The truth behind the numbers: Chinese investor interest in Australian commercial real estate
Following the dramatic changes in the Chinese share market over the recent months, our partners in Australia and on the ground in China believe there are some important dynamics to understand about Chinese institutional investor demand for commercial real estate – and some potential changes ahead for this market.
The truth behind the numbers: Chinese investor interest in Australian commercial real estate
In 2014 some striking numbers appeared regarding Chinese Direct Investment (CDI) in Australian commercial real estate. According to a report from KPMG, 46% of CDI in Australia was in commercial real estate at a value of A$4.3 billion[1]. This is literally quadruple the investment volume of 2013. But what’s the real story beneath the numbers? And what trends do we see ahead?
The dramatic plunge of the Chinese share market has shifted dynamics considerably within the institutional investor space since our update on Chinese investors and residential development in July. The Shanghai Composite Index is currently sitting at 3,382 – a significant drop on the peak of over 5,000 it reached in June. That’s a fall of around 34%.
“This development will likely create a flight to bricks and mortar,” comments John Stawyskyj, Built Environment Partner in the Ashurst Sydney office. “It’s common to see an increased desire to invest in real estate asset when equities markets drop. This issue will be whether we’ll see interest in commercial real estate and whether Australia has enough assets to sell to hungry buyers.”
Against this volatile backdrop, our partners in Australia and on the ground in China believe there are some important dynamics to understand about Chinese institutional investor demand for commercial real estate – and some potential changes ahead for this market. “The share market collapse may change the game,” notes Michael Sheng, Partner in the Ashurst Shanghai office.
“The yields available in commercial real estate in Australia, the ease of financing and surplus cash may see a more rapid maturation in the Chinese commercial real estate investor base.”
– Kenneth Nguyen, Partner in the Ashurst Sydney office
The big numbers on CDI into Australian commercial property are more about hotels than about office
The headline numbers in the KPMG report on investment into commercial property are exciting, but it’s important to look closely at what the numbers represent. Many of the transactions represented are the purchase of commercial property to redevelop into residential. These include some of the biggest headline deals of last year, such as Greenland Group’s acquisition of two commercial properties at the corner of Pitt Street and Bathurst Street in Sydney’s CBD (one of which they intend to redevelop into the highest residential tower in Sydney and the other into a boutique hotel).
In addition to these greenfield and brownfields investors, we are seeing some State-Owned Enterprises (SOE) diversifying into commercial real estate, and they are looking primarily at hotels, which have a natural customer base of Chinese tourists, and some A-grade office.
At this stage, in spite of the numbers, Chinese investors aren’t really there yet in terms of true commercial real estate, such as offices. With the significant exception of the CIC/Investa property deal, where Chinese sovereign wealth fund CIC purchased a $2.5 billion portfolio of office towers from Investa Property Group, generally investors are looking for assets that have a direct link back to the Chinese market and a Chinese customer base. With true commercial real estate there’s no direct link back, which makes it a harder sell to Chinese investors right now.
Companies contemplating outbound investments – including investment in commercial real estate – may face issues raising the required funds if they’re relying on the equities platform
The recent share market slide in China has seen companies contemplating outbound investment, including M&A abroad, reassess their plans because the ability to raise funds using the share market platform and the equity raising capacity has dramatically decreased. That has had a negative impact on outbound investment generally.
Usually when the share market slumps, people look to invest in real estate, but there may be constraints for listed companies in China that want to heavily tilt towards commercial real estate due to their inability to properly raise equity using that platform.
Chinese investor interest in Australian commercial property is a yield play – but their expectations on yield may be lower than other investors’
The justification for Chinese investors to invest in true commercial real estate is different to investing in residential or in five star hotels. In the residential space when Chinese companies invest they are essentially selling to a Chinese market; and when it comes to five star hotels, they are investing because they have a strong Chinese tourist market to promote to.
“Commercial investment is purely a numbers game, because there is no strong link back to the Chinese market. Cap rates are compressing, interest rates are low resulting in upward pricing, so it is narrowing the pool of buyers available,” comments Ken Nguyen, Finance Partner in the Ashurst Melbourne office. But because Chinese investors aren’t cash strapped, their yield expectations might be a bit lower than those of traditional fund investors that look for a 7-8% return on bonds. Real estate developers are more likely to be comparing the return to what they can get in China.
Chinese investors are far less likely to rely on traditional Australian bank funding for their acquisitions
Chinese investors generally have an advantage in their financing abilities as they can raise cheap debt finance from Chinese banks. This gives them a competitive advantage, as they’re not relying on Australian bank debt or note issuance, so they can be more aggressive in how they approach large transactions.
At the same time, it’s easier for Australian banks to work with Chinese investors in the commercial investment space – there’s no construction risk and no presales risk. As their interest in this asset class grows, it’s very important for Chinese investors to get local expertise in terms of project managers, legal practitioners and financiers so they fully understand local nuances.
As Chinese investment in commercial matures, we may see some interesting structures and trends emerge
With the Chinese share market falling so profoundly, we may start to see the dynamics of investment in Australian commercial assets changing. Yield expectations may fall and the need to have such a strong link back to the Chinese market may also lessen. Chinese conglomerates with surplus cash certainly won’t be investing heavily into equities, so they may tilt towards commercial real estate.
In this environment we might see someone establish an outbound property fund in China – a C-REIT – that invests purely in offshore real estate. As China matures as an international real estate investor, the next stage will be to start developing specialist REIT offerings as an alternative to equities.
1^Demystifying Chinese Investment in Australia, KPMG, May Update 2015
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