Foreign demand for China property plunges

Foreign investment into Chinese commercial property plunged last year, with industry observers attributing the drop to high prices, renminbi depreciation and stricter capital controls. This came even as domestic demand for local real estate continued to ramp up strongly.

Moreover, overseas buyers are likely to lower their return expectations for mainland commercial real estate this year and may shift focus to other destinations in Asia, such as Japan, said Joe Zhou, head of China research at property services firm JLL.

The share of foreign investment in mainland commercial property fell to 13.2% last year from 32.4% in 2015. In renminbi terms, overseas inflows declined nearly 40% to Rmb27.6 billion ($4 billion) in 2016, from Rmb44.55 billion in 2015. The vast bulk (86.8%) of property deals in 2016 were done by domestic investors.

Shanghai was the top destination for commercial property flows in Asia-Pacific in the fourth quarter, accounting for 16% of the regional total of $41.7 billion, according to JLL.

That said, an executive at one Chinese institutional investor questioned whether the bulk of the flows were truly local, arguing that many of them were being done by Chinese multinationals using their offshore capital.

“The deals appear to be onshore sales, but if you dig deeper, you find that shareholders of the buyer – the ultimate owners – will often be from outside China,” he noted.

In 2016, commercial property transactions – covering office buildings, shopping malls, industrial buildings, hotels and serviced apartments – in China totalled Rmb209 billion ($30 billion), up 52% from the year before, according to JLL.

The office sector accounted for the biggest share, with 55% of total volume, followed by shopping malls, with 19%. Geography-wise, Shanghai attracted the biggest portion (48%) of investments in China last year.

Reasons for flagging demand

Foreign investors think mainland property prices are too high now, Zhou said.

To invest in office buildings, foreign investors would want capital appreciation of about 20-30% in total over the next two to three years.

Foreign investors’ funding cost for buying mainland property is about 4% year, as they borrow money offshore in dollars to put into Chinese assets, said Lee Wee-Liat, Asia head of the financial institution group and property research at BNP Paribas Securities. On top of that, many investors believe the renminbi will weaken 2-3% per annum over the next two to three years.

However, the capital appreciation of office space in Beijing and Shanghai is forecast to be only about 2-3% a year for the next two to three years, said Lee. “You wouldn't expect 10% [annual increases] like in the last few years."

Overseas investors want to see higher returns because they have a lower risk tolerance for mainland property than their Chinese peers, said JLL’s Zhou.

Moreover, rising property prices have pushed rental yields in tier-one cities – such as Beijing, Guangzhou, Shanghai and Shenzhen – down to 3.5-4% per annum last year, from about 4-4.5% in the past three years, he added.

Domestic investors will accept yields potentially as low as 3%, but foreign investors want rental yields of at least 4-5%, Zhou said.

Yield expectations vary because foreign and domestic investors look at the Chinese property market differently, said Lee. Many foreign funds have an investment horizon of four to five years, he noted, while mainland investors might typically have a 10- to 15-year horizon.

In addition, foreign investors have a tendency to measure investment return by rental yield relative to interest rates, said Lim Su-Aik, head of China property ratings at Fitch. Doing so makes it more difficult to justify buying mainland property, as domestic borrowing rates consistently exceed rental yields, Lim told AsianInvestor.

Another factor worrying foreign investors are controls on capital outflows, Zhou said. A source told AsianInvestor that it can take more than six months for foreign investors to get approval to remit money out of China.

Overcapacity concerns

Analysts also cited potential over-supply as a major risks in the mainland commercial property market. Lim pointed to overbuilding of shopping malls and office buildings in tier-two cities and overbuilding of industrial space in tier-three and lower cities.

Moreover, strong growth in e-commerce has also supported aggressive investments in logistics, such as warehousing, to the point of risking over-supply, he added.

Indeed, industry leader Global Logistic Properties warned of an oversupply in logistics properties and slowed its development pace in 2016, Lim said.

Meanwhile, foreign investors continue to largely avoid the mainland residential property, due to uncertainty in regulation in the sector, JLL’s Zhou said.

Last month the Asset Management Association of China said it would stop registering funds that directly and indirectly invest in residential property projects in top-tier cities. Also, private funds are banned from providing financing services for real estate developers to buy land.