ROUNDTABLE: Flying through turbulence

Real estate investment in China has grown significantly in recent years. So much so it sits in second spot in terms of capital raised – attracting $57 billion – for property investment since the Global Financial Crisis, according to property services firm Cushman & Wakefield's 2016 Great Wall of Money report.

Yet, the message from the five property professionals at PERE's annual China roundtable feels more cautious, albeit still optimistic. Senior executives from Ascendas Singbridge, KaiLong Rei, Anbang Insurance Group, CITIC Capital and Starwood Capital Asia say volatility at the macroeconomic level, not just in China but globally, is making the nation a more difficult place to find compelling risk-adjusted returns.

Turbulent currency markets feature at the top of the roundtable's list of macro factors inhibiting real estate investment. Last year's unexpected devaluation of the renminbi (RMB) sent widespread chills across global markets and further entrenched the views that China's economy was teetering on the edge of a cliff.

“We are deploying money on behalf of overseas investors in China in US dollars. As the RMB depreciates your overall returns will be lowered, so we have to watch how we can hedge it and work out how expensive it is to hedge among other considerations,” says Hei Ming Cheng, founder, director and chief executive at Shanghai-based investment manager KaiLong Rei.

“It's the whole world that is changing. The US is talking about raising interest rates making the US dollar stronger. So even though the RMB is strong, or almost the same against other currencies, against the dollar it is depreciating.”

Kevin Colket, managing director at Starwood Capital Asia, adds that on a relative basis the RMB is one of the more over-valued currencies.

“As a US dollar-denominated real estate private equity fund that invests globally, it is currently difficult for us to achieve risk-adjusted opportunistic returns in China that are as attractive as in the US, and Europe, given high seller expectations driven by per-square-meter valuations, huge amounts of new supply, a high cost of financing and a high cost of hedging the RMB.”

Aside from the fluctuations of China's currency the roundtable also points to the growing threat of black swan events that can turn a market on its head without warning.

“The world is in uncharted waters, there is very little history to find precedence, to find guidance. One will have to go back to the first principles and make decisions based on that. Given the nature of real estate, a long term investment approach would be needed, taking into consideration that the current conditions are short term,” says Jonathan Yap, chief investment officer, head – real estate fund, at Singapore-based firm Ascendas Singbridge.

“We are concerned with the macro and I would definitely agree that the world is in a place where you can't go to a textbook to solve problems,” adds Theo Cheng, Anbang Insurance Group's head of real estate, global investment.

Political uncertainty

With China's economy slowing, the expectation is that the government will step in given that China has a policy toolkit set to burst. China has already embarked on a series of monetary easing measures since late 2014 and to date, there have been six policy rate cuts since November 2014, the most recent one being in October 2015.

Yet, the roundtable predicted less active involvement from Beijing going forward.

“Every time there is volatility or slow growth the government tends to use monetary policy to intervene and stimulate if there is worry about stability, but this time I think the government is pretty determined to let it play out and see what happens. It shows they are pretty confident in the country. We will not see a lot of stimulus from the administration,” says Stanley Ching, senior managing director, head of real estate at CITIC Capital.

“They have a lot of room to move in order to push up the economy, but they don't want to over do it. It's a cautious approach,” adds KaiLong's Cheng.

One impact of the need to understand the complex political and macroeconomic climate in China is a loss of focus on the actual real estate, says Anbang's Cheng.
“All of us are spending more time pretending to be politicians and macro-economists, we are meant to be real estate people. All these geopolitical factors and all the interplay means we spend more time away from the real estate part, which is what we were hired to do, but then that also makes it more interesting.”

But, when looking at the underlying real estate opportunities, while the panel is optimistic about China, pricing is causing much consternation.

Says Colket: “Once a significant correction in asset prices occurs-which we believe is inevitable when China makes more progress on its planned economic reforms and local investors realize that they can't count on prior levels of asset appreciation-we believe that a significant opportunity will arise to buy large amounts of existing assets in infill locations at discounts to replacement cost. We can then add value by significantly enhancing cash flows through targeted asset repositioning strategies.”

Colket points to the hospitality industry in China as a case in point.

“While there is distress across multiple asset classes in China, it is most prevalent in 4-star and 5-star hotels, where the supply-demand imbalance is the most significant. We estimate that more than two-thirds of these hotels do not generate enough cash flow to pay their debt service. We believe, however, that hotel performance in certain Tier 1 and Tier 2 cities should improve substantially over the next few years, as new-supply growth slows substantially and demand accelerates from the new service-based economy. We also expect to generate additional value and significantly increase cash flows by leveraging our substantial hotel operating and brand-building experience.”

KaiLong's Cheng agrees that a hands-on approach is more important than ever when investing in China. “The slowdown in the Chinese economy also has an impact on the way we underwrite deals. In the past it was easy to go and buy things and it was guaranteed that the price would go up, you didn't need to work on anything and you'd get a decent to a good return, nowadays it is more challenging. Prices are not cheap anymore and you have to really find angles in deals to add value rather than bet on price. It's an asset management intensive part of the real estate cycle.”

Even with sophisticated property owners at the helm not every market in China is ripe for property investment. Several economists and analysts have called China the tale of two cities because the gap between the property markets in the top-tier and lower-tier regions is widening.

The roundtable too says it is important to constantly remind oneself that China is not a single market. The sheer size and number of regions and cities mean that multi-tier and multi-speed property markets are inevitable. Indeed, much of the country's growth has been driven by local initiatives and developments over the years rather than by Beijing.

“Investing in China has changed because it was always about picking the city, now it is picking markets within the city. It is getting very micro now. One can no longer say 'it's China so throw a dart at the map.” Some properties in one street make sense. The same street but another property would not work at all,” says Yap.

“There are so many things in China going on that are developing at a much faster speed than in the west. It's innovative, things change nearly every day and what you did on the last project might not work on the next one. In China you really have to have a local team and understand the demand and where it is coming from now, and planning where it will come from in the future,” adds CITIC's Ching.

For instance, Ching points to China's dynamic retail marketplace. He says there is a lot of competition from e-commerce, but technology also creates opportunities as occupiers, like Alibaba, which is moving forward with its supermarket initiative. Ching says groups such as Alibaba now use space like an Apple shop, where a consumer comes in and tests the products, but places the order online.

The roundtable discusses senior living as a longer term strategy, agreeing that it was an undersupplied marketplace where significant returns can be made. However, this was tempered as they agree currently nobody has worked out how to monetize the sector. But both developers and groups converting underutilized assets into senior living could yet make money.  

Logistics is another sector the roundtable is bullish on due to undersupply, with CITIC set to launch a logistics-focused strategy later in the year. However, the roundtable says that, currently, international players dominate the scene in raising capital and new entrants must work hard to differentiate their offerings.

Colket says of how Starwood is approaching the opportunity in China: “While we wait for pockets of distress and more realistic pricing to materialize, we are actively focused on forming operating company and brand platform JVs with established local Chinese partners across multiple asset classes. Not only would these platforms offer the prospect of strong, immediate investment returns, they would also enable us to better source, close on and add value to distressed deals.”

Cautious Capital

Even for those investment managers that are able to spot great opportunities within China the fundraising environment is difficult. The roundtable says this is again largely due to macroeconomic uncertainty.

“It's tough to be fundraising, especially from international investors. I think there will be more domestic capital investing in China. People are worried about the big picture, the currency, economic slowdown, and are not easily convinced by China. They are taking a macro perspective and it takes them longer to make a decision and fundraising is tough,” says CITIC's Ching.

According to PERE Research & Analytics data so far in 2016 no new China-focused opportunistic or value-add funds have been launched, and four funds launched last year have so far only collected $775 million towards a total $2.28 billion target.

Yet, Ascendas Singbridge's Yap suggests that while raising blind-pool commitments to invest in China is a challenge, there is still appetite among investors for different structures across the risk spectrum.

“China as an economy and an investment location has changed a lot. There is more room for lots of different capital to match different investment mandates. The mega deals are still going to attract the biggest investors who may do a co-investment or a JV, but if it is smaller or a specific situation that requires more active asset management I can't imagine institutional capital doing this one deal at a time, it is going to be too hard and painful.”

“I think there will be a matching process whereby the capital marries with the mandates it wants. Maybe the conventional wisdom that we are used to will no longer be the case, for instance insurance money is stable and liability matching so looks for core returns. These days they are also looking for opportunistic returns too, and at the same time there are others moving down the risk curve who are looking at three cycles' time.”

KaiLong's Cheng says that, while in the past, Chinese investors are generally reluctant to hand over discretion to investment managers, that dynamic is changing. “They want to do it by themselves but they know they can't always do that, so they want to see a deal first before partnering with you. Then gradually you'll build trust and then they will give you the money.”

Although, Anbang's Cheng adds that some investors are more equipped to go direct than others.

“There are times when we have faced hurdles and we could have used more help, say on certain deals where having a local fund manager fronting the deal may have helped our bid. We are prudent in many ways and are learning step-by-step.”

Cross-border bound

Faced with a slowing economy at home many Chinese investors are increasingly looking overseas to find returns. Chinese outbound real estate investment reached nearly $30 billion in 2015, doubling that of 2014, an April report by London-based consultancy Knight Frank says.

Insurance giants in particular continue to splash out on trophy properties. For example, Ping An Insurance purchased Tower Place in London for $506 million in January 2015, and Anbang acquired the Waldorf Astoria in New York for $1.95 billion, among others notable deals.

“We are already a global company so it is not about investing more overseas or investing more in China, we see it as one portfolio. We obviously have exposure to China, but for asset allocation we are cautiously seeking acquisitions overseas, not just in real estate,” says Anbang's Cheng.

“When it comes to day-to-day our problem in real estate is that, we are under-invested globally, we started doing this not long ago. And as often as you see our name in the press, not all press reports are accurate and we have only done a handful of deals globally.”

Knight Frank's report adds that a mixed group of investors consisting of lesser known small-to-mid-cap companies and developers, and individuals are increasingly active in their investments overseas and this shows no signs of abating.

“Anbang and Ping An are big enough to have their own teams to go and do outbound investments, but there are a lot of medium-sized insurance companies who need to find people who can deploy money and do asset management for them, which is a big opportunity,” says KaiLong's Cheng.

KaiLong has been a group that has taken advantage of Chinese capital wanting to head across borders. In April, the firm closed Outbound Investment Fund II, a follow-on vehicle to its maiden European fund, which was established late last year. The Shanghai-headquartered real estate investment management firm also has an active London office and partnership with a local operating partner to source properties with a value-add investing strategy.

So far, the fund has raised capital from Chinese high-net-worth investors and family offices, and has invested in three office properties in London spread over 103,420 square feet.

CITIC is also branching out overseas, says Ching. “We closed a deal in London last week and we have strong interest from a lot of Chinese investors, whether high-net-worths or smaller financial institutions for outbound investment opportunities. We will try and expand the scope of our investment a little bit more going forward.”

CITIC Capital partnered with Cindat Capital Management to form a joint venture partnership to acquire a majority stake in a luxury residential development project in London. The total equity size of the investment is understood to be $155 million. The two Chinese investment management and advisory firms purchased a 70 percent stake in 60 Curzon Street in London's Mayfair district from a fund run by the London-based investment manager Brockton Capital.

Not that getting equity out of China is always straight forward. Since late last year, the government has imposed stringent regulatory controls on outflows. For instance, the State Administration of Foreign Exchange (SAFE), China's foreign exchange regulatory agency, has allegedly been limiting the approval of quotas to convert RMB into foreign currency for overseas transactions. PERE knows of a number of property deals that had to be aborted because the Chinese party involved could not get the approval to expatriate its money.

However, KaiLong's Cheng says the control over flow is temporary, and in the medium to long-term capital will have to be allowed to leave. “China has to make changes slowly, it doesn't have the system to accept a huge inflow or a huge outflow of capital at one time.”

Jonathan Yap
Chief investment officer and head, real estate funds

Jonathan Yap is responsible for looking after the development of the firm's fund management business and creation of new funds for the Group. Yap has over 24 years of real estate experience, including working for Australian Stock Exchange-listed Lend Lease from 1997 to 2004.

Stanley Ching
CITIC Capital Holdings
Senior managing director, head of real estate

Stanley Ching heads CITIC Capital's real estate business. He has over 20 years of professional experience in investment management, investment banking and corporate banking with a China focus.

Hei Ming Cheng
KaiLong Investment Management
Founder, director and chief executive

With over 30 years of real estate experience in the Greater China Region, Hei Ming Cheng has covered: ground-up real estate development, real estate investment, fund management and commercial banking operations.

Theo Cheng
Anbang Insurance Group
Head of real estate, global investment

Theo Cheng is responsible for Anbang's real estate and real estate-related investment activities, with a focus on overseas investments. Before joining Anbang, he was part of the Macquarie Capital team in Hong Kong.

Kevin Colket
Starwood Capital Asia
Managing Director

Prior to relocating to Hong Kong in March 2015 to lead the firm's Asia efforts, Kevin Colket was co-head of the firms' Global Hotel Acquisitions Group based in London and led Starwood Capital's hospitality acquisition efforts in Europe from 2012. Colket also previously worked in Starwood Capital's Greenwich, Connecticut office from 2007.

Questioning credibility

Chinese institutions face a battle to convince overseas property sellers and brokers that they are reliable real estate investors.

Negative sentiment toward Chinese institutional capital spiked after Anbang Insurance Group pulled out of its bid for Starwood Hotels & Resorts back in April.
For two weeks, the insurance giant was locked in a bidding war with US hotelier Marriott International for the listed, high-end hotels giant, but withdrew its bid citing “various market conditions,” provoking scrutiny from western property professionals.

“Credibility is the word thrown at us. What we do is just like what all investors do, some deals get done and some deals don't, many things can go wrong during negotiations up to the very last minute, especially when you are a foreign investor. When Anbang is said to pull from a deal then the question of credibility for capital from China is asked and there are all the negative headlines, but when a western sovereign fund for instance pulls from a deal, they are considered prudent and disciplined,” says Anbang's Cheng.

“The reality is we withdrew from one deal, but we have closed deals elsewhere. It just takes time for brokers and advisers to convince sellers that they shouldn't worry about dealing with Anbang, Ping An and China Life.”