Savills recently published “China Investment Market: A Changing Market, A Time to be Brave?”. The report looked at investment market by examining the financial environment and the performance of other key investment classes, review China-wide investment performance including platform investment and niche market investments and talk about some themes and featured topics in the market.
Capital market: Credit becoming increasingly scarce but upside still exists
From the end of 2016, Chinese government has introduced a series of measures to deleverage the economy including a clampdown on the shadow-banking sector and raising the bar on onshore bond issuance, which hit most to private companies. Having difficulties accessing capital, more small-to-medium sized developers have turned to more expensive sources of capital such as offshore debt and mezzanine loans. In 1H/2018, Chinese developers’ ability to service their debt is the weakest in three years.
Despite of the challenges ahead, some upside factors still remains. China’s pension funds and insurance capital still have significant potential and expected to play a bigger role in commercial real estate market. REITs are also on the horizon, which will be an important way for investors to exit the market.
Benchmarking China in Asia Pacific: transaction value slightly decreased
Asia Pacific’s real estate markets were faced with rising headwindes in 2018—impending trade war, rising interest rates, tighter access to credit. Transaction volume in Asia Pacific in 2018 reached RMB1,108 bn, down by 6% YoY according to RCA. Hong Kong, Seoul, Tokyo, and Sydney recorded the highest sales volume in 2018. Mumbai, India—as the fastest expanding market among Asian cities—witnessed the biggest year on year growth in sales volume among key Asian cities.
Each Asian city has its unique geography, culture, economic and social characteristics. China still has a negative yield spread, comparatively low liquidity and transparency and capital values have reached significantly high levels that there is no foreseeable sharp capital value increase expected in the next couple of years. In addition, China is striving for a stable and more sustainable GDP growth. For investors, however, China is still a market that they want to allocate capital in so as not to miss the growth of this huge economy.
China’s en-bloc investment market: liquidity remains tight, market entering into adjustment
The overall China commercial real estate investment market has been slow in 2018. The total consideration for income producing properties that were more than RMB100 million was RMB189 billion, down by 20% YoY. Office remains a popular asset class given its high liquidity and transparency, most active markets for investments remain in Tier-1 cities and fast growing Tier-2 cities such as Chongqing, Hangzhou, Wuhan and Chengdu. The volume of retail investments remained stable with most of the big deals focused on Tier-1 cities. Investors are still actively searching for industrial properties because of their rental growth potential and comparatively high yields.
Opportunities emerged for insurance and overseas capital
Until the end of 2016, Chinese developers and local PE funds had access to plentiful sources of capital at comparatively low cost and therefore were the major buyers of commercial real estate in China. They tended to make short-term investments that relied on high leverage. However, such a strategy is getting hard to execute under the tightened credit environment.
Foreign funds which used to be outbid by domestic investors are expected to fill the funding gap in China. In the next 12 to 18 months, international private equity funds should become more active in the market, potentially in the form of a JV with local developers or SOEs.
Insurance companies remain a consistent source of buying core assets that provide long-term stable cash flows with limited risk.
Other institutional investors with sufficient capital stock—including pension fund and sovereign wealth funds—are also expected to be more active in the current market with a focus on core assets that have limited risk and an investment horizon of 5-10 years. Such long-term investors place value on stable cash flow and capital value growth in China in the comparatively long future, so they are more willing to put in more CapEx to extract the most out of the assets.
Corporations are also expected to maintain self-use demand in the investment market.
Project conversions and non-performing loans to be the focus of opportunistic capital
The Tier-1 city office and retail market continue to be the asset class that has adequate liquidity, transparency and underlying support to attract core money.
Opportunistic investors are likely to focus on converting older underperforming assets into higher and better-used assets. These conversions are likely to continue in a fairly long term with a growing number of aged projects struggling in the competitive market and demand from the for-lease sector showing no signs of slowing down.
The NPL market is getting larger as the government requires banks to clear up their balance sheets and companies are facing increasing repayment pressure. Foreign investors are looking for opportunities to invest in large NPL portfolios.
Market outlook: Uncertainty sentiment lead to correction in certain submarkets and asset classes
2019 is likely to be filled with uncertainty and change, whether it be geopolitics, financing conditions or new disruptive PropTech.
Tighter credit, a slower economy and ample supply are likely to result in a price correction in some markets and asset classes. This will likely lead to more buying opportunities at valuations that investors have not seen in a while.
As the market reaching the zenith of the property cycle, investors continue to move up the risk curve to secure desired returns with value-add, conversion and niche market investments playing a more significant role in future investment strategies. While China risks may still be akin to emerging markets, returns are looking ever more core in nature.