HOT STORY: Curbs to enthusiasm

For two weeks last month, the bidding war between US hotelier Marriott International and Chinese insurer Anbang Insurance Group for the listed, high-end hotels giant Starwood Hotels & Resorts seemed like a heavyweight boxing match. Each bid looked like it would deliver the knock-out blow, until the next landed, with even more force than the last. 

Ultimately, having started the fight with an unsolicited, all-cash bid of $76 a share, just as the dust was settling on an already approved union between Starwood Hotels and Marriott, Anbang also ended it after deciding it had fought hard enough.

The consequences of this failed joust for such prime US accommodation have been felt more widely than by only Starwood Hotels and its two suitors. Beyond forcing Marriott to pay far more than it originally expected to for the 1,300-property business, it also has provoked western executives into scrutinizing the Chinese institutional investor community – until now considered among the world’s most coveted private real estate investors.

A source familiar with Anbang insists it is business as usual for the firm, regardless of the hype, following the failed Starwood Hotels bid. He says its overseas investment ambitions haven’t been dampened and points to over $8 billion of agreed and fully completed overseas property deals in just under two years. He says Anbang remains one of the world’s most active private real estate investors.

But its about-face on the biggest-ever Chinese takeover of a US company is nevertheless expected to cause the insurer reputational damage and the appeal of Chinese institutional capital as a credible, accountable and legitimate partner in cross-border deals, has been challenged.

According to a poll by PERE, 62 percent of respondents felt Anbang’s failed bid had tainted the reputation of Chinese capital in international property markets. That percentage takes on further significance given approximately half of PERE’s readership is US-based currently.

“Are they real and can they close? Two fundamental questions I get asked by Western clients,” says Darren Xia, head of property services firm JLL’s international capital group for China. “They want to know whose capital is real and whose is not; who needs to raise capital and whose capital is already sitting in an offshore bank account.”

Losing grip
Chinese capital has accounted for an increasingly greater share of global investment volumes since the global financial crisis, particularly recently. According to a report by property services firm Knight Frank, total Chinese outbound property investment reached $30 billion in just the first 10 months of 2015, double the total deployed in 2014. The year was the most productive year for Chinese insurers in particular, with over $4 billion invested in overseas real estate compared with $2 billion a year prior.

It was all going as per the Chinese government’s rulebook – allowing domestic institutions to diversify into higher-yielding offshore markets as part of a long-term strategy under the reform agenda of the Third Plenum of 2013 – until the summer of 2015 when volatility struck the Chinese stock and international currency markets. That volatility continued into 2016 with another stock market rout in January followed by further tempering of the renminbi-dollar exchange rate.

Economic uncertainty as well as President Xi Jinping’s anti-corruption crackdown (more than 300,000 officials were reported to have been punished on corruption-related matters last year) has triggered an acceleration of capital outflows from China since the second half of 2015. Stringent regulatory controls on outflows, imposed since the end of last year, is the Communist Party’s way of getting the narrative back in its grip, onlookers say.

“Everyone is trying to find a legal way to transfer RMB into a foreign exchange. But it is difficult because the government is closing doors one by one. Once you figure out a way, it closes the door,” says Johnny Zhang, executive director, real estate investment at Ping An Trust, the asset management subsidiary of one of Anbang’s main competitors, Ping An Insurance.

Regulatory roadblocks

PERE was told of one club involving a domestic insurer and a Chinese state-owned asset management company which in January was seeking to invest in the US hospitality sector. The transaction took more than the usual time to complete because the QDII (Qualified Domestic Institutional Investor) license – a government program permitting registered Chinese financial institutions to invest a specific quota of funds in foreign financial assets – did not arrive for one of the investors.

Paul Guan, partner in the real estate practice at Paul Hastings, explains that once a Chinese institution has exhausted its QDII quota, it needs fresh approval from China’s State Administration of Foreign Exchange (SAFE). Furthermore, the China Insurance Regulatory Commission (CIRC), the insurance regulatory body in China, is ensuring insurers do not invest more than 15 percent of their assets overseas. Investors in China have told PERE that QDII quotas usually issued each February were not forthcoming this year. However in a February press conference, CIRC denied that it had suspended QDII approvals.

Nonetheless, there has long been public admission, even by the Chinese government, that it is strengthening capital controls to restrict large outflows. In a January meeting, the People’s Bank of China reportedly pledged to “severely crack down” on illegal foreign currency transactions. Currently, foreign exchange transfers from China cannot exceed more than $50,000 per individual. The police already has shut down one underground bank in the Zhejiang province for conducting $62 billion worth of illegal transactions, including foreign exchange dealings, and 10 such banks in the Guangdong province for $7.9 billion of unapproved dealings, according to report from investment bank Goldman Sachs. Local press reports, meanwhile, say the government is also planning to review the threshold for outbound investment via the Shanghai Free Trade zone to $50 million from $300 million previously.

Statistics on the impact on outbound property deals are challenging to locate given these curbs only intensified in November last year, leaving much to anecdotal evidence.

“Looking back six months ago, regulators had been softly telling the market to stay low profile because the Chinese don’t want to be seen going outbound in an aggressive manner. But that did happen, which is why capital restrictions are in place,” says Xia. “Today, people are asking about overseas deals more quietly and not doing a media splash. People who have already invested overseas are also currently not using new sources of capital from China but operating only via their business overseas.”

Hit by both sides

Regulatory curbs are said to be causing Chinese capital to lose bids, impacting a prior reputation for being aggressive bidders, particularly for trophy properties. China Investment Corporation’s (CIC) A$2.45 billion (€1.68 billion; $1.89 billion) takeover of Investa Property Trust in July last year – a deal that triggered a premium pricing trend in Australia for subsequent portfolio sales – is a recent example. As David Blumenfeld, partner in charge of the Hong Kong real estate practice at law firm Paul Hastings, pointed out at a roundtable discussion earlier this year, the ability to close a deal is also an important consideration taken into account by UK and US sellers in finalizing a buyer and that has now come into question where Chinese institutional buyers are concerned.

Anbang has denied that regulatory constraints led to its failed Starwood Hotels bid. Its chairman Wu Xiaohui refuted claims suggesting the CIRC opposed the deal because it would surpass the 15 percent overseas assets’ allocation norm for insurers. According to Caixin Media, he said Anbang has assets that far exceed RMB1 trillion, enough to carry out its foreign investment program.

Some sources argue, however, there might be more substance in the potential obstructiveness of western regulators. In March, Anbang agreed to acquire the Strategic Hotels & Resorts, another US hotels business, from private equity real estate giant Blackstone for $6.5 billion. A source closely involved with the deal told PERE that the firms are still working out potential issues with the US regulators.

Anbang’s $1.95 billion Wardorf Astoria hotel purchase last year was also reportedly reviewed by the Committee on Foreign Investment in the United States (CFIUS), a committee tasked to assess the national security implications of mergers, acquisitions and takeovers by a foreign entity of a US business. According to the Associated Press, concerns emanated from one of the floors of the Wardorf being home to the US ambassador to the United Nations.

A former Chinese state fund executive says anticipating the kind of resistance deals might receive from US authorities has become part of an American manager’s consideration of a buyer. “It has been rumored for a long time that for national security and reputational reasons the US authorities are concerned about a Chinese firm buying control of a major platform,” he says. “So a safer bet would be to look at a strategic minority stake rather than a buyout.”

Eric Wurtzebach, senior managing director at capital markets and advisory firm Macquarie Capital in New York, says regulatory scrutiny by CFIUS is also cropping up in sectors such as data centers and industrial assets. “I don’t view it as a big hindrance to getting deals done. I think it’s something that should be reviewed earlier and opposed to later,” he says.

Cultural dissonance
The hype around Anbang is not limited to perceived regulatory bottlenecks, however. Several media reports have suggested that the insurer’s failure to convince Starwood Hotel’s board that it had the necessary funding in place was in fact the deal-breaker. Questions have also been raised around Anbang’s opaque ownership structure. PERE’s source familiar with Anbang rejects those assertions, insisting given it tabled a binding bid all the approvals and funding were already in place.

However the growing mystique surrounding Anbang, and other Chinese institution’s style of investing remains.

Wurtzebach says that one of the biggest challenges while dealing with Chinese investors is that you “may not always know where you stand on a deal.”

“I think there are a few misconceptions about how quickly a deal can get done and timing. While you may think you are close to closing a deal, the key decision-maker may not have weighed in at all. From a cultural perspective, generally speaking, the chairman makes the decision. If you’re not talking to the chairman or someone the chairman trusts, you can spend a lot of time and not really know where you stand,” he says.

One source told PERE an anecdote about a team of executives from a large state-owned Chinese insurer which earlier this year accompanied an asset management firm on a tour of US markets for potential investments. The team had been instructed by their board to return in exactly five days, including travel time. They had a fixed itinerary – pre-approved months before the trip – and were barred from taking any detours. While in Los Angeles, the asset manager asked if they could go to San Diego since an exciting deal had come up. The request was turned down.

Such restrictions are not uncommon. All state-owned enterprise senior personnel need to submit their passports to their boards, a measure believed to be imposed to prevent them from fleeing the country amid tougher anti-corruption rules.

“As these businesses become bigger, people are realizing they are restricted by internal procedures. There is less freedom to travel, freedom to hire more people, freedom to establish ground branches in foreign markets,” says a Beijing-based advisor. Then there are those he calls the “tire-kickers” in China: those individuals who make casual commitments on a deal during an overseas business trip but are unable to get internal approvals once they get home and need to backtrack.

JLL’s Xia agrees that advisors need to spend time “educating and hand-holding Chinese capital,” especially new entrants for their offshore deals.

“We often encounter a longer time lag in turning things around,” adds Matt Posthuma, real estate lawyer at law firm Ropes & Gray. “We send something to them [Chinese clients] but because there are lots of layers of approval, we hear back a lot later. The Chinese legal and tax systems also tends to place more emphasis on form over substance. This is often different to the systems of other institutional investors.”

Perception is a two-way street. Chinese advisors say western clients also need to realize that they cannot expect “dumb capital” from China. While many Chinese institutions may be inexperienced investors in global gateway cities, they have the reputation of being smart negotiators.

“In many cases, US operators and fund managers want Chinese capital because they see some successful, headline deals in the market and they want to find capital from China that will pay the highest price or that will execute the deal that US capital won’t,” says Wurtzebach.

Nevertheless, Chinese deep pockets are not the only reason why many international managers want to strike partnerships. There are also strategic reasons. “Chinese capital is not a one-way cycle,” says Xia. “It might be the strategic capital they want to start nurturing a relationship with if they want to access opportunities in China.”

But a thorn in nurturing this relationship can reside in accepting the differing ways in which a Chinese investor analyzes a real estate deal. Many are known to pay greater attention to metrics such as the replacement cost during the underwriting process instead of solely focusing on yield and cash flow. According to a real estate broker, one of the reasons Anbang was drawn to Strategic Hotels was because it was able to acquire it at around 30 percent to 40 percent below replacement cost.

Greg Peng, founder and chief executive officer of Chinese capital advisor, Cindat Capital Management, explains: “A lot of Chinese investors do look at appreciation and pay less attention to yields and cash flows because that is how China has been. China’s domestic property market has been a developer market and concept of yields and cash flows are not common.”

Keep calm and carry on
There are routes being explored to navigate some of these cultural and regulatory roadblocks.

In March, for instance, Ping An Trust raised its first RMB capital from retail investors for two residential development projects in the US. The firm raised around $50 million for a fund and formed a joint venture partnership with Chinese developer Great Eagle Holdings and a subsidiary of Chinese financial services firm China Orient Asset Management for the projects.

The decision to raise retail capital for offshore deals is understood to have been a response to tougher regulations restricting the outflow of insurance capital.
Such restrictions could well lead to other types of Chinese capital seeping out of the country and into western markets. For example, increasingly, Chinese real estate investment managers, the latest being KaiLong Real Estate Investment, are also starting to establish offices in international markets to develop local expertise.

Whether these folk find themselves embroiled in the negative fallout from the Anbang saga remains to be seen. One Chinese investment advisor, who assists clients in offshore deals, says the clear message for any Chinese investor from the insurer’s aggressive assault on US real estate is that patience by Chinese institutions needs to return.

“Only increase the size of checks for deals over five to seven years of time,” he says, “There is no rush. Be happy with a strategic minority and learn along the way. Be influential not dominating. Get yourself transparent with regulators on both sides.”

On Anbang’s failed bid for Starwood Hotels, the former Chinese state fund investor says: “In retrospect, the risk management by Anbang should have been exponentially higher if it was doing a mega deal in the seventh year of a real estate cycle. After spending $6.5 billion on Strategic and $2 billion on Waldorf, shouldn’t they have paused and thought of corporate governance and risk management instead of going for a $14 billion deal?”

Others continue to defend Chinese capital saying the tendency to brush the country’s capital with one broad stroke is unfair. They point to Chinese institutions, including Ping An Insurance, and CIC, which have successful joint venture partnerships and have made landmark acquisitions in both the US and Europe.

“Capital from China seems to have taken on its own aura,” says Wurtzebach. “While there are a number of executed deals that make headlines, there tends to be far more deals that do not cross the finish line with Chinese capital than deals that get reported. That’s the nature of the deal, not necessarily the nature of Chinese capital. You could say the same thing of capital from any other geographic region.” Additional reporting by Meghan Morris