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Containing the Chinese property dragon

04/10/2017

The multi-billion dollar splurge of Chinese money into Australian real estate over the past three years is being stymied by regulatory changes in both countries, writes James Perkins.

Authorities in China have moved to quarantine the country’s cash reserves after an unprecedented foreign spending boom over the past decade.

Together, Chinese individuals and businesses invested around US$1.03 trillion in foreign property, stocks and bonds in the decade to mid-2015, according to Knight Frank.

It is thought that, in total, US$3.8 trillion left the country in during that time, and Australia was the second largest recipient of this money. First, it flowed into the mining industry, but over the past three years it has been into real estate.

These funds fuelled a residential construction boom, as Chinese investors are, by law, only allowed to invest in new houses and apartments in residential real estate – there are ways, however, for investors to get around these rules: through family based in Australia, for example.

Additionally, there has been a sustained period of increased commercial real estate values, driven in part by Chinese investment.

But the Australian construction and real estate industries should already be prepared for the flow of money to significantly reduce.

Zakazukha connects Australian and Chinese businesses, by helping bridge the cultural and language barriers between business people of the two nations.

We like to keep an eye on economic trends and regulatory changes that could affect the trading relationship between the two countries. This sudden contraction of funds from China has been on our radar for some time.

First, it is important to look at just how fast the Chinese investment into Australian real estate ramped up.

In the five years to FY16, real estate investment from China into Australia increased more than seven times to $31.9 billion, according to the Foreign Investment Review Board (FIRB).

2010-11 – $4.1 billion
2011-12 – $4.2 billion
2012-13 – $5.9 billion
2013-14 – $12.4 billion
2014-15 – $24.3 billion
2015-16 – $31.9 billion

*Proposed Chinese investment into Australian real estate, FIRB

In total, around $47.3 billion worth of direct investment from China was approved by FIRB in FY16, making it the largest amount from any nation.

Almost three-quarters of that Chinese investment into Australia was for real estate.

Chinese companies bought around 38% of Australian residential developments in 2016, driving a residential construction boom in both apartments and housing.

And that is not counting private purchases by Chinese nationals, which further drove the boom in new residential construction.

In total, there were 41,445 foreign investment approvals in FY16, according to FIRB, compared to 37,953 the previous year – pushing the total amount of foreign investment in Australia to $247.9 billion, compared to $191.9 billion in 2014-15.

Of the total foreign investment, residential real estate accounted for 29 per cent of approvals, worth $72 billion, while 20 per cent of approvals were for commercial real estate.

The total real estate investment from all foreign investors, not solely China, was worth $122 billion – a 25% increase on the previous year, and Chinese money accounted for 44 per cent of that investment.

KPMG’s 2016 Demystifying Chinese Investment report, adds further evidence of the influence of Chinese money in Australian real estate.

The report, which excludes residential property, showed that $5.55 billion of direct investment into Australian commercial real estate came from China in FY16, which was 36% of total Chinese foreign the investment into the country – the third consecutive year it was the biggest investment platform.

Even within the commercial property framework of the KPMG report, however, there was a shift of funds into residential development during 2016.

Last year, residential developments accounted for 51 per cent of the value of the commercial real estate deals, compared to just 27 per cent in 2015.

This shift was driven by a lack of suitable inner city office buildings, which pushed investors to the middle rings of cities and into residential developments.

New South Wales and Victoria (Sydney and Melbourne) were identified by KPMG and the FIRB as attracting the lion’s share of the real estate investment.

Credit Suisse estimates that, during 2016, as much as 25% of new housing in New South Wales was bought by Chinese investors.

But the exodus of cash from China has ground to a halt in 2017 as a result of the central government’s capital controls, which include greater scrutiny on large deals, and more focus on enforcing a $50,000 foreign investment limit for individuals.

The latest figures from China’s State Administration of Foreign Exchange show that in the final quarter of 2016, the foreign exchange deficit reduced 43% year-on-year to US$94.3 billion.

Bloomberg has reported that Chinese international purchases plunged 67 per cent in the first four months of 2017, and global law firm Linklaters predicts it will be down 40-50 per cent year-on-year.

Further, China’s non-financial outbound direct investment (ODI) slumped 30.1 percent in March compared to the previous year, according to Reuters, after falling nearly 49 percent in the first quarter.

McKinsey and Company, a global management consulting firm, states that the value of Chinese merger and acquisition activity abroad dropped to US$31 billion in the same period, down 64 per cent on the previous year.

China’s crackdown on capital flight has targeted both companies and individuals.

The government has blocked big corporate deals deemed outside a company’s core business, while individuals have found it increasingly difficult to circumvent a US$50,000 limit on exporting cash.

Adding further hurdles to foreign investment in Australian real estate is the Australian Prudential Regulation Authority (APRA), which increased pressure on banks to restrict their lending to foreign nationals – hence developers such as Triguboff are being forced to offer their own finance.

Further, Australia has embarked on what it calls the “most significant reforms to (its) foreign investment framework in 40 years”.

In its latest budget, the Federal Government has capped foreign investment in new developments at 50%, and has implemented a vacancy tax for investors that leave properties unoccupied, as well as changing the capital gains tax withholding rate, reducing the threshold to $750,000 and lifting the rate to 12.5%.

Most analysts believe that the capital controls out of China will have a much greater impact on investment in Australian real estate than the APRA guidelines.

The headwinds created by the capital controls and tighter regulations in Australia are having an impact. In late April, Treasurer Scott Morrison revealed that applications for foreign investment into real estate in 2017 were expected to drop to around 15,000, compared to 40,000 the previous year.

National Australia Bank has reported that in the final quarter of 2016, foreign buyers accounted for just 10.9% of all new property purchases – 19% in Victoria, but only 9.3% in New South Wales – well down on the overall 2016 figures secured by Credit Suisse.

Meanwhile, long-time property developer and owner of Meriton, Harry Triguboff, told the Australian Financial Review in May that for the first time, his company has been forced to offer Chinese buyers finance to settle on their apartments.

The Australian has reported that 80% of Chinese investors who bought properties off the plan in Australia can’t settle on the properties and are regretting their decision, as they struggle to settle on the properties due to the capital controls.

For those in the construction industry, it will be important to be mindful of how the significant drop in foreign investment in their industry this year.

In 2016, Chinese investment in Australia reached a peak not seen since the heady days of the mining boom in 2008.

This investment, most of which was in Australian real estate, has played an important role in cushioning the nation from the mining downturn, but is this new boom on its last legs?

Let’s hope not.

Australia has been the second largest beneficiary of Chinese foreign investment worldwide behind the United States over the past decade and the nation’s economy could be in for a shock if the money stops.

Given the success of the controls in such a short period, there are hopes they will be relaxed. Many Australian housing developers will be hoping that is the case.

There is a silver lining to this story, however, as a new infrastructure ‘boom’ is already gearing up in Australia – one that Boral CEO Mike Kane believes will be bigger than the housing boom.

Just in the nick of time.