By Jack Stubbs
“The investment amount coming from state-owned enterprises has decreased, which is exactly what we thought would happen. It makes sense for the government to pull back, because some of the investment hasn’t proven to be very successful,” said Yang Chen, managing director of Colliers International’s Asia Pacific Division in San Francisco. “We have not seen a stop of inbound investment from China into the U.S. commercial real estate market, [but] we see that the investment criteria is becoming more stringent. Investors, whether institutional or high net-worth individuals, are becoming pickier and smarter about understanding the local market in terms of choosing their investment product types,” she said.
Chinese investment in U.S. real estate has been a hot topic in the industry over the last few months, and momentum has shifted since the Chinese government announced changes in regulation in fall of 2017. On August 18th, 2017, China’s State Council released new guidelines aimed at regulating the country’s overseas investments in real estate and other industries. Since fourth quarter 2016, China had signaled plans to curb domestic firms’ abilities to invest in foreign assets after proclaiming that Chinese companies had been spending too much on foreign soil. The August 18th announcement was the first published official guidance regulating China’s overseas investment.
According to one report written by Cushman & Wakefield summarizing the potential implications of the decision of China’s State Council, “2017 China-U.S. Inbound Investment Capital Watch,” the overall intent of the regulations was to reduce Chinese overseas businesses exposure; promote healthy growth of overseas investment; drive the output of China’s products, technology and services in order to meet the needs of national economic and social development in China; and manage foreign exchange reserves to stabilize the value of the Chinese currency.
Overseas investments in real estate, hotels and entertainment were restricted, and the establishment of equity-investment funds and any investment platforms that weren’t linked to a specific project were also restricted. And while investment in real estate was curtailed for the time being, investment in other in other business sectors—research and development facilities, logistics facilities and incubator spaces, for example—was supported, and continues to receive capital allocation from the Chinese government.
Written soon after the announcement made by China’s State Council, the report also made forward-looking statements about what course investment activity might take in 2018: the report highlighted how restrictions will continue to weigh on overall transaction activity, but U.S. economic growth and the liquidity, safety and diversification benefits of its commercial real estate markets will continue to attract Chinese capital. Furthermore, the report indicates that investment activity will favor deals most likely to receive state approval, including logistics entities and properties, R&D facilities, as well as student and senior housing projects.
Another general trend observed is that regulations passed last fall do not mean that investment by Chinese companies in U.S. commercial real estate has halted completely, it has nonetheless begun to take on different forms. “Our interpretation, immediately after the announcement, was that we thought the [regulations] were mostly targeting state-owned enterprises, with the acquisitions of large companies hitting the headlines, especially in New York,” Chen said.
Offering another perspective, Holly Yang, senior vice president at Kidder Mathews’ office in Bellevue, Wash. emphasized how investment activity has shifted to targeting smaller prospects in the U.S. commercial real estate market. “The money coming from China has definitely cooled down, you used to see all these shopping sprees and mega-billion dollar deals,” Yang said.
In the bigger picture, the objective with the regulatory announcements made last fall was not so much to eliminate investment from China into the U.S. altogether, but rather to regulate any investments that are made, according to David Bitner, head of Capital Markets Research at Cushman & Wakefield in San Francisco. “I believe that the institution of the regulations related to mounting concerns about excessive leverage and speculative investment, as well as the use of real estate investment as a way to get past other forms of capital controls. While China’s government’s view is still to go global—they are encouraging firms to invest abroad and diversify—they’ve also been trying to build a new framework that enables them to regulate the flow of capital,” he said.
The intent with the regulations, according to one view, is not to halt investment entirely, but rather ensure more oversight over the investment that does occur. “The whole philosophy behind the capital control is not just to limit money coming out of China overseas; it’s more a way to organize, supervise and regulate it so investors don’t go on a shopping spree with no oversight,” she said. “I think there will be a new form of money coming overseas; it’s just harder for individuals to invest millions in an investment property.”
The regulatory announcements made in fall 2017 followed a two or three year trajectory where Chinese investment in U.S. real estate had been slowing, according to the Cushman & Wakefield report. After hitting a high in 2016, Chinese investment in the United States declined significantly in 2017, a decline that was not limited to real estate. According to the Rhodium Group, overall Foreign Direct Investment flows from China into the U.S. fell 35 percent in 2017 to $29 billion.
In the San Francisco Bay area, investment volumes from all investors declined 17 percent in 2017 year-over-year from 2016, and Chinese acquisitions fell even more, declining 52 percent during the same period, according to the report. The sharpest declines were in hotel (down 69 percent) and industrial properties (down 79 percent), while investment in office assets fell 56 percent.
In Seattle, while total deal volume across all investors declined by 23 percent from 2016 to 2017, while acquisitions by Chinese investors fell even more, by 81 percent to 78 million. The leading cause of the decline was the absence of hotel deals in the Seattle metropolitan area, according to the report.
Roughly ten months after the announcement made in fall of 2017, the types of projects that Chinese investors are targeting—as well as the means by which they are are investing this money—are changing in both the Bay Area and Puget Sound markets. “I think private investors are still very active, but they’re very selective on projects. The perception is that we are at a peak or already there…the process is scrutinized [with the regulations], but if you pass the procedure, there are a lot of initiatives to form REITS and funds in China, which make it easier for individuals to invest their money in commercial real estate,” Holly Yang of Kidder Mathews said.
In the Puget Sound region in particular, mixed-use projects and familiarity with certain products is attracting a large portion of investors, according to Holly Yang. “Mixed-use projects are very attractive, as well as stable-income office properties. There’s also investment in the residential sector, because these are the projects that [investors] are very familiar with. [Hospitality] is another hot sector,” she said.
Yang also sees industrial assets becoming interesting to this group of investors. “I think interest in industrial [properties] will increase; but these investors are still relatively new to our market…vacancy rates for industrial properties are some of the lowest in the Puget Sound region right now, so I think investors will pick that up for sure.”
As far as the commercial real estate market in the Bay Area, institutional investors have trended towards targeting smaller-scale investment projects since the changes in regulations took place, according to Yang Chen of Colliers. “It used to be that bigger-name institutional investors from Asia were looking for larger projects, where the more attention [the project] would grab, the better. But that trend has changed; we see that companies are more interested in smaller-scale projects with a faster turnaround timeline for delivery,” she said.
The speed of execution is also met with interest for faster returns, as well. “Product-type wise, [investors] are less interested in development sites or residential properties for condo development. In the past, everyone was looking for fully-entitled land to build condos,” Yang Chen said. “That trend has shifted. Now, we’re seeing more of existing-income properties that already have an income stream—office, research, incubator, R&D centers, medical offices—with potential development opportunity.”
Since the announcement last fall, private, high net-worth individuals or privately-held companies—rather than large-scale institutional investors—have been the ones going after investment opportunities in the Bay Area and Seattle. And geographically, Yang Chen has seen more activity in Silicon Valley area rather than in San Francisco proper, a trend due in part to the higher cap rates and higher cost of construction and cost of living in San Francisco.
Gateway cities like San Francisco and Seattle, whose economies continue to be driven by leading technology companies, may not feel the effects of the investment regulations as much as some other markets in the long run, according to Yang Chen. “The emphasis and influence on technology in the Silicon Valley and Seattle isn’t going to change for Chinese investors, which impacts real estate,” she said.
Holly Yang of Kidder Mathews echoed this underlying idea, emphasizing how Seattle in particular continues to benefit from the continued presence of large-scale technology companies. “I think in Seattle, we’re very lucky, and we’ve been in the right place at the right time for the last few years. We have major economic drivers like Amazon and other companies. The cooling effect across the U.S. still applies to Seattle, but because we are a top commercial real estate investment destination, the money from China is still coming, just in lesser volume,” she said.
In recent months, there have been a number of investment and development activities occurring in the Bay Area and Puget Sound markets that indicate that investment interest continues in both markets. On May 4th, 2018, China-based real estate private equity firm Gaw Capital Partners announced the final close of its third U.S. value-added real estate fund the Gaw Capital US Fund III, bringing total commitment raised for this fund to its hard cap size of $412 million. The fund will primarily target U.S. west coast real estate opportunities in the Bay Area, Southern California and the Pacific Northwest, with an emphasis on creative office and hospitality assets as well as platform investments with attractive risk-adjusted returns, according to a statement released by the company. Goodwin Gaw, Chairman and Managing Principal of Gaw Capital Partners, said in the statement, “The U.S. west coast continues to be a hive of youthful entrepreneurial spirit and innovation, creating an abundance of long-term redevelopment and repositioning opportunities in the local real estate market.”
On June 6th, 2018, the Chromer Building, an office building in the heart of downtown Seattle formerly occupied by Amazon sold for $32.5 million. The buyer shares the same address as Plus Investment USA, Inc., an entity affiliated with Seattle-based real estate investment company Plus Capital Partners. Plus Investment directs and manages U.S. investments for Plus Investment Holding Group, an international investment services company that owns and operates companies with a primary focus on servicing China’s rapidly growing luxury marketplace. Plus Investment is involved in global capital management, finance, aviation acquisition and leasing, and real estate development, including the first Sotheby’s International Realty franchise in China, which is a vital part of their new luxury lifestyle platform, according to the company’s web site.
More recently on June 19th, California-based Laconia Development and project partner Vanke, a residential real estate developer based in China and the country’s largest homebuilder, celebrated the groundbreaking of ‘Spire,’ a 41-story, 370-unit condominium project in Belltown.
In the Bay Area, there have been signs over the last couple years that Chinese investment in the local market is set to continue as well. In May 2016, China-based Modern Land announced the formation of AMG Capital LLC, a U.S.-based affiliate company formed by Chairman Lei Zhang and John Landrum, the company’s CEO. Modern Land Founder and Chairman Lei Zhang said in a statement released by the company, “The formation of AMG Capital LLC is another step in Modern Land’s commitment to invest in quality U.S. real estate with our existing clients from China. We believe that our team has the experience, the focus, a disciplined strategy and the commitment to be very successful.”
In January 2017, Newmark Cornish & Carey announced that its San Francisco NGKF Capital Markets team had arranged a joint-venture equity deal—between San Francisco-based Prado Group and New York-based Vanke Holdings USA LLC, the US affiliate of China Vanke—for the development of 2240 Market Street, a 5-story, 45-unit luxury residential project located in San Francisco’s Duboce Triangle. Construction began at 2240 Market Street in 2017 and is anticipated to be completed mid-2019.
Additionally, structural shifts in China’s economic strategy—such as the country’s ‘Made in China 2025’ plan, which looks to comprehensively upgrade Chinese industry—mean that
investment will continue to occur in tech-centric regions like the Bay Area and the Puget Sound. “In general, China’s economy is switching from an economy that is heavily reliant on manufacturing to boost GDP towards relying on innovation and more high-tech products that have less impacts on the environment,” Yang Chen said. “Even after the announcement about investment being restricted, we’ve still seen a very high level of investment coming to the Silicon Valley,” she added.
While investment isn’t occurring directly into real estate assets per-se, investment in other technology-related assets is changing the landscape of the commercial market, according to Yang Chen. “The investments aren’t going towards so-called ‘real estate,’ but instead towards investment in tech—and real estate could be a bi-product of that. Investors are coming into the Silicon Valley and purchasing space or becoming an incubator center or office building where they will establish a spot in the Silicon Valley that can be their center-point of contact,” she said. “These state-owned organizations are trying to take advantage to being a bridge between the Silicon Valley and their provinces in China so that they can be a landing pad.”
In the broader political and economic context, the long-term impact on real estate remains unclear, according to Holly Yang. “It’s hard to say how the global and political environment affects commercial real estate, because there are other factors all happening together. With the Chinese government tightening capital from certain insurance agencies, that probably gives more incentive for high net-worth individuals to actually move money more quickly overseas,” she said.
Chen echoed the sentiment. “I think the political environment remains unclear, especially between China and the U.S. … there are a lot of challenges for those looking to invest in the U.S. in terms of getting money out of China, regardless of whether there’s a trade war or not,” she said. “The challenge is not how to allocate the money overseas; it’s more about incentivizing people to do so. The playground is still very active, but there are multiple sectors of buyers and sellers learning at a different pace.”
Yet regardless of the current political currents and the short term impact on the industry, global trends still point to long-term collaboration and integration. “The important thing is to look at the political subtext to these regulations. In spite of the rhetorical conflict between the U.S. and China, I still think the overall drift is towards greater global capital market integration, including in real estate,” Bittner said. “I don’t think the regulations change anything about the fundamental attractiveness of U.S. real estate assets, which is true of both Seattle and the Bay Area in the long term.”