will be far more nuanced.” 

According to Dr. Chin, the new rules could only change how Chinese investors deploy their money. Other options include using offshore financial institutions to engage in property acquisitions, or use Hong Kong- or Singapore-based entities to purchase assets. 

“Outbound investment will continue but the pace of capital deployment is likely to slow as investors adjust to the new rules and fine tune their investment strategies,” added Chin. 

Pullback Could Affect Prices for Top Properties

One area that could see an impact is pricing for the top assets in core U.S. markets. Chinese investors have been willing to pay top dollar — and that top bid could be going away. But, also in this case, some analysts say that may not be a bad thing either. 

“The Chinese have stepped on some of the crazier things that happened in the market,” according to Barry Sternlicht – chairman and CEO Starwood Property Trust, who addressed the topic of the overall CRE market in his earnings conference call earlier this month. “If there are six bids at $1 billion and one guy is at $1.5 billion, I would ask you to tell me where the [loan to value] is?” 

Sternlicht’s implication that the other six bidders are better indication of where the market top stands based on returns reflects the fact that Chinese investors, along with other foreign investors, have shown a greater willingness to invest in real estate as basically bond equivalent credit yields. 

“They are not really real estate players,” Sternlicht said. “They are just buying the yield.” 

Richard Hill and James Egan, REIT analysts at Morgan Stanley Research, said the investment restrictions on Chinese buyers could have the biggest impact on office and hotel properties located in gateway cities, particularly Manhattan. Real estate transaction volumes are likely to come under pressure in affected markets, creating headwinds for prices over the medium term. 

“Over the medium term, it’s another headwind to CRE prices and reinforces our cautious view on office REITs exposed to [New York City],” the Morgan Stanley analysts said. “With regard to the U.S. residential real estate, Chinese buyers represent the largest share of foreign investment, but only 0.7% of all sales over the past year and therefore we expect minimal impact to both prices and volumes.”

By Mark Heschmeyer
August 24, 2017