How some investors could benefit from US-China tensions

Chinese investors continue to reel from regulatory roadblocks imposed by its government as well as US authorities, and this, amid an escalating trade war, is leading to a drop in investment volumes. According to the Los Angeles-headquartered law firm Paul Hastings, there is a potential for other groups, especially Japanese investors preparing their overseas real estate investing debut, to fill the void left behind in the market.

Philip Feder, partner and former chair of the global real estate practice of Paul Hastings, speaking at a press briefing, said he sees the Japanese institutions becoming strategic investors in the US. For instance, these investors would look to purchase housing and multifamily assets.

Led by the world’s largest pension fund, the ¥158.6 trillion ($1.4 trillion; €1.2 trillion) Tokyo-based Government Pension Investment Fund, Japanese institutional investors and other conglomerates are embarking on a global real estate investment strategy. In June 2018 for example, MBK Real Estate, a California-based wholly-owned subsidiary of Tokyo-based conglomerate Mitsui & Co., acquired nine senior living assets in the US for $382 million.

“Other investors are standing by to take over the more prominent shares of the real estate market. Sovereign wealth funds from Middle East, Norway, and Korea are still looking for trophy assets and big portfolio deals,” Feder added.

There has been a visible pause in Chinese investments in US commercial real estate. In the second quarter of 2018, for instance, Chinese investors sold $1.29 billion of US commercial real estate, but only purchased $126.2 million of property, according to Real Capital Analytics. This is understood to be the first time Chinese investors became net sellers for a quarter since 2008.

There are several reasons for this pull back.

In August, the US Congress and president Donald Trump signed the highly-anticipated Foreign Risk Review Modernization Act of 2018. The act significantly amends the authority and process of the Committee on Foreign Investment in the US to review foreign direct investment that raises national security concerns, according to a white paper published by Paul Hastings in October.

According to Derek Roth, a Los Angeles-based partner in the real estate practice of Paul Hastings, CFIUS has led to increasing scrutiny on real estate investments with elements of national security concerns, such as data centers. In addition, the CFIUS program also impacts deals involving assets located close to sensitive security locations. As an example, Roth mentioned a foreign investment in a hotel asset, where a government organization regularly hosts conferences, could potentially come under extensive investigation, jeopardizing the final approval of the deal.

Roth explained he spends time to educate clients on CFIUS’s approval issue since it can lead to a tedious process for transactions.

The ongoing trade war between the two countries has been an added barrier. Citing a hypothetical example, Roth said a Dutch investor would probably see less CFIUS scrutiny than a Chinese investor.

“There is even more sensitivity with China now obviously, with US-China relations fraying somewhat. It will be very difficult if you have transactions that involve CFIUS approval for sellers to sign off for that risk. That makes Chinese bidders much less competitive in auction deals for instance,” Roth said.

In his view, Chinese investors who are still active in the US are pursuing more strategic, off-market investments rather than bid for trophy assets in auctions.