By Jack Stubbs
“When the regulations were announced, suddenly a lot of [momentum] shifted,” said Xinyi McKinny, Senior Managing Director of China Direct Investment at brokerage firm Cushman & Wakefield, referring to new regulations passed in China just over a month ago aimed at curtailing overseas investments.
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 the last quarter of 2016, China had signaled plans to curb Chinese firms’ abilities to invest in foreign assets, after revealing 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.
KcKinny published a report on behalf of Cushman & Wakefield summarizing the details of the changes in investment regulations, the larger intent of China’s state Council, and some of the potential implications of the changes.
The intent of the changes, according to the report is 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.
According Skip Whitney, executive vice president and partner at Kidder Mathews, the announced changes in investment regulations took people in the industry by surprise. However, the underlying trends motivating the changes have been in the works for the past year. “The severity of what the government has enacted caught a lot of people off guard, I think, but this has been something that’s been going on for the past year. There had been indications that the government was going to move to restrict real estate investment overseas,” Whitney said.
Three categories of overseas investments were established in the announcement: supported, restricted and prohibited. Notably, overseas investments in real estate, hotels and entertainment are restricted. Furthermore, the establishment of equity-investment funds and any investment platforms that aren’t linked to a specific project are restricted. There is also no specified financial value threshold for any of the three categories.
The restrictions on real estate investment are particularly noteworthy, given what happened in 2016. That year, China ranked number one among foreign investors in U.S. commercial real estate. The five largest Chinese investment transactions were among the top ten largest transactions in the U.S. in 2016. And while the changes in regulations puts an embargo on overseas investments, there is already substantial enough Chinese investment in the U.S., particularly in the coastal cities, according to Whitney. “It’s going to impact new investors who have not been quick enough to be able to see what has happened. This definitely impacts the amount of business [that will be done], but there’s a lot of Chinese investment already in the U.S., particularly in Seattle and in the Bay Area and Los Angeles. The money won’t be expatriated back to China; it will likely stay here to be reinvested,” he said.
Historically, the east and west coasts have been the primary recipients of significant Chinese investment, according to the report. New York City accounts for nearly half of the overall investment (46 percent), the San Francisco Bay Area for 15 percent; Los Angeles for 7 percent; Chicago with 5 percent; and Seattle contributing to 2 percent of Chinese investment.
The changes in regulation are due in part to China’s desire to stabilize the banking economy and currency. However, the government’s mindset might change over time if they feel that their economy is strong enough to support itself, according to Whitney. “At some point the government is going to ‘turn the faucet on’ a little, and let things come out… the government might feel that their economy is strong and mature enough to encourage off-shore investment in real estate,” he said.
While for the time being investment in real estate is restricted, investment in other business sectors is supported: research and development (R&D) facilities and incubator space will receive additional capital allocation from the Chinese government, as will the the logistics sector, meaning that investment in logistics portfolios and the development of new facilities will be more active, according to the report. This might include the acquisitions of businesses where the core business is not real estate development but rather holds a significant portfolio of owned logistics properties. Additionally, China’s major real estate developers will remain active in residential developments, and investment in stabilized office sector assets and hotels will slow down.
With the new investment restrictions, the focus will shift to development and asset management, a point that McKinny was keen to emphasize. “This year, the transaction volume is down, so I think the focus needs to be shifted to maintaining the properties that we have right now…commissions usually come from the property development and management side, [so] the changes will involve lots of repositioning of assets,” she said.
Among the brokerage community, the embargo on Chinese investment in U.S. real estate, the changes might have an impact. “As to whether [the changes in regulation] will affect brokerage firms, last year a lot of brokers made commission through investment sales after transactions went through,” McKinny said.
Over the last several years, Seattle and Bellevue in particular have become much more prominent in the eyes of overseas developers and real estate investors, according to the report. In June 2015, Hong Kong-based Gaw Capital Partners bought Columbia Center, Seattle’s tallest building, for $711 million—one of the largest deals in the region’s history. Recent growth within the commercial real estate market has been spurred especially by the presence of tech tenants like Amazon, Microsoft Expedia and Facebook over the years.
Although investment directly into commercial real estate is currently prohibited under the new changes, the ability of Chinese companies to invest in technology might to some degree counterbalance this particular restriction, according to McKinny. “I would think that some companies will invest in office—not typical Class ‘A’ assets, but they want to invest in some office buildings to do R&D to be the incubator to basically promote technology and bring the technology back to China,” she said. Due to the extreme concentration of tech companies in certain areas, some of the nation’s tech-driven cities might not be impacted as much by the new changes in regulation. “[Investment] will be pretty concentrated in those tech hubs: San Francisco, Seattle, New York…because if you don’t invest in those places, then there aren’t many other places where [one] can invest in technology,” McKinny added.
The fact that investment in tech-related incubator companies is still permitted by the government means that, for the foreseeable future, investment transactions will take on different forms, according to Whitney. “[The money] may be invested in different ways, but this is just a short-term situation…something like innovation and incubators is high on the list for offshore investment, so maybe [a Chinese company] buys a building that happens to have an incubator in it.”
To say that Chinese real estate investment in the U.S. is categorically prohibited would be an oversimplification of the situation, according to Whitney, who delineated between different sub-sectors within the industry. “You can’t say as a blanket statement that real estate in the U.S. by China is terminated. It’s not, it’s just shifting. You might not see as much coming in as far as development and acquisitions, but you could see more money coming in on the debt side,” he said.
Looking ahead, it is unclear what the longer-term implications of the changes in regulations will be. In her report, McKinny notes that the new policy is aimed to regulate international investments out of China for the next nine months. In the year-to-date analysis, government statistics indicate that the changes in regulations has already sent China’s foreign direct investment down over 40 percent this year. During the first half of 2016, Chinese investment in the U.S. totaled $15.96 billion, while at the halfway mark of 2017, that figure has fallen to $4.17 billion.
Despite the new changes in regulations, investment from China in U.S. industries is not being halted indefinitely, according to Whitney. “Chinese investors are still a prominent capital source and will continue to be. This is just a short-term setback for many of the investors in China…it’s important to clarify that Chinese money is not going to go away.”