By Steve Collins, President, Americas Capital Markets, JLL
In our view the shift in the PBoC’s FX regime will be supportive for developed market real estate over the longer term though has minimal impact in the shorter term. The integration of Chinese capital in global real estate markets is clearly growing. In the U.S., Anbang Insurance’s record breaking purchase of the Waldorf Astoria for $1.95 billion earlier this year was a clear statement of intent.
In the U.S., direct Chinese investment in commercial real estate has increased significantly over the last five years, growing from $61.0 million in 2009 to $1.7 billion in 2014 and has already reached $1.2 billion at mid-year in 2015. In overall terms, however, this number is fairly small compared to the total U.S. investment volumes so any short term market volatility caused by the RMB devaluation is unlikely.
The story is much more one of the long term potential of Chinese investors to support real estate investment volumes both through direct investment, and also indirectly, through debt markets, for four key reasons:
- The devaluation is important in strategic terms, but it is unlikely to impact too materially the ability of Chinese investors to afford FX denominated assets in the short term. That is to say the Chinese can continue to afford to buy FX denominated assets after a 3.0 percent devaluation where the Russians have clearly struggled after 50.0 percent devaluation. Moreover, given expectations that PBoC will devalue further, it makes sense for Chinese investors to make FX acquisitions sooner rather than later. Foreign assets such as real estate will continue to be seen as an attractive store of wealth for long term investors, and the Chinese are looking to preserve their future wealth against an uncertain future for the RMB. Although currencies such as the Sterling, Franc and Japanese Yen tend to be perceived as safe havens for capital preservation, the current environment has led the DXY, also known as the dollar strength index, against other strong currencies to appreciate 6.8 percent year-to-date. Meanwhile, the Federal Reserve Trade – Weighted U.S. Dollar Index, whose largest weight is given to the Chinese RMB, is up 6.0 percent. Given the EUR stabilizing after its recent decline, the strength of the USD will continue to increase as the RMB and other Asian currencies continue to devalue. As a result, USD denominated assets look particularly safe.
- The devaluation underlines the challenges facing the Chinese economy. This year’s Q1 and Q2 GDP growth at 7.0 percent was the slowest pace of growth in six years. Last month’s PMI manufacturing data registered the fifth month of contraction. As the market questions China’s growth assumptions, investor risk aversion increases. This has a very direct impact on emerging market currencies and equities as investors are pushed towards risk free assets, such as U.S. Treasuries. This in turn keeps downward pressure on yields which helps prop up the supportive borrowing cost environment that real estate markets have benefited from post –GFC. It is worth recalling China is by far the largest owner of U.S. treasuries, holding some $1.3 trillion, providing another cap on treasury yields and subsidizing U.S. consumption.
- The Chinese corporates will be forced more actively to manage their FX exposure which implies greater demand for FX tools. It is estimated that Chinese corporates hold some $1.3 billion of dollar denominated debt. Clearly this is a number which is more than matched by its huge foreign exchange reserves of over $3.5 trillion, so there is no FX debt issue per se, however, the move will make it more expensive to service this debt so corporates will be incentivized both to reduce debt levels and to store more FX or to hold FX denominated assets as a hedge against future RMB devaluation. Real estate is not liquid enough to work as an FX hedge however there is a feed through in demand for U.S. treasuries and USD.
- This move into risk free assets is also driven by Chinese capital. RMB and stock market volatility (as witnessed in the first half of this year) effectively creates a wall of Chinese capital looking, despite locally imposed restrictions, to invest in low-risk assets with stable returns—again, supporting the argument for real estate. This has already been apparent as the PBoC has been purchasing shares of companies on the Shanghai Composite to counteract the effects of the stock market slide. This state-led buying has led to a 28.0 percent decline in shares in accounts of wealthy investors (those with $2.19 million or more), cashing out and possibly directing that capital to U.S. real estate. China has recorded huge capital outflows over the last quarter of $137 billion, a weaker local currency will add fuel to this fire.
The move by the Chinese has generated considerable discussion around the intentions of the PBoC and for the future of the RMB. In our view, the PBoC’s decision was driven in part by their desire to maintain a degree of competitiveness against neighboring currencies. However, the issue is much more of adjusting policy to allow the currency to trade more in line with market forces and to allow some policy flexibility. The move underlines the relative attractiveness of developed market real estate assets as a store of wealth, a source of income and as a hedge against RMB volatility. Furthermore, in our view, concerns over slower Chinese economic growth and the implications that has for global demand will add to the demand for risk free assets which will keep European and U.S. sovereign debt demand high, acting as a further boost for the real estate market as borrowing costs remain low.