SECTOR OVERVIEW

Chinese Foreign Direct Investment (FDI) in the U.S. doubled in 2013 to an estimated USD14 billion dollars of which real estate played a significant part[i]. Almost 20 commercial real estate deals were announced last year worth USD 1.8 billion with high profile transactions such as Fosun Internationals purchase of Chase Manhattan Plaza, Greenland Holdings 70% stake in the Atlantic Yards project in Brooklyn, Greenlands planned USD 1 billion investment in downtown Los Angeles, China SOHOs purchase of the GM building in NYC, and the Dongdu International Groups purchase of the Detroit Free Press and David Stott buildings in downtown Detroit all attracting considerable attention.

In terms of Chinas domestic real estate, the market continued to grow despite repeated attempts by the central government to control it. According to the National Bureau of Statistics, real estate investment reached 19.8% of the countrys GDP in 2013 as compared to 16.2% in 2012, and property sales were up, allowing developers to increase their expansion. 2013 construction starts grew by a reported 13.5%[ii] .

KEY TRENDS

For Chinese FDI to the U.S. liberalized reform policies for Chinese outbound investment and an improved outlook for the U.S. economy will see the real estate sector continue to rise in 2014. Successful high profile investments like those mentioned above should stimulate increased investment from high net worth individuals, insurance companies, and pension funds wishing to diversify their portfolios. U.S. service firms with expertise in this sector will benefit from assisting Chinese companies to implement their business strategy in the U.S. market. Other opportunities exist at all levels of real estate investment such as general construction, building and construction management, and financing for Chinese invested projects.

Foreign investment in domestic real estate continues to be highly regulated: the elimination of investors ability to contribute foreign debt and allowing only equity contributions severely limits the options for foreign participation; registered capital requirements limit investment and any increase in registered capital is time consuming and requires numerous approvals; and initial investment contributions from the foreign partner are prohibitively high.

Foreign investors should also be wary of oversupply in the second-tier city commercial real estate market. Many developers have, over the past few years, migrated to Chinas second-tier cities to construct large malls, hotels and office space. They have saturated the commercial property market, and as a result, excess supply has placed downward pressures on commercial property value. In the short-term, commercial property prices could fall, and investors should be cautious.

COMMERCIAL OPPORTUNITIES

1) Regulatory Considerations

Outbound Chinese FDI is expected to reach USD 500 billion over the next 5 years, according to a speech given by Premier Li Keqiang at this summers Davos Forum[iii]. An attempt by Chinese companies, both SOE and private, to diversify their holdings will drive this significant outward flow of capital, and current policies meant to control and inhibit this flow have been, and expect to be further, loosened.

Foreign investment in the domestic real estate market in both Renminbi and foreign currency is technically prohibited. That said, there are a number of vehicles available to foreign investors in the form of Foreign Invested Venture Capital Investment Enterprises (FIVCIEs) and Equity Investment Funds (EIFs) that, although permitted to invest in high-tech high growth domestic companies, may invest in domestic real estate depending upon local conditions and approvals. The biggest hurdle to establishing a foreign invested property fund is gaining government approval and, again, this is subject to local conditions applied on a case by case basis.

The Shanghai Pilot Free Trade Zone (SH FTZ) allows an EIF to invest in prohibited industries regardless of whether foreign capital is involved (up to 5%) and depending on whether it is classified as a domestic EIF. This measure, while significant for the development of the zone, may or may not be applicable to provincial authorities outside of the zone.

2) Commercial Considerations

According to recent news reports, CITIC Securities was given approval to launch a prototype REIT to be listed on the Shenzhen Stock Exchange that will pay dividends to investors based on rental income from two CITIC owned office buildings. This appears to signal a shift in the central governments policy of slowing the overheated property market and allows a channel to open for property developers to raise funds. In February of this year, state-run Greenland Group was allowed to list its shares on a mainland exchange and it has been reported that two more developers had received regulatory approval for new stock sales. This is also a signal that the government is allowing for additional funding channels.

For foreign investment in Chinas real estate market, two structures outside of the conventional bank loan or security markets are available: real estate trusts and real estate private equity funds which raise capital in Renminbi. These vehicles have been used with some success by foreign developers and are offering excellent returns to Chinese investors.

MARKET CHALLENGES

The domestic real estate market continues to have significant barriers to foreign investment. It remains to be seen whether FIEs registered in the Shanghai Pilot FTZ will be able to invest RMB denominated capital into the domestic real estate market outside of the constructs of the zone. The real estate market continues to be heavily regulated and will continue to be controlled due to market volatility by the central government.