US President Donald Trump was on US Air Force One, returning from a rally in Florida on August 1, when he declared war on TikTok. Within two weeks, he signed an executive order banning the Chinese viral video app. Chinese technology firm Tencent, which owns the WeChat messaging app, was simultaneously banned from doing any US transactions.
TikTok and Tencent are the latest casualties in a bitter US-China feud that has raged over issues from trade to finance, from technology to infrastructure, to Hong Kong’s national security law – even the origins of the coronavirus pandemic. The consequences have been far-reaching. Chinese investment in North America overall hit its lowest point in a decade in 2019 with just $5.5 billion of completed deals, according to analyses by law firm Baker McKenzie and research provider Rhodium Group.
The Xi change is really a sea change. And, it has had a practical impact on how CFIUS has evaluated various categories of Chinese buyers – Mario Mancuso, Kirkland & Ellis
Geopolitical tussles combined with heightened regulatory scrutiny of international deals involving Chinese capital and Beijing’s own restrictions on outbound investment have diminished Chinese capital’s participation in global financial markets in the latter years of the last decade. But has a death knell sounded for China’s buying in the West?
PERE asked this question of the private real estate industry, which has closely tracked the rise and fall of Chinese investors’ high-profile transactional pursuits, and the collateral damage to their credibility as a major capital source. The answer, explored in this deep-dive piece, might surprise.
To be sure, the days of Chinese investors’ trophy purchases in Manhattan and Canary Wharf are over for now. State-owned enterprises are no longer the most prominent outbound investor group. But a more measured, low-profile and strategic capital base from China is still investing through more regulatory friendly approaches. Critically, while deal activity is down to low triple-digit million figures, it is not at zero. If anything, fraying US-China relations could ultimately redirect Chinese capital to Western countries with friendlier ties to China than those stateside.
CFIUS and other US roadblocks
During the peak of Chinese merger and acquisitions activity from 2014 and 2016, the likes of conglomerates Anbang Group, Dalian Wanda and HNA amassed a property empire of Hollywood studios, insurance companies, luxury hotels and office skyscrapers. Anbang, the poster child of this shopping spree, invested nearly $18 billion across a pool of assets.
These investors have since wound down most of their overseas portfolios. But the fallout of that aggressive approach continues. In August, the Chancery Court of the State of Delaware completed an acrimonious five-day trial involving Anbang and South Korean asset manager Mirae’s failed $5.8 billion deal for 15 high-end US hotels. After agreeing to acquire the portfolio in September 2019, Mirae terminated the deal in April, citing issues around fraudulent deeds of some of the hotels, according to a Bloomberg report. Anbang counterclaimed the pandemic’s impact on the hospitality sector made Mirae pull the plug. Both parties sued each other for breach of contract. A court verdict is expected this fall.
People who actively partnered with Chinese capital in the heydays of the last decade admit the Anbang saga prompted both the industry and US regulators to reevaluate their due-diligence approaches, especially against the backdrop of changing bilateral relations.
“It has been a decade in transition in US-China relations. Some of these marquee real estate deals mark that transition nicely,” says Mario Mancuso, a partner heading the international trade and national security practice at law firm Kirkland & Ellis.
Mancuso says while there has been press focus on the Trump administration’s role in escalating tensions with China, structural changes within China are less discussed. “The Xi era has, in part, cracked down on certain economic practices by Chinese companies and state-owned enterprises, which have contributed to a slowing down in activity. But the Xi era has also been marked by a highly personalist and authoritarian approach. This shift in China has catalyzed a CFIUS agency practice skeptical of distinctions once held between SOEs, sovereign wealth funds and private companies in China for the purposes of assessing a Chinese buyer’s fitness to acquire a US asset,” he explains. “So, the Xi change is really a sea change. And, it has had a practical impact on how CFIUS has evaluated various categories of Chinese buyers.”
Real estate historically was exempted from the Committee on Foreign Investment in the United States. But, in the last few years, the interagency federal body has widened its review of foreign deals for national security implications to include the sector. Simultaneously, acquisitions by Chinese investors accounted for the largest proportion of CFIUS notices filed by any country between 2017-19. Indeed, 51 of the 140 Chinese covered transactions were in the US finance, information and services sector, in which real estate falls.
A new regulation passed in February 2020 further expanded CFIUS’s jurisdiction to non-controlling investments in US real estate. Regulators are now also inquiring about non-notified transactions, including deals that closed years ago. CFIUS’s investigation into ByteDance’s 2017 acquisition of what became TikTok, for example, was only launched in November 2019. Lawyers say they are aware of CFIUS actively seeking to scrutinize some previously closed real estate deals, too.
Fewer Chinese investors are transacting in the US as a result. According to property services firm CBRE, inbound Chinese capital in H1 2020 was $98.5 million, accounting for 0.8 percent of total foreign investment.
But this is not the whole picture. What such data cannot accurately capture are indirect transactions, including fund commitments and minority interests in joint venture partnerships, which are rarely publicized, as well as non-institutional deals. On the day Jay Neveloff, who chairs law firm Kramer Levin’s real estate practice, spoke to PERE, for example, he was working on a “mid-sized” transaction in the US involving a Chinese entrepreneur. He says he has also advised Chinese developers, that already have assets and capital within the US, for their condo development projects.
“We are seeing the sovereigns continue investing as LPs, with no rights and not doing co-investments, which could potentially raise CFIUS concerns,” adds Ivan Schlager, international trade and national security partner at Kirkland & Ellis.
In March, for example, a Chinese sovereign wealth fund invested in a “club” joint venture partnership with another Asian sovereign fund and a US manager. The venture acquired a portfolio of last-mile distribution centers in secondary and tertiary US markets. PERE understands the parties elected not to make a CFIUS filing due, in part, because none of the assets were located within close proximity to any sensitive government facilities or urban areas.
“I think some sovereign investors view these ‘lower-profile’ deals as a win-win. They are still able to achieve stable, core-type returns from long-term, triple net leased properties with investment grade tenants, and also have less of a CFIUS spotlight shining on them because they are not buying multi-billion dollar skyscrapers or hotel portfolios in downtown Manhattan or other major coastal markets,” says Jack Creedon, partner and global co-head of Ropes & Gray’s real estate investments and transactions group.
Average ticket sizes have also changed. The deals Creedon has worked on recently have all been on the smaller side, more in the $100 million-$300 million range. “I do not think some of the perhaps perceived transactional challenges involving certain Chinese investors over the past year or so has been a total turn-off for US investors wanting to do deals or JVs with sovereign wealth funds,” he says. “To be sure, overall transaction and investment volume is significantly off the high-water mark set a couple of years ago. But I have seen deals get done, albeit different styles of deals: less high-profile and more private, club-JV types of structures in non-core or non-gateway markets.”
Chinese deal-making 2.0
This strategy aligns with Beijing’s mandate, too, given the government’s continuing clampdown on speculative overseas investments through foreign exchange controls since 2016. Non-speculative investments, however, especially in sectors such as healthcare and senior care, are still approved. Beijing-based Cindat Asset Management is one well-known investor in this space. As of January, the firm’s total exposure to senior care assets was north of $1.5 billion in net asset value, which included portfolio acquisitions in the UK and US.
“In terms of senior care investments, we are the largest Chinese buyer in the US,” says Greg Peng, the firm’s CEO and co-founder. “These types of transactions are not specifically ‘forbidden’. In fact, some Chinese insurance companies were still keen to invest into our deals at the beginning of this year. But the attitude changed once covid-19 hit.”
While the politically charged atmosphere in the US is a limiting factor for cross-border deals, things are playing out differently in Europe. China’s souring ties with the UK over the crackdown in Hong Kong and Chinese capital controls contributed to a 40 percent drop in Chinese M&A investment in Europe last year, according to Baker McKenzie’s survey. But the $13.4 billion investment in the continent was still twice the North American volume.
“The sentiment in the US towards China is likely more critical than perhaps from Europe, where it is appreciated that foreign investors in general, including the Chinese, improve the liquidity of the market,” says Hans Vrensen, head of research and strategy at investment manager AEW Europe, adding that the relevance of Chinese capital in European property markets has not changed in the past two years.
Private capital, for one, continues to chase UK assets for diversification and wealth preservation purposes. Eric Zhao, a director and Chinese capital markets specialist at property services firm Savills, sees the same type of Chinese investors investing consistent amounts of capital this year to last. “They are transacting less openly, but still transacting,” he says.
The other active investor group are mainland Chinese and Hong Kong developers. A prime example is CC Land, a developer in Western China, which in 2017 acquired London’s ‘Cheesegrater’ office tower from REIT British Land and Canadian investor Oxford Properties for £1.2 billion ($1.5 billion; €1.3 billion). Today, CC Land’s UK portfolio totals assets of roughly $5 billion in gross development value, which includes two residential developments and office assets in the UK.
“One’s appetite to risk changes as a foreign group gets to know a territory better. When we started, we were buying conservative, fully-let assets. We have gone up the risk curve and now will also buy opportunistic development, albeit with planning,” says Adam Goldin, head of CC Land’s UK business.
The firm remains acquisitive, targeting high-quality, large scale prime assets with gross development values of around £1.5 billion. “The overarching determining factor for us is whether we want to own the asset. Our driving force has always been the quality, more than the returns it generates over a five-year hold,” he explains. “If we do like a trophy asset, like many other high net worth and trophy hunter investors, we will find a way to buy it and to access the capital.”
The sentiment in the US towards China is likely more critical than perhaps from Europe, where it is appreciated that foreign investors in general, including the Chinese, improve the liquidity of the market – Hans Vrensen, AEW Europe
Goodwin Gaw, chairman of Hong Kong-based private equity real estate firm Gaw Capital Partners, sees European deals by Chinese investors ticking up as a consequence of current US-China relations: “You’re going to see Chinese capital in the US drop off significantly. Europe especially, with countries that show openness to Chinese investors, will probably benefit.”
Gaw Capital partnered with consortiums including Chinese investors on major US and European deals in the past decade, most prominently the $711 million purchase of the Columbia Center in Seattle in 2015 and the Lloyds of London building in London for $321 million two years earlier. But it will be previously less fancied parts of the latter region where he expects continued notable investment from China.
“The UK has no choice but to take a similar tack to the US,” says Gaw. “France probably also. But Germany could take a more independent stance and there are smaller countries that can take advantage of being friends with both sides. So, now we’re seeing Chinese interest in other European markets, particularly those with bilateral arrangements in place.”
Elsewhere in the continent, positive bilateral relations due to China’s One Belt One Road policy, is drawing more Chinese capital toward places like Hungary, Poland, Slovakia and Italy. In August, the Chinese investment firm Fosun acquired an office asset in Bucharest through Resolution Property, a London-based manager in which it owns a majority stake. Of such buyers, James Burke, associate director at broker Savills, says: “They have the ability to do both stable, income-driven transactions as well as more opportunistic ones.”
The past few years have also seen significant asset sales by cash-strapped Chinese groups, many of which are under government pressure to repatriate capital. Chinese investors were the biggest sellers of US properties in 2019, offloading $20 billion more than they bought, according to Real Capital Analytics. One active seller was Dalian Wanda, which agreed to sell its 90 percent stake in Chicago’s 101-story Vista Tower for $270 million, believed to be its last-remaining real estate asset in the country.
Yet Chinese asset management companies like Cindat could become beneficiaries of this divestment spree. “Chinese asset management companies are the army of distressed solution providers,” says Peng. “If they buy an asset to help a Chinese owner solve a financial situation, and to repay loans to Chinese banks, and later on work on some restructuring to sell the asset locally, it is still considered an approved transaction.”
The asset management arms of China’s four state-owned ‘bad banks’ can buy these assets, often sold at a discount, on more flexible terms. For instance, they can give sellers participatory positions in the profits generated from the asset. Or they can provide a loan back in China equivalent to the purchase price, removing any foreign currency requirements.
“They have access to the decision-makers back home, which makes things a lot easier,” Peng says of the asset managers. “Most of the US groups will be dealing with the US teams who don’t have decision-making powers and can make the market quite confused. They usually also have other dealings with those Chinese owners back in China, therefore have more ways to negotiate a deal with them on their US assets.”
No more trophy hunts
Tracking Chinese transaction activity is tricky as many deals are completed off-market. It is also challenging measuring fund-level commitments by Chinese investors, or detecting beneficial ownerships. Indeed, PERE has previously reported on the circumventing measures often used to bypass capital controls.
A Singapore-based agent PERE spoke to completed a large Sydney office acquisition this year for a Singapore-based investment firm on behalf of a Chinese investor, the identity of which was never reported.
What is evident from transaction data, however, is the absence of any billion-dollar deals by Chinese investors in recent years: 2017 was the last banner year in Europe, for example, including CIC’s €12.2 billion purchase of the Logicor logistics property portfolio from Blackstone.
At the peak of Chinese interest in prime global real estate assets, it was almost ‘mandatory’ for agents and vendors to incentivize these buyers to participate and bid at the top range of the pricing – Priyaranjan Kumar, Alvarium Investments
If Chinese investors are no longer trophy hunting, the industry will need to readjust its perception and treatment of this pool of capital, believe marketing agents. Chinese capital, especially first-time overseas buyers, have long had the reputation of being premium payers. Sources involved in the ‘Cheesegrater’ deal, for instance, say CC Land was never even on the shortlist of bidders to buy the 46-story office tower. The original plan was for British Land to sell its 50 percent interest while Oxford Properties would retain its half share. CC Land’s unsolicited bid was for the full 100 percent stake in the asset at a trumping price considered “top of the market”, PERE was told.
“Transactions such as Cheesegrater and Walkie-Talkie stand out because if the ‘premium’ was not offered by the buyers, the access and pole position granted to complete the transaction would have been missing,” says Priyaranjan Kumar, managing director, head of Singapore at multifamily investment firm Alvarium Investments. “That premium often was the price vendors demanded for taking on an element of execution risk with unknown and first-time buyers.”
What many Western sponsors and marketing agents are reluctant to publicly acknowledge is the strategic thinking behind selecting a bidder shortlist. The story of Chinese investors’ splashy bets is as much a story about the inner workings of auctions and the cross-border capital dependency.
“Every seller wants that special buyer who can pull up pricing for the top bidder in the market. You then get firms to scour the planet looking for that special bidder,” says Kumar, who brokered several cross-border deals during his time at broker Cushman & Wakefield.
“You don’t care where the investor comes from or assess early on how executable they are or not, as long as they can put a reasonably diligenced price on a piece of paper that can support the asset selling at a valuation delivering real GP profit.”
For a while, Chinese investors were a prime target for that. Kumar says at the peak of their interest in prime global real estate assets, it was “almost ‘mandatory’ for agents and vendors to incentivize these buyers to participate and bid at the top range of the pricing.”
“It kept domestic buyers honest. The industry had a bias to conclude deals with known domestic buyers unless a foreign buyer offered a pricing differential that mitigated that risk.”
In addition, Chinese firms gained market know-how. CC Land now has a dedicated five-person team in the UK covering investment, development, and asset management operations, including Goldin, who joined the firm in late 2017. Goldin was not there when the Cheesegrater deal closed, so did not comment on its specifics, but agrees the firm evolved its approach as it gained presence and experience in the market. “Our aim was to become a first-class custodian of real estate in the UK. We employed a team to execute that, and our profile in the UK now is higher and better,” he says.
Our aim was to become a first-class custodian of real estate in the UK. We employed a team to execute that, and our profile in the UK now is higher and better – Adam Goldin, CC Land
Chinese investors 2.0 may not be as trophy-oriented as before. But certain types of investors from the country will likely remain active on the international deals circuit.
Shifting political winds, however, will influence cross-border capital flows between China and rest of the world more than ever before. The outcome of the November presidential elections in the US could be a crucial deciding factor, with some observers optimistic a Joe Biden victory could reset bilateral relationships. Kirkland & Ellis’s Mancuso agrees while the relationship may be different at the margins under the Democratic candidate’s presidency, the US-China bilateral relationship is also structurally changing.
“There have been episodes before in US-China history, whether it was the accidental bombing of the Chinese embassy in Belgrade, the Taiwan crisis of mid-90s or the downing of US aircraft in the South China Sea,” he says. “There have always been instances of US-China friction. But the difference these days is the friction is systemic, not episodic, and that the power balance between China and the US is different.”
This shifting power balance is also why China’s – and its financial markets’ – place in the world is irrefutable.
“The obvious growth and increasing competition in the Chinese economy from a service, information and technology standpoint means, at some point, there needs to be a closer collaboration between the West and China,” says Justin Curlow, global head of research and strategy at AXA IM – Real Assets.
“This must be more of a two-way, similar level playing field surrounding information, trade and investment.”
Nearer term, however, the gap between the two is discernably wide. While conflicts continue to rage in other sectors, private real estate deal volumes will remain unlikely to reach the highs of the last decade.
Additional reporting by Merle Crichton